Why did Sempra buy back 15% of its own shares, and how was it financed?

The company repurchased about 36 million shares at $20 each in a Dutch auction tender completed in February 2000, costing roughly $735 million. It was funded mainly by $500 million of 7.95% notes due 2010, $200 million of 8.9% mandatorily redeemable trust preferred securities, and short-term commercial paper issued by Sempra Energy Holdings and guaranteed by the parent. The filing says the move increased financial leverage, and management presented it as part of a strategy to boost flexibility and position the stock for growth in market value.

Why was the dividend cut, and what does it mean for income investors?

The quarterly dividend was reduced to $0.25 per share ($1.00 annualized) from $0.39 ($1.56 annualized), starting with the Q2 2000 payment. Management said the cut improves financial flexibility and lets the company retain more earnings for reinvestment in the business. Investors focused on current income should expect roughly a 36% lower dividend. The 1999 dividend payout ratio was 94% of earnings, and 126% in 1998, so the prior rate was not comfortably covered.

What are the main regulatory risks for the California utilities?

Key open items include the CPUC decision on ending the electric rate freeze (expected Q2 2000), the 1999 Biennial Cost Allocation Proceeding (a proposed decision would cut natural gas revenues by $208 million at SoCalGas and $38 million at SDG&E), the timing of a refund of over $400 million to SDG&E customers from overcollected rate-reduction bond proceeds, and whether the CPUC will open electric distribution to competition. Much of the gas business is protected by balancing accounts, but the filing notes that electric earnings and some noncore volumes are now exposed to market and competitive risk.

How much exposure does the company have to energy trading and environmental liabilities?

Sempra Energy Trading reported 1999 operating revenues of $450 million and net income of $19 million, but its balance sheet carried $1.5 billion of trading assets and $1.4 billion of trading liabilities, and it had 'notional' derivative positions of about $24.6 billion. About $116 million of counterparty exposure is rated below investment grade. On environmental matters, the company estimates remaining remediation liabilities of about $70 million, roughly 90% of which is authorized for rate recovery through the Hazardous Waste Collaborative. Management believes unrecovered costs would not have a material adverse effect.

SRE/SREA 10-K FY1999 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 29, 2000. Cited figures are marked; the original filing is the authoritative source.

Sempra Energy's 1999 Form 10-K reports net income of $394 million^a, or $1.66 per diluted share, up from $294 million ($1.24) in 1998, with total revenues and other income of $5.435 billion.

Results were driven mainly by lower business-combination costs at the California utilities, stronger contributions from Sempra Energy Trading (net income $19 million^b), Sempra Energy Financial, and Sempra Energy International, which swung to a $10 million profit. Operating income rose to $802 million from $629 million. The 1999 figures also include a $303 million depreciation effect tied to the sale of SDG&E's fossil plants, which generated $466 million in net proceeds, and a $80 million quasi-reorganization credit to equity.

The more consequential story for investors is the capital structure shift announced after year-end. In February 2000 Sempra repurchased roughly 36 million shares (about 15% of outstanding stock) at $20^c per share through a Dutch auction tender, funded by $700 million of new senior notes and trust-preferred securities plus commercial paper. The quarterly dividend was cut 36% to $0.25 per share ($1.00 annualized) from $0.39.

Management states the debt-to-capitalization ratio would have been 62%^d on a pro forma basis, up from 50%, and says it expects to maintain strong investment-grade ratings, which the agencies reaffirmed. Management also targets generating one-third of consolidated earnings from unregulated businesses by 2003, though it cautions that this cannot be assured.

Risks flagged in the filing include regulatory uncertainty in California (pending CPUC decisions on ending the electric rate freeze, natural gas industry restructuring, and BCAP rates, with a proposed $208 million SoCalGas revenue decrease), a potential refund of over $400 million to SDG&E ratepayers from rate-reduction bond overcollections, roughly $70 million of environmental remediation liabilities (about 90% recoverable through rates), and the volatility inherent in energy trading, where SET's counterparty exposure includes $116 million rated below investment grade. The company also reports no material pending litigation.

02—Key points

Key Highlights

Net income rose 34% to $394 million ($1.66 diluted EPS) from $294 million ($1.24) in 1998, helped by lower business-combination costs ($14 million after tax in 1999 versus $85 million in 1998).
Operating income increased to $802 million from $629 million, and total revenues and other income reached $5.435 billion, up from $5.015 billion.
Sold SDG&E's South Bay and Encina power plants and 17 combustion turbines for $466 million in net proceeds, completing recovery of most of SDG&E's stranded costs in June 1999.
Executed a Dutch auction tender in February 2000 to buy back about 36 million shares (15% of outstanding) at $20 per share, financed with $700 million of new debt and trust preferred securities.
Cut the quarterly dividend 36% to $0.25 per share ($1.00 annualized) from $0.39, starting with the Q2 2000 payment, to improve financial flexibility.
Debt-to-capitalization rose to a pro forma 62% from 50% after the tender offer, though management says it expects to maintain strong investment-grade ratings, which rating agencies reaffirmed.
International growth continued through the Chilquinta Energia and Luz del Sur acquisitions in Chile and Peru (with PSEG), plus Mexico and the Nova Scotia gas franchise (a $700–800 million investment), while Sempra Energy Trading expanded into Europe with net income of $19 million.

03—Questions

Frequently Asked Questions

Why did Sempra buy back 15% of its own shares, and how was it financed?
The company repurchased about 36 million shares at $20 each in a Dutch auction tender completed in February 2000, costing roughly $735 million. It was funded mainly by $500 million of 7.95% notes due 2010, $200 million of 8.9% mandatorily redeemable trust preferred securities, and short-term commercial paper issued by Sempra Energy Holdings and guaranteed by the parent. The filing says the move increased financial leverage, and management presented it as part of a strategy to boost flexibility and position the stock for growth in market value.
Why was the dividend cut, and what does it mean for income investors?
The quarterly dividend was reduced to $0.25 per share ($1.00 annualized) from $0.39 ($1.56 annualized), starting with the Q2 2000 payment. Management said the cut improves financial flexibility and lets the company retain more earnings for reinvestment in the business. Investors focused on current income should expect roughly a 36% lower dividend. The 1999 dividend payout ratio was 94% of earnings, and 126% in 1998, so the prior rate was not comfortably covered.
What are the main regulatory risks for the California utilities?
Key open items include the CPUC decision on ending the electric rate freeze (expected Q2 2000), the 1999 Biennial Cost Allocation Proceeding (a proposed decision would cut natural gas revenues by $208 million at SoCalGas and $38 million at SDG&E), the timing of a refund of over $400 million to SDG&E customers from overcollected rate-reduction bond proceeds, and whether the CPUC will open electric distribution to competition. Much of the gas business is protected by balancing accounts, but the filing notes that electric earnings and some noncore volumes are now exposed to market and competitive risk.
How much exposure does the company have to energy trading and environmental liabilities?
Sempra Energy Trading reported 1999 operating revenues of $450 million and net income of $19 million, but its balance sheet carried $1.5 billion of trading assets and $1.4 billion of trading liabilities, and it had 'notional' derivative positions of about $24.6 billion. About $116 million of counterparty exposure is rated below investment grade. On environmental matters, the company estimates remaining remediation liabilities of about $70 million, roughly 90% of which is authorized for rate recovery through the Hazardous Waste Collaborative. Management believes unrecovered costs would not have a material adverse effect.

04—Continue

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