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The View from Wall Street:A Capital Markets Perspective
Debra G. CoySvanda & Coy Consulting
2010 Mid-America Regulatory ConferenceJune 7, 2010
What does Wall Street think of water utilities?
Water utilities’ stock prices have typically held up better than broader market indexes during steep downturns – but have under-performed on recovery rallies
Drinking Water Investment Needs Remain High
Treatment Projects
$ 53.2
Other
$ 2.3
Storage Projects
$ 24.8Source
Projects$ 12.8
Estimate of infrastructure projects needed in 2007-2026 for water systems to continue to provide safe drinking water
Emphasis is on transmission & distribution projects
Pipe replacement cycles are not keeping up with increasing deterioration
Transmission & Distribution
Projects $183.6
($ Billions)
$335 Billion needed for U.S. drinking water utilities over the next 20 years to ensure compliance with existing and future water regulations
Source: EPA’s 2007 Drinking Water Infrastructure Needs Survey & Assessment
Where Does the Money Need to be Spent?
Investor-owned utilities operate in 9 out of 10 states with the greatest infrastructure spending needs
Not shown: Alaska (Less than $1.0 billion) Hawaii (partially surveyed state)
Source: EPA’s 2007 Drinking Water Infrastructure Needs Survey & Assessment
4 of top 9states withgreatest spendingneeds are in MARCterritory
Capital Spending Metrics
Source: CA Turner Report, (2005)
$3.45
$1.61
$1.11
$1.32
$0.00
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
Water Electric Telephone Gas Dist.
Capital Invested per Dollar of Revenue
Financial Implications of Capital Intensity
• It takes > $3 in capital spending to generate ~ $1 in revenue• Replacement costs continue to rise, dramatically outpacing the book value of
assets in the ground• Water infrastructure has a long asset life, with long depreciation schedules,
especially for transmission pipes
What does this mean?• Consistently negative free cash flow• Necessary to regularly access debt and equity markets to fund capital investments• Important to keep Wall Street comfortable with the “regulatory compact” – that fair
returns will follow the needed investment
Water is the most capital-intensive utility
Capital Spending Metrics
Capital spending is very high relative to D&A and operating cash flow…
Is this sustainable?
Typical ratios for regulated water utilities
Capital spending to depreciation & amortization 3 - 4x
Capital spending to operating cash flow 1.2 – 1.5x
Net plant to revenue 4 – 5x
Is Current Capital Spending Sustainable?
Water utilities can sustain current levels of capital spending
Only if…
Water utilities can regularly access equity & debt markets to fund capital programs
AND, receive fair (and timely) returns on their investments
Otherwise…
By delaying non-mandated capital expenditures, the water utilities could quickly generate positive operating cash and spend closer to their depreciation rates
BUT, then they will fall further behind on needed replacement infrastructure spending
Investment Risk Considerations
– Infrastructure replacement needs– Pressure on critical water supplies– Costly environmental regulations– High cap ex requirements & low depreciation rates– Effects of regulatory lag– Local political risk– Ability to access capital markets
Water utilities are supposed to be low-risk regulated monopolies…
But are they really low risk?
Importance of Regulation
Commissions that work with utilities to minimize rate shock, while stimulating infrastructure investments, are viewed most favorably by the investment community.
• Allowed ROEs and Ability to Earn the Allowed ROE – this is the bottom line
• Consistent Regulatory Treatment
• Timely Decision Making
• Mechanisms to Minimize Regulatory Lag
There is no “one size fits all” approach to regulation – and regulators must balance the needs of investors with the needs of consumers
How Investors Evaluate Regulatory Treatment
Source: US Consumer Expenditure Survey Anthology, (2008)
Annual Household Utility Spending
Water and the Consumer
Water is still a relative small part of the overall consumer utility budget – this helps with the affordability discussion
Consolidation of Small Systems
• Pros– Opportunity for customer growth– Opportunity for additional capital spending with return on
investment
• Cons– High capex needs with lagging return on investment– Potential dilution to overall earned returns on equity
Investor point of view