Why did NU swing from a large loss in 2005 to strong earnings in 2006?

The 2005 loss was driven by about $322.6 million of after-tax charges tied to exiting the competitive energy businesses, including mark-to-market losses on wholesale contracts and impairments. In 2006 those businesses were largely sold: the competitive generation sale produced an approximately $314 million after-tax gain, and NU Enterprises' results improved sharply. A $74 million CL&P tax reduction from an IRS ruling also added to 2006 earnings. Investors should view the 2006 figure as flattered by these non-recurring items; underlying regulated earnings were about $0.80 per share.

What is the growth outlook for NU after 2006?

NU projects 2007 EPS of $1.30 to $1.55 and compound annual EPS growth of 10% to 14% through 2011, measured against 2006 EPS excluding the $0.48 per share CL&P tax benefit. The growth is driven mainly by transmission rate base, which management expects to grow about 23% per year, and by distribution and generation rate base growth of about 7% per year. This growth depends on timely regulatory approvals for transmission and distribution investments.

How much capital will NU need to spend, and how will it be funded?

NU projects Utility Group capital expenditures of about $4.9 billion for 2007-2011, including about $1.2 billion in 2007, with roughly $2.5 billion for transmission. NU expects to fund about 60% of capex with internally generated cash, so the Utility Group companies, especially CL&P, will need to issue debt regularly. CL&P is expected to issue about $500 million of new debt in 2007, and PSNH, WMECO and Yankee Gas up to $75 million each.

What are the biggest risks to the investment case?

Key risks include regulatory outcomes (PSNH and Yankee Gas rate cases, FERC rehearing on transmission ROEs, and the Connecticut distribution rate case planned for mid-2007), the cost of compliance with environmental rules such as the PSNH mercury scrubber (estimated at $250 million and potentially higher), and litigation including the Con Edison merger dispute. Liquidity is tighter in 2007, and credit ratings are near the investment-grade floor, so a downgrade could raise collateral requirements and borrowing costs.

Is NU still exposed to competitive energy businesses?

Only minimally. NU has exited substantially all of NU Enterprises' competitive businesses, selling its generation assets, retail marketing and most energy services units. What remains is primarily Select Energy's wholesale PJM and New York contracts (about 7.5 million MWh of obligations at year-end 2006, down from about 22 million MWh in March 2005) and a few energy services units being wound down. NU projects roughly breakeven results from NU Enterprises in 2007, excluding mark-to-market effects on those remaining contracts.

ES 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 1, 2007. Cited figures are marked; the original filing is the authoritative source.

Northeast Utilities (NU), headquartered in Berlin, Connecticut, filed its combined 2006 Form 10-K on March 1, 2007 covering NU and its regulated subsidiaries CL&P, PSNH and WMECO.

The headline story is a sharp earnings recovery: NU earned $470.6 million^a, or $3.05 per diluted share, in 2006 versus a $253.5 million loss ($1.93 per share) in 2005, driven mainly by the exit from its competitive energy businesses (NU Enterprises). The $1.34 billion sale of the competitive generation business to Energy Capital Partners in November 2006 produced an after-tax gain of roughly $314 million, and a $74 million income tax reduction at CL&P from an IRS private letter ruling also boosted results. Excluding these one-time items, the regulated Utility Group earned about $123.5 million, or $0.80 per share, versus $0.93 in 2005, reflecting higher operating costs, lower sales and a weak PSNH and Yankee Gas return.

The investment story is now a regulated growth story. NU is a pure-play regulated utility serving about 1.9 million electric customers and 200,000 gas customers, and management projects 2007 EPS of $1.30 to $1.55^b and compound annual EPS growth of 10% to 14% from 2006 (excluding the PLR benefit) through 2011. That growth rests on a roughly $2.5 billion transmission capital program for 2007-2011, with transmission rate base expected to grow from about $1.1 billion to $3.0 billion, earning a 12.4% FERC ROE on most new regional projects.

Total Utility Group capital spending is projected at about $4.9 billion^c over 2007-2011. Key risks investors should weigh include a sharply weaker liquidity position: NU expects roughly $350 million of 2007 tax payments tied to the generation sale, plus approximately $1.2 billion of capex, so it expects to borrow on its credit facilities and see cash fall significantly by year-end.

Ratings are investment grade but near the floor (Baa2/BBB-/BBB), and regulatory outcomes are material, including a pending PSNH rate settlement, a Yankee Gas rate request, uncertainty around FERC rehearing on transmission ROEs, and a $250 million^d PSNH scrubber commitment. Litigation includes a pending $1 billion-scale merger dispute with Consolidated Edison, where NU's claims and Con Edison's damage claim of at least $314 million remain unresolved.

02—Key points

Key Highlights

2006 net income of $470.6 million ($3.05 per diluted share) versus a 2005 loss of $253.5 million, largely reflecting the sale of NU Enterprises' competitive generation business for $1.34 billion (about $314 million after-tax gain).
Underlying Utility Group earnings were about $123.5 million ($0.80 per share) excluding the $74 million CL&P tax benefit from an IRS private letter ruling, versus $122.3 million in 2005, with transmission earnings rising to $59.8 million ($0.39 per share).
2007 EPS guidance of $1.30 to $1.55 per share; management targets 10% to 14% compound annual EPS growth from 2006 levels through 2011.
Transmission is the growth engine: roughly $2.5 billion of 2007-2011 transmission capex, with rate base projected to rise from about $1.1 billion (2006) to about $3.0 billion (2011), mostly earning a 12.4% FERC ROE.
Liquidity tightens in 2007: about $350 million of federal and state tax payments on the generation sale, roughly $1.2 billion of planned capex, and dividends above $100 million, leading management to expect revolver borrowings and lower year-end cash.
Credit ratings are investment grade but thin: senior unsecured ratings of Baa2 (Moody's), BBB- (S&P) and BBB (Fitch), with a potential collateral call of about $136.8 million plus $52.4 million if ratings fall below investment grade.
Notable legal and regulatory exposures include the Consolidated Edison merger litigation (NU seeking about $32 million; Con Edison claiming at least $314 million), the NRG and Constellation disputes, a pending PSNH rate settlement (about $37.7 million annualized increase) and a $250 million mercury scrubber requirement at PSNH.

03—Questions

Frequently Asked Questions

Why did NU swing from a large loss in 2005 to strong earnings in 2006?
The 2005 loss was driven by about $322.6 million of after-tax charges tied to exiting the competitive energy businesses, including mark-to-market losses on wholesale contracts and impairments. In 2006 those businesses were largely sold: the competitive generation sale produced an approximately $314 million after-tax gain, and NU Enterprises' results improved sharply. A $74 million CL&P tax reduction from an IRS ruling also added to 2006 earnings. Investors should view the 2006 figure as flattered by these non-recurring items; underlying regulated earnings were about $0.80 per share.
What is the growth outlook for NU after 2006?
NU projects 2007 EPS of $1.30 to $1.55 and compound annual EPS growth of 10% to 14% through 2011, measured against 2006 EPS excluding the $0.48 per share CL&P tax benefit. The growth is driven mainly by transmission rate base, which management expects to grow about 23% per year, and by distribution and generation rate base growth of about 7% per year. This growth depends on timely regulatory approvals for transmission and distribution investments.
How much capital will NU need to spend, and how will it be funded?
NU projects Utility Group capital expenditures of about $4.9 billion for 2007-2011, including about $1.2 billion in 2007, with roughly $2.5 billion for transmission. NU expects to fund about 60% of capex with internally generated cash, so the Utility Group companies, especially CL&P, will need to issue debt regularly. CL&P is expected to issue about $500 million of new debt in 2007, and PSNH, WMECO and Yankee Gas up to $75 million each.
What are the biggest risks to the investment case?
Key risks include regulatory outcomes (PSNH and Yankee Gas rate cases, FERC rehearing on transmission ROEs, and the Connecticut distribution rate case planned for mid-2007), the cost of compliance with environmental rules such as the PSNH mercury scrubber (estimated at $250 million and potentially higher), and litigation including the Con Edison merger dispute. Liquidity is tighter in 2007, and credit ratings are near the investment-grade floor, so a downgrade could raise collateral requirements and borrowing costs.
Is NU still exposed to competitive energy businesses?
Only minimally. NU has exited substantially all of NU Enterprises' competitive businesses, selling its generation assets, retail marketing and most energy services units. What remains is primarily Select Energy's wholesale PJM and New York contracts (about 7.5 million MWh of obligations at year-end 2006, down from about 22 million MWh in March 2005) and a few energy services units being wound down. NU projects roughly breakeven results from NU Enterprises in 2007, excluding mark-to-market effects on those remaining contracts.

04—Continue

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