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Ben Coyne

CNL AT A GLANCE

P/E ► 13.1 AVG EV/EBITDA ► 9.61 HIGH ROA ► 5.9% AVG ROE ► 10.5% AVG Debt to Equity ► 2.16 AVG Current Ratio ► 1.52 AVG Interest Coverage Ratio ► 1.12 AVG

 

 

 

 

 

 

Cleco Power is a regulated electric utility with 1,400 MW of generating capacity serving customers throughout southeast Louisiana. ^[1] In 2007 Cleco generated 4,504 thousand MWh and purchased 6,221 thousand MWh to meet the demand of their 273,000 ^[2] residential and commercial customers, posting a net Income of $151 million.

Cleco is in the process of constructing Rodemacher 3, a new "clean coal" plant with lower emissions (but without carbon sequestration) that will add an additional 600 MW to Cleco's generation capabilities (a 44% increase over the utility's current generation capabilities). ^[1] However this plant faces two potential setbacks. The 2008 Financial Crisis has restricted financing to companies worldwide, so the plant faces the threat of rising borrowing costs as loans come up for refinancing. The political tides have also begun to turn against coal technology, and the election of Barack Obama will likely accelerate this process. ^[3]

Cleco Power's rates are set by the Louisiana Public Service Commission, and the company has a pending rate case due to be decided by June 2009 which will determine future rates. Cleco is requesting a return on equity (ROE) which is higher than what has previously been authorized in the state. ^[4] Furthermore the current recession has the potential to reduce Cleco's earnings as customers decrease their electricity consumption. This is a concern primarily for commercial and industrial customers, since consumer power demand is fairly inelastic.

Business and Financials

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'*See Cleclo Midstream below '**May vary from subcomponent totals accounting for adjustments

Business Segments

Cleco Corporation has two main operating segments. Cleco Power is the company's largest division, accounting for over 96% of revenue in Fiscal 2007. ^[1] Cleco's Midstream business has historically contributed as much as 20% of revenue, but the business has been dwindling and the company's forward looking strategy will focus on their utility business. ^[5] Cleco's revenue is seasonal, with sales peaking in the summer when air conditioning use is at its highest.

Cleclo Power (99.5% of Revenue, 56% of Net Income)

Cleco Power is a regulated utility serving 273,000 customers throughout Louisiana. ^[6] Although customer growth has slowed in recent years, the company is in the process of building a large new power generation facility initially scheduled to come on line in late 2009 which will diversify the fuels the Company relies on for electricity production.^[5] The facility is called Rodemacher 3, and it will burn [[petroleoum coke to produce 600 MW of additional capacity for Cleco (a 44% increase). Rodemacher 3 will also double Cleco's rate base and trigger a regulatory proceeding which will review Cleco's current rates and decide the rates the company is allowed to charge in the future.

Cleco Midstream (.5% of Revenue, 36% of Net Income)

Cleco Midstream owns one power generation facility and is invested in a joint venture in another plant. The business is limited by the high supply of gas fired electricity generation in the area and an outdated infrastructure which limits the amount of capacity that can be sold.^[1] The large increase in Midstream's net income was caused by the bankruptcy of Calpine Tolling Agreements, the company that sold the output from Midstream's primary power plant prior to March 2006. Calpine guaranteed the sales under the contract, and the default of the company eventually forced a settlement worth $85 million. Midstream's subsidiary sold this asset for $78 million, or 92% of face value.^[1] This is a one-time sale, and earnings are expected to return to normal levels in the future. Cleco Midstream's net income figures always seem to be at odds with their operating income figures because of accounting standards that require Midstream to report all of the income from their investments in power generation facilities as income from investees. This is accounted for in net income, but not in operating income.

Trends and Forces

Gloomy Political Environment for "Clean Coal" Power Plants

Political support for new coal powered plants, and even clean coal plants, has been on the decline. ^[5] President Elect Barack Obama has indicated that past support for coal power plants will be changing. Jason Grumet, a top Obama energy advisor has said "[Obama] is confident, as all economic analysis I have seen suggests he should be, that his carbon cap program, an 80% reduction [of 1990 levels by 2050], will make it absolutely ludicrous to even contemplate any type of coal, or new coal, that is not 100 percent sequestered.^[7] Cleco's Rodemacher facility makes use of some new technologies to reduce emissions, but the plant's current specifications will not meet the new Obama standards. The exact terms of the Obama plan are are still unclear as of November 2008, but it is clear that Coal Power plants are loosing their political backing.

Cleco Power has a Rate Case Pending

Cleco Power is regulated utility which means that the rates it can charge for electricity (which is the basis of Cleco's revenue) are determined by the Louisiana Public Service Commission (PSC/PUC). This system allows for the advantages of constructing only one expensive electric infrastructure in any given region while maintaining control over the rates electric companies can charge since they have a monopoly on electricity sales in their area. Cleco filed a rate case in July of 2008 to request a total rate increase of $250.1 million, which would give the company a 12.25% Return on Equity. ^[8]This case is due to be decided by June 2009. The commission reviews Cleco's case and the costs the company has been incurring to decide if the increase is appropriate. The costs related to the construction of the Rodemacher 3 generation station will be an important issue in the case. Louisiana's Public Service Commision is regarded as being average in terms of tolerance, but Cleco's request is the highest proposed ROE for any utility in the state by 50 basis points, and the New Orleans City Council has historically endorsed a ROE around 11% for Electric utilities. ^[9]

Tightening Credit Could Halt Construction of New Plant

The 2008 Financial Crisis has restricted almost every corporation's access to financing and the situation will have a profound effect on the utilities industry ^[10] Cleco is especially vulnerable since they are in the middle of capital intensive project to construct Rodemacher 3. Cleco issued $250 million of 10 year bonds during June 2008 for general company financing and to put towards the continued construction of the new plant. The bonds were issued at 6.65% while the 10 year Treasury notes (considered risk free) were priced at 4.10%. ^{[11] [12]} This indicates that investors were placing a moderate 2.55% risk premium on the project. Cleco has another $63.5 million in long term debt due within the year which will have to be refinanced, ^[11] and even though risk free rates have been lowered by the Federal Reserve, investors have been placing a high risk premium on all loans throughout Q3 2008. ^[13] A rise in the risk premium that investors place on the Rodemacher project will increase costs and could delay construction.

Recession will Slow Electricity Consumption

Economic data as of late November 2008 indicates rising unemployment and a general economic downturn that is worsening at an accelerating pace. ^[14] While demand for residential electricity is relatively inelastic, ^[15] Cleco is already expected to have negative free cash flow in the upcoming years ^[5] in a market that increasingly unwilling to loan out money. ^[16] The more substantial impact of the slowdown will be decreased demand from Cleco's industrial customers. Cleco's several industrial customers manufacture wood and paper products and accounted for base revenue of $23 million in 2007, but these companies are now experiencing a downturn in their industries. ^[1] Cleco has an upcoming rate case where these demand reductions could be taken into account to maintain Cleco's expected rate of return. However since the rate proceeding is scheduled to take place right before Rodemacher 3 enters service and it the plant's completion date is uncertain, it is unclear how a reduction in demand will affect the company.

Competition

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After a wave of deregulation in in the late 1990's and early 2000's, most states have re-regulated their electricity markets. This system allows for the advantages of constructing only one expensive electric infrastructure in any given region while maintaining control over the rates electric companies can charge since they have a monopoly on electricity sales in their area. Investors are also assured that if they back the construction of this infrastructure there will be no competition for electricity sales down the road. Louisiana's electricity market is regulated which protects Cleco's Utility Division, the primary profit generator. The other large electric utilities that operate in Louisiana are mostly subsidiaries of Entergy (ETR), but Southwestern is another major player in the state.

• Entergy (ETR) is one of the nation's largest utilities with 2007 revenue and net operating income of $11 billion and $1.17 billion respectively. Both Entergy Louisiana and Entergy Gulf States rely relatively disproportionately on commercial and industrial sales compared to Cleco. While residential sales are usually inelastic, the commercial and industrially weighted customer base of Entergy will demonstrate a more elastic demand curve as corporations will be looking cut costs in a recession.
• Southwestern Electric Power is a division of American Electric Power Company (AEP), a large national utility that generates most of its income from from Ohio, Oklahoma, and Indiana.

References

1. ↑ ^{1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8} Cleco Corporation 2007 10k
2. ↑ Cleco Investor Website
3. ↑ Advisers to White House candidates discuss their positions on energy, climate, environment. Event Coverage, 04/15/2008
4. ↑ SNL Electricty Briefing Books. SNL.com
5. ↑ ^{5.0 5.1 5.2 5.3} Cleco Corporation Morningstar Equity Research, Ryan McClean 10.13.2008
6. ↑ | Cleco Website : Investor Relations
7. ↑ Advisers to White House candidates discuss their positions on energy, climate, environment. Event Coverage, 04/15/2008
8. ↑ SNL Electricty Briefing Books. SNL.com
9. ↑ SNL Electricty Briefing Books. SNL.com
10. ↑ "Investors Risk Tilting at Windmills in the Utility Sector" Liam Denning. Wall Street Journal 11.22.2008
11. ↑ ^{11.0 11.1} | Cleco 10Q 9.30.2008
12. ↑ Federal Reserve 10 Year Treasury Note Historical Prices
13. ↑ "Economic Fears Reignite Market Slump" SUDEEP REDDY, JENNIFER SARANOW and ANN ZIMMERMAN, Wall Street Journal 10.16.2008
14. ↑ | "Job Losses Surge as U.S. Downturn Accelerates" Conor Dougherty. WSJ 11.22.2008
15. ↑ "Investors Risk Tilting at Windmills in the Utility Sector" Liam Denning. WSJ 11.22.2008
16. ↑ "Economic Fears Reignite Market Slump" SUDEEP REDDY, JENNIFER SARANOW and ANN ZIMMERMAN, Wall Street Journal 10.16.2008
17. ↑ | DOE Louisiana Electric Sales Figures