Moody's To Focus On Cash Flow, Debt In Energy Merchants
31 May 11:55
NEW YORK -(Dow Jones)- In analyzing energy merchants, Moody's Investor
Service is focusing its efforts on sustainable cash flow generation, debt
levels and the quality and diversity of assets, the rating agency said in a
report released Friday.
As had been widely leaked by the time of the report's release, Moody's also
concluded that energy trading, as presently configured, may lack
investment-grade characteristics unless it is tied to a more stable core
business that generates strong sustainable cash flow. Moody's also called for a
restructuring in the near term for the sector to regain investor confidence.
"The typical business model marries a Baa3-caliber energy producer and
distributor with a volatile, confidence-sensitive trading operation," Moody's
said. "A negative credit event, either in the core energy business or in the
trading segment - resulting in even a modest rating downgrade - can trigger a
significant call on cash."
(This story was originally published by Dow Jones Newswires)
Copyright (c) 2002 Dow Jones & Company, Inc.
All Rights Reserved
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Moody's To Focus On Cash Flow, Debt In Energy Merchants -2
31 May 12:49
Moody's said the lack of regulatory oversight and opaque accounting aren't
conducive to keeping counterparty confidence. It also said energy merchants
often lack the level of market risk management, liquidity management and
internal controls characterized by the most sophisticated traders in the
securities market.
Moody's also sees increased litigation risk from shareholders and end-users
as well as loss of investor confidence from the ongoing newsflow about industry
disclosure.
Ahead of the report's release, industry analysts said Moody's overall
concerns about the credit quality of the sector had largely been discounted by
financial markets. Market watchers now are keen to see what kind of criteria
companies can follow to stay investment grade.
Investment-grade ratings are key in the energy business, since downgrades to
junk trigger collateral calls by trading counterparties that can produce a
"sudden and precipitous" call on liquidity when companies are already under
stress. Also, companies' profitability is directly linked to cost of capital,
which spikes higher as credit quality diminishes.
Moody's said the financial flexibility of some energy merchants operating in
a trading environment hasn't kept pace with the level of business risk that has
developed over the past few years.
"Importantly, we will include a sudden loss of energy market counterparty
confidence in our worst case scenarios - evaluating the resources a company can
draw upon to stay afloat in the event of a sudden erosion of counterparty
confidence," Moody's said.
The rating agency will focus on disclosure in financial reporting, in segment
reporting and segment performance. Moody's also highlighted the importance of
transparency in segment reporting to understand earnings power, the ability to
generate cash flow, financial flexibility and the volatility of different
operations.
Moody's noted that a direct comparison among energy merchants is difficult to
accomplish, because no two energy merchants have a similar operations platform.
What's more, under GAAP, energy merchants have significant discretion about the
assumptions used to value their trading book, which also complicates investors'
ability to compare the profitability and financial soundness of different
companies, Moody's said.
(This story was originally published by Dow Jones Newswires)
Copyright (c) 2002 Dow Jones & Company, Inc.
All Rights Reserved
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Moody's To Focus On Cash Flow, Debt In Energy Merchants -5
31 May 14:54
Moody's said a series of limitations on accounting and disclosure creates
challenges for analyzing the true profitability of marketing and trading
operations and understanding the scope of their contribution to a companies'
overall financial results.
While companies now provide additional disclosure, Moody's said information
on segment reporting and segment performance as well as the breakout of
operating income of trading and merchant operations by type - such as pure
trading, asset-based and fee-based - the disclosure of unrealized earnings in
relation to the timing of conversion to cash and a tracking method of trading
income versus cash flow would be helpful.
Moody's said debt figures based only on publicly disclosed information can be
misleading. It's attempting to portray a measure of the effective leverage of
energy merchants by determining whether a company is likely to support
off-balance sheet commitments, regardless of whether a legal obligation exists.
It noted that leverage in the sector - much of which in the form of off-balance
sheet debt - has increased from investment in expansion over the last few
years.
While it favorably views plans by companies such as Mirant, Dynegy, Reliant
Resources, Williams Cos. (WMB), El Paso Corp. (EP), Calpine Corp. (CPN) and NRG
Energy Inc. (NRG) to shore up their financial positions, Moody's said the moves
still would leave half with high effective leverage. Moody's declined to
identify those companies, since its calculations include information that isn't
public.
Based on publicly disclosed figures as of Dec. 31, Williams, El Paso,
Calpine, NRG Energy and Mirant show net debt to adjusted capitalization of over
50%, even assuming recently announced debt-reduction efforts, according to a
table in the Moody's paper.
With the accounting and disclosure limitations, Moody's said cash flow is the
better measure for assessing credit quality. The agency is focusing on cash
flow coverage of debt and cash flow return on assets and capitalization as the
critical components of its analysis.
Against that backdrop, Moody's foresees a sweeping restructuring of the
energy trading sector in the intermediate term.
Among the potential developments are consolidation into a smaller number of
well-capitalized companies with diverse assets bases and strong liquidity
profiles. This scenario includes the participation of financial institutions
with solid credit ratings and trading operations that are broadly diversified
by asset class, customer and geography, with an example being UBS AG (UBS) unit
UBS Warburg's winning bid for Enron's trading assets.
Other possibilities include more joint venture or joint alliance formations
where an asset-based company teams with a company with strong trading systems
and expertise and together achieve a stronger credit rating.
Moody's also envisions the establishment of a clearing system/trading
exchange that will provide liquidity, transparency and will result in a more
efficient transfer of credit risk.
-By Nicole Bullock, Dow Jones Newswires; 201 938 2039;
nicole.bullock@dowjones.com
(This story was originally published by Dow Jones Newswires)
Copyright (c) 2002 Dow Jones & Company, Inc.
All Rights Reserved |
