Reflecting an expectation that planned asset sales will occur, Aquila Inc. retained a “stable” ratings outlook but had its debt downgraded to below investment grade by Moody’s Investors Service on Tuesday. In response, the Kansas City-based company said it was “prepared to respond to the potential effects” the downgrade to “Ba2” could bring.

Following Moody’s announcement, an Aquila spokesman told NGI that it will be “two months or so” before the company “does what it needs to do to make things right,” and bring about needed investor confidence and corporate stability. “Things have dramatically changed in just the last two months,” he said. “There’s just no business out there.” The company has begun its exit from the wholesale marketing and trading sector, and has cut hundreds of employees from the headquarters, as well as Houston and London, as it prepares to focus on regulated utilities.

In its ratings report, Moody’s noted that Aquila’s “poor returns from investments outside the regulated utility business in the U.S. have resulted in a significant deterioration of operating cash flows.” The investments were financed almost exclusively with a “high level of debt,” including international utilities, a telecommunications and utility-related construction company, communications technology, five long-term gas delivery contracts, merchant energy wholesale services and non-related investments. “The poor performance of some of these investments resulted in impairment charges of $895 million and restructuring charges of $71.8 million” in the second quarter.

To meet liquidity “pressures,” analysts noted that Aquila is relying on asset sales this year and into 2003. Already, Aquila has completed more than $480 million in asset sales, and wants to complete up to $1 billion worth by the end of this year. Moody’s expects Aquila to achieve its needed asset sales, but analysts noted that “proceeds below expectations could negatively impact the company’s liquidity and outlook.” However, “a supportive rating factor” is Aquila’s “unencumbered asset base of mostly regulated utilities,” which could give it some financial flexibility.

“The Ba2 rating incorporates the execution risk associated with completion of the asset sales as the company transitions from a diversified merchant energy company into a mostly regulated utility company with some unregulated generation assets,” Moody’s noted. “The new rating also considers the ongoing cash impact of gas pre-pay agreements, which will be a substantial drain on cash flow over the next several years. With about 95% of projected future earnings coming from regulated assets, the restructured Aquila generates cash from operations which supports its capital spending and dividends, but leaves little cash flow to service debt. In short, the asset sales expected in the near term do not generate enough proceeds to appropriately capitalize the company at the former rating level.”

“While we’re naturally disappointed by the news, we’ve been preparing to conduct business operations under this possible scenario and will continue to deliver safe, reliable and economical energy to our customers,” said CEO Robert K. Green. “We’re committed to achieving a stronger credit profile and will remain focused on executing our asset sale program and exiting the wholesale energy marketing and trading business.”

Specifically, Aquila’s stabilizing initiatives have already included terminating its Cogentrix acquisition, reducing the dividend by 42%; identifying more than $100 million in cost reductions; and completely exiting the wholesale energy trading business (see Daily GPI, Aug. 7). At the end of the second quarter, Aquila reported total assets worth $11.9 billion.

The downgrade did not affect Aquila any worse than other stocks on Tuesday, losing 4%, or 15 cents, to end at $3.78.

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