Following through on earnings-related warnings it issued this spring, PNM Resources last Tuesday said continued weakness in the wholesale power market has caused the utility to drastically drop its 2002 earnings estimate from $3.00 per share to between $1.90 to $2.10 per share. In order to rein in expenses, the Albuquerque, NM-based company is taking the hatchet to its construction expenditure plans for this year by slashing its planned budget in this area by $111 million.

The company’s share price Wednesday dropped over $4 in early trading and closed down $3.96 at $18.73, but had rebounded to just under $20.00 per share by Friday morning.

Tuesday’s announcement came as a surprise to analysts who had expected the company to report second quarter earnings of 55 cents per share and full year 2002 earnings of $2.65 per share. Following the announcement Merrill Lynch (ML), citing the “massive drop in its earnings outlook, driven mainly by the virtual evaporation of its wholesale power marketing business” dropped its rating from BUY/Strong Buy to Neutral/BUY on Wednesday.

ML analyst Stephen I. Fleishman noted that PNM’s April guidance, which predicted a much smaller drop-off, was based on power prices in the $30 to $40/MWh range. Those prices have since fallen to the $teens to upper $20’s. “Gas may set the marginal price in the western market, but water sets the stage. And dams are dumping it without even generating power….Spark spreads are razor-thin.”

“The market itself has all but shut down in the ‘second wave’ of the crisis spawned by Enron’s implosion last year. There may be liquid behind the dams, but there does not appear to be liquidity in the market,” Fleishman said. He sees the market taking time to recover.

In setting the new guidance, PNM Resources Chairman Jeff Sterba said that “although the PNM electric utility continues to perform well, the depressed level of wholesale prices in the West, coupled with the significantly decreased trading activity in that market, has severely limited the potential of our power marketing arm so far this year. We are lowering our earnings expectations because it appears increasingly likely that these adverse conditions will persist through the end of 2002.” The company expects second quarter earnings to be in the area of 25 cents per share.

PNM reported a 25% reduction in wholesale sales this year compared to the first half of 2001. The company pointed to several contributing factors, including an abundance of available hydropower from the Pacific Northwest, cooler weather through May and June, low natural gas prices, the number of new generating plants coming on line, and the lingering slowdown in the regional economy.

Also, fewer creditworthy counterparties and political and regulatory uncertainty related to the western marketplace have significantly reduced market liquidity and trading volume, as some companies have curtailed their activity or exited the business altogether, PNM said. Sterba underscored the point that the company is not planning on exiting the wholesale market. “When the market turns, we’ll be there to provide energy where it’s needed, but we’re going to take a more cautious approach to future growth.”

Sterba remains sanguine about an eventual turnaround in the wholesale market. “We will continue to position ourselves for the upturn in the wholesale market, because I continue to believe it will happen. It has to happen because the market is going to provide those kinds of signals, but we are not going to jump the gun in getting there too soon.”

A mild spring and reduced gas generation in New Mexico impacted the performance of PNM’s gas utility. “While we’ve done many things to control costs and improve service in our gas business, it continues to underearn — above and beyond the impact of weather — and regulatory relief will be necessary to remedy that situation.” To that end, the company expects to file a gas rate case with state regulators by the end of the year.

“Fortunately, PNM Resources has the liquidity and the financial strength to weather this downturn in the market,” Sterba said in a prepared statement. “We have a steady cash flow from our utility operations, a relatively low level of debt and a healthy cash position. We intend to maintain this conservative financial posture.”

Fleishman agreed, saying the company’s “cash and credit seem solid, and we do not think it is another energy merchant credit down-spiral.”

PNM said it would control expenses and limit capital expenditures. Construction expenditures in 2002, originally budgeted at $391 million, have been reduced to $280 million. Planned construction expenditures through 2003 have been reduced in total by over $400 million.

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