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Content-Type: text/plain; charset=us-ascii Content-Transfer-Encoding: 7bit X-From: Henry Emery <HEMERY@firstunion1.com< X-To: dblake3@firstunion1.com, GJONES@FIRSTUNION1.com, HEMERY@FIRSTUNION1.com, JHAVILA@FIRSTUNION1.com, mdowd@firstunion1.com, PDOWD@FIRSTUNION1.com, REMERY@FIRSTUNION1.com, SBENOTT@FIRSTUNION1.com, TPULLIG@FIRSTUNION1.com, VWEIR@FIRSTUNION1.com X-cc: X-bcc: X-Folder: \RBUY (Non-Privileged)\Buy, Rick\Inbox X-Origin: Buy-R X-FileName: RBUY (Non-Privileged).pst The following is a report on the Energy and Natural gas sectors from Credit Suisse First Boston. Please call us at 713-853-2407 if you have any questions. Thanks, Hank Emery _______________________________________________________________________________________________ THIS FIRST CALL NOTE MUST BE SHOWN IN ITS ENTIRETY, INCLUDING ALL DISCLAIMERS CREDIT SUISSE FIRST BOSTON CORPORATION Equity Research Americas Energy Curt Launer 212/538-4269 curt.launer@csfb.com Philip Salles 212/538-4221 philip.salles@csfb.com Andy DeVries 212/325-2518 andy.devries@csfb.com Natural Gas & Power Catalysts In Place, EPG Up 8%, ENE Poised to Recover, Group Positioning Solid Summary Group led by El Paso (EPG, 51.02, Strong Buy), up 8% on positive meetings, discussion of regulatory risks and increase in "hedged" production. Storage revision moves Sept natural gas price down 20% and E&P shares 7% lower. IPP's rise 4% in recovery from recent weakness. Natural Gas & Power "majors" up nearly 3% vs 2% rise in S&P 500. EPG gain plus 3% upside moves in Dynegy (DYN, 42.25, Buy) and Williams (WMB, 32.81, Buy). Kinder Morgan (KMI, 55.71, Strong Buy) up 2% for week and 7% y-t-d as best performer in group. Duke (DUK, 38.75, Strong Buy) up 2%. Enron (ENE, 36.35, Strong Buy) off 1% for week. At 20x '01 eps est of $1.80 and 16.2x '02 est of $2.25, ENE is trading at average p/e of group and 15%-20% less than overall market. Premium growth rate above 20%, dissipation of recent concerns, positive group and company fundamentals point to recovery. "Cheap growth" aspect of sector valuations identified in 20% discount to S&P p/e despite premium growth rate. Catalysts in 3Q'01 eps up 20% despite lower yr-over-yr commodity prices, stable to higher sequential commodity prices and some improvement in regulatory environment. Viewpoint Despite a significant drop of nearly 20% in the September '01 natural gas futures related to a storage reporting "snafu" that moved exploration and production shares 7% lower, the natural gas and power group, led by a nearly 8% gain in EPG rose about 2%, in line with the S&P 500. Stronger performance, reversing declines by Independent Power Producers (up 4% last week) helped DYN and WMB rise about 3% each. In terms of natural gas prices, our focus remains on longer term supply and demand fundamentals that point to a sustainable range of $3-$4 per mcf. We consider this range as beneficial for the merchant, pipeline and producing sectors of the industry. We have previously commented on the "cheap growth" attraction of the Natural Gas & Power group compared to the overall market. An earnings growth rate in excess of 15% and a price/earnings multiple about 20% below the S&P 500 currently are the valuation criteria that summarize this opportunity currently. In our opinion, the shares that best fit this investment model currently are EPG at 13.4x '02 eps (discussed below) and WMB, at 12.2x '02 eps. We also emphasize ENE at 16.2x '02 because its premium p/e is gone, but its premium growth rate remains. DYN, at 17.2x '02 eps and KMI at 23.2x '02 are very attractive currently as well. We look for 3Q'01 eps growth above 20% despite lower year-over-year commodity prices; stable to higher sequential natural gas and power prices; and improvement in the regulatory environment as catalysts for recovery and upside for the group.. EPG Analyst Meeting Details Growth; Regulatory Issues EPG held analyst meetings last week that focused on earnings growth, especially in its Merchant Energy unit, additional hedging of natural gas production and the regulatory and legal issues in the FERC "market power" and "marketing affiliate abuse" cases pending against the company. In the two cases pending against EPG, new information will be available soon. Legal briefs were due Fri, Aug 24 and "reply briefs" are due on Sept 7. Rulings by the FERC Administrative Law Judge (ALJ) are expected "on or before" Oct 9. Initial comments from the EPG legal briefs substantiate the position that the company did nothing wrong, has already been exonerated by the FERC in a March '01 ruling on the affiliate matter and did not have, or exercise, market power. We anticipate that the legal comments filed by the California Public Utilities Commission (CPUC) will attempt to sensationalize EPG internal documents that discuss use of pipeline capacity to manipulate the market. However, this is only if these documents are taken out of context and without any recognition of the economic, operational and regulatory realities of the situation. In our opinion, obvious and prejudicial comments by the ALJ indicate a probability of the "affiliate case" being ruled against EPG. We regard the "market power" allegations as clearly unproved. From a financial point of view, the significance of this outcome is that the affiliate case carries no financial penalties and does not open EPG to civil liability in California. In this event, we would ascribe a possibility to settlement discussions emanating from the CPUC because they are seeking a financial windfall, not a technical victory in their case against EPG. From a business perspective, EPGs Merchant, Pipeline, Production and Field Services units producing sustainable and visible eps growth in the 15%-20% range. Our modeling concurs with these projections. Our Merchant Energy estimate shows 25% ebit growth, mostly related to non- commodity based fee and margin business. In Production, EPG has 75% of '01 production hedged at $3.85 per mcf, 60% of '02 hedged at $4.19 per mcf and 35% of '03 at $4.19 per mcf. Our model shows EPGs leverage to natural gas prices of about $0.02 per share per $0.10 per mcf change. At or above a $3.20 realized gas prices indicates some conservatism in our '02 estimates. Our estimates remain $3.30 in '01 & $3.80 in '02. We rate EPG Strong Buy and it is on the CSFB Focus List. We recognize the regulatory issues with an interim target of 15x our '02 estimate or $57 as the October 9, 2001 ALJ decision approaches. Our longer-term target, recognizing its premium growth rate is 20x '02 eps or $76 per share. ATG Responds to Full Rate Review by PSC AGL Resources (ATG, 22.81, Hold) plans to ask the Georgia Public Service Commission (PSC) to reconsider its decision for a full rate review at its gas utility. The PSC staff said that ATG is earning 4%-7% more than its allowed ROE of 11%. Approximately $30-52 million pretax, or $0.35- $0.60 per share after-tax is at stake in this matter. ATG has responded that a rate reduction is unjust based on its calculation of a 9.9% return. A PSC ruling is expected in March '02. We are maintaining our current estimates, albeit with a higher level of uncertainty with the outcome of the rate case. Our eps estimates are $1.55 in '01 and $1.60 in '02. Our valuation thesis for ATG points to its dividend yield of 4.7% and a p/e target of 15x '02 eps. Currently this derives a target price of $24 and a Hold rating. Please see report dated July 26, 2001 for additional information. AGA Revises Natural Gas Storage Number Upward September natural gas prices fell 18% last week after the American Gas Association (AGA) revised its 3 billion cubic feet injection report to 50 bcf for the week ended August 10, 2001. While reporting an injection of 86 billion cubic feet for the week ending August 17th, the AGA restated the storage injection for the week ending August 10th from 3 bcf to 50 bcf injection. Many market participants expressed concern with the initial 3 bcf storage number which the AGA had previously stated would not be revised. Please see page 13 for more details and historical natural gas storage information. UGI Closes Propane Acquisition from NI UGI Corp's (UGI, 29.09, Buy) 52% owned propane subsidiary Amerigas propane (APU, 23.50, Buy) announced the completion of its acquisition of Columbia Propane from NiSource (NI, 26.22, Buy) for $202 million last week. The transaction includes the issuance of 2.3 million APG units to NI. Our analysis shows an addition of $0.10 per share in earnings in '02 for UGI (and a plus in a completed assety sale for NI). We are maintaining our '01 eps estimate of $2.05 in '01 and raising our '02 eps estimate from $2.25 to $2.35 in '02 for UGI. Industry Fundamentals Pricing Our index of natural gas prices for 2001 closed August 24 at $4.85 per mcf, down $0.18 for the week and $1.01 above the same week in 2000. The near-month September contract closed at $2.71 per mcf, down $0.60 from the week before. Our index for 2002 closed at $3.26, down $0.40 from the previous week. The "12-month strip" closed the week at $3.21 per mcf, off $0.46 for the week and $0.43 lower than the comparable week a year ago. The near-month (October) futures contract for West Texas Intermediate (WTI) closed at $26.93 per barrel, up $0.30 for the week. This compares with $32.03 a year ago. The September futures contract expires August 21 at $27.91. Nuclear plant outages stand at 6% of total nuclear generating capacity versus 7% a year ago. N.B.: CREDIT SUISSE FIRST BOSTON CORPORATION may have, within the last three years, served as a manager or co-manager of a public offering of securities for or makes a primary market in issues of any or all of the companies mentioned. CREDIT SUISSE FIRST BOSTON CORPORATION CREDIT SUISSE FIRST BOSTON CORPORATION Curt Launer 212/538-4269 curt.launer@csfb.com CREDIT SUISSE FIRST BOSTON CORPORATION CREDIT SUISSE FIRST BOSTON CORPORATION Copyright © CREDIT SUISSE FIRST BOSTON, and its subsidiaries and affiliates, 2001. All rights reserved. CSFB may, to the extent permitted by law, participate or invest in financing transactions with the issuer(s) of the securities referred to in this report, perform services for or solicit business from such issuers, and/or have a position or effect transactions in the securities or options thereon. In addition, it may make markets in the securities mentioned in the material presented in this report. PLEASE REFER TO TICKER CSFBDISC FOR IMPORTANT LEGAL DISCLOSURES. First Call Corporation, a Thomson Financial company. All rights reserved. 888.558.2500
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