The key lessons learned in the financial massacre of leading gas and electric companies are that “balance sheet matters…real cash flow matters…assets matter…and dividends matter,” Southern Co.’s CFO Gale Klappa told the Banc of America Securities Energy & Power Conference last Wednesday.

Southern excels on all counts, Klappa said, with 90% of its earnings coming from its five regulated utilities with rates in place that will provide “strong, predictable, very visible earnings” for the next three years. The company expects to see 3% growth a year from this regulated sector and to build that to 5-6% growth in future years with contributions from its unregulated power generation and niche service businesses. The unregulated segments will “add earnings growth, but not risk,” Klappa assured, pointing to long term contracts, many with its own utilities, for the generating units.

He questioned how some companies in the industry can be projecting 8-10% earnings growth, while demand for the power commodity itself is only expected to grow by 3% a year. And with all the new power plants in the works, Klappa sees an over-supply. “I don’t think all the blood’s on the floor yet.” He noted that while most independent power producers have canceled projects due to come on line after 2003, they have not cancelled the more immediate projects — most of which are too far along to cancel. That means “many regions are vastly oversupplied and will be for the next three years.”

Southern’s earnings projections are good, short of a double-digit recession. “It would take a lot for us not to be able to deliver those numbers.” Even a cool summer in the Southeast wouldn’t shake them. “It would have to be winter to be cooler than last summer.” While Southern does not see a strong pick-up in the economy in its area, “we’re not seeing any further deterioration,” which may be an indication the economy will come out of its trough and start up.

Southern is very committed to its dividends, Klappa said, advising the company has “a bias toward raising it at the end of this year.” Southern’s annual dividend rate currently is about 5% of its stock price. The Southern CFO cited a Standard & Poor’s survey of S&P 500 companies over the years which showed dividends were responsible for 40% of the total return of those companies.

Unlike a number of others in the industry which are showing growth by no longer amortizing goodwill, Klappa said, Southern’s earnings growth will be cash. He stressed the low risk associated with any of Southern’s operations, pointing out that with its Georgia Power utility, which contributes 50% of its earnings, the rate scheme now in place in Georgia calls for the public utility commission to review forecasts and authorize expansions. The ratepayers are then at risk for the projects. In its merchant operations, it requires long term contracts with creditworthy parties. “We do not take merchant risk; we don’t take fuel, currency or foreign government risk….We have no spark spread risk for the next three to five years….There is no place in the business where we take the fuel risk.”

Southern expects earnings from its competitive operations to double by 2005 from the $100 million those operations brought in 2000. Part of those profits could come from the company’s planned acquisition of the retail operations in Georgia of NewPower Holdings. Southern expects to know by the end of July if its bid for the customers of the bankrupt Enron affiliate are successful. NewPower holds about 15% of the Georgia retail market, in which Atlanta Gas Light, Shell, and Scana also compete.

Southern is not actively seeking power plant acquisitions. “We’re big enough that we don’t have to be bigger,” Klappa said. If it did look at some of the merchant power currently on the market (“We get phone calls every day”), they would have to pass some very strict tests, including being accretive to earnings and credit neutral. The other issue is that “no one knows what FERC’s new market power test is going to look like.” The Commission offered and then withdrew a new market power test, because “everybody fails it.” The Commission has promised a technical conference to develop a new one, but there has been no action so far.

Southern could make selective purchases, “but only if it fit our strategy and only at the right price.” While a lot of merchant plants are on the market now, Klappa believes there’s more to come.

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