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HE AT A GLANCE

P/E ► 20.4 AVG EV/EBITDA ► 7.56 AVG ROA ► 1.9% AVG ROE ► 6.1% AVG Debt to Equity ► 5.33 HIGH Current Ratio ► 27.3 VERY HIGH Interest Coverage Ratio ► 2.52 AVG

 

 

 

 

 

 

Hawaiian Electric Industries (NYSE:HE) is the primary electric utility in the state of Hawaii. It also operates the third largest commercial bank by assets in the state. HE's electric utilities both generate and transmit power to 95% of Hawaii's population, while its banking unit provides deposit, checking, insurance, and lending services to individuals and businesses in Hawaii and Guam. It's electric utility subsidiaries and contracted partners have a combined generation capacity of 2,223 megawatts (MWH) ^[1], making it one of the smaller electrical utilities in the United States, but the largest in Hawaii. Its geographical dominance in Hawaii is highlighted by the fact that HE is the only electric public utility for 95% of the state's 1.2 million residents^[2]. HE's banking unit, American Savings Bank (ASB), is one of Hawaii's largest financial institutions with $5.4 billion in total assets as of year-end 2008^[3], and has the second-largest branch network in the state ^[4]. All together, Hawaiian Electric Industries posted revenues of $3.2 billion and net income of $90.3 million in 2008^[5].

Between HE's electric utilities and its banking services, the company has tied its fate to the state of Hawaii. Hawaiian Electric Industries (HEI)'s monopoly on Hawaiian electricity customers is an enormous barrier to entry for would-be competitors. This monopoly comes at a price, however; it's geographical isolation also means that HE's utilities have to maintain higher generating capacities than similar utilities on the mainland that share excess generating capacity. Although the company has been diversifying away from fossil fuels in recent years, these still account for over 93% of the utilities' generation capacity. As a result, the company's earnings are highly susceptible to the price of the oil and coal it burns^[6].

HE's banking unit earns nearly 84% of revenues from fees and interest income on its loan portfolio and interest and dividends from investments. In 2007, ASB earned $425 million in revenue and $84 million in net income^[7].

As the only source of electricity to the majority of the state's population, HEI is also heavily regulated and vulnerable to Hawaiian energy policy changes. Since nearly 76% of HEI's generation capacity is fossil fuel based, Sociopolitical pressures like the push to reduce energy dependence on fossil fuels are forcing the company to adapt its energy portfolio (the types of energy used in generating electricity)^[8]. The bank is facing pressures from lower interest yields that threaten the company's net interest margin, or the weighted average interest rate on the overall loan portfolio^[9]. ASB is relatively unaffected by the downturn of Mortgage-Backed Securities (MBS) as the bank has mostly stayed out of these troubled securities^[10].

Business Overview

As a holding company, Hawaiian Electric Industries operates its electric utilities and banking units separately. While many utility companies often use holding companies as parents to the overall utility group, HEI is a combination of a electric utility holding company and a banking unit it acquired in 1998. Its combined electric utilities control 95% of the retail electrical market across the Hawaiian archipelago and are responsible for the delivery of electricity to over 439,000 retail customers. American Savings Bank, HEI's banking unit, provides a full range of banking and insurance services to individual and business customers through its 63 branch offices and insurance agency subsidiary. It is the third largest bank in Hawaii by total deposits, and accounts for over a third of HEI's net operating income^[11].

Due to Hawaii's increasing demand for electricity (1.63% annualized growth from 1990 to 2006 ^[12]), Hawaiian Electric Company (HECO), HEI's utility company, has encouraged local efforts to develop alternative energy sources in addition to welcoming efforts by some customers to generate their own power using renewable resources, like solar water heating^[13]. This, combined with the company's plans to add 500MW of generation capacity by 2016, should help the electric utilities improve its generating efficiency assuming that Hawaii's electricity demand continues to increase at historical rates^[14].

Business and Financial Metrics

• Financial Metrics

HE had revenues of $2.536 billion in 2007, up 3% from 2006. Net income fell 22% to $85 million in 2007 due primarily to a 30% decrease in its electric utilities's net income. The electric utilities had combined revenues of $2.106 billion in 2007, up 2.5% from 2006. The 30% drop in HE utility revenues was partially due to a $16 million refund paid to electric utility customers, a $12 million dollar plant write-down^[15], and a combined increase of $43.1 million in operating expenses. This was partially offset by a $32 million increase in revenues from electricity rate increases^[15].

HE's banking unit, American Savings Bank (ASB), had revenues of $425.5 million in 2007, up 4.19% from 2006. ASB's net income fell 4.8% from $55.8 million in 2006 to $53.1 million in 2007 due to a flattening yield curve and increasing competition in attracting loans and new deposits^[16]. net interest income fell by $5.5 million to $197.2 million in 2007 from increased funding costs for loans, and a smaller investment and mortgage portfolio (fewer interest & fees). In addition, ASB increased its provisions for loan losses from $1.4 million in 2006 to $5.7 million in 2007. The bank claims that delinquencies were historically low, and expects them to rise with the weakening outlook on the economy^[17]. ASB's non-interest income rose $8.8 million in 2007, up 14.8% from 2006 primarily from an increase in deposit fees. Non interest expenses rose by $3.6 in 2007, up 2% from 2006 from increases in management compliance costs.

• Business Metrics

Hawaiian Electric Industries Kilowatt Hour sales by customer, 2007^[18].

Rising demand has put pressure on HE's electric utility subsidiary's generating facilities and forced the company to purchase more than 4.2 million kilowatt hours (KWH) of power in 2007, which accounted for 41.8% of total 2007 KWH sales (up from 40.4% in 2006) ^[19]. Electric utilities typically purchase other utilities' excess generating capacity to meet abnormally high customer demand, although they usually do so through Electricity Transfer Markets (systems that allow utilities to buy and sell excess power at wholesale prices determined by supply and demand). Since Hawaii is so isolated from the mainland, HE's electric utilities are not able to take advantage of Electricity Transfer Markets, and are forced to contract any additional capacity in advance.

In order meet rising electricity demand, HE's electric utility subsidiaries, Hawaiian Electric Company (HECO), Maui Electric Company (MECO) and Hawaiian Electric Light Company (HELCO) have committed $151 million as of 2007 to expand their generation capacity in both conventional and renewable energy platforms^[20].

Business Segments

Hawaiian Electric Industries has three main electric utilities, Hawaiian Electric Company (HECO), Maui Electric Company (MECO) and Hawaiian Electric Light Company (HELCO), that accounted for 83% of revenues and 61% of net operating income for HE in 2007. While they operate independently, both MECO and HELCO are considered subsidiaries of HECO in HE's 10-K ^[21]. HEI's other segment, American Savings Bank, accounted for nearly 17% of revenues and 39% of net operating income in 2007^[22].

Electric Utilities (83% Revenue, 61% Net Operating Income)

Through its electric utility subsidiaries and contracted partners, Hawaiian Electric Industries had a combined generation capacity of 2223 Megawatts (MW) and served 439,897 retail customers in 2007. In order to provide the additional power necessary to meet peak energy demand, HE has purchase agreements with AES Hawaii, Kalaeloa Partners, L.P., Apollo Energy Corporation, Hamakua Energy Partners, HPOWER, and Kaheawa Wind Power for an additional 540 MW of capacity^[23]. HE's energy portfolio (sources of power generation) consists almost exlusively of oil and diesel combustion with only 140 MW of capacity devoted to renewable sources as of 2006, though this excludes the 540 MW of contracted wind power. As of 2007, HE has plans to expand its renewable energy generation capacity to 500 MW by 2016^[14].

• Hawaiian Electric Company (HECO): In fiscal 2007, HECO served nearly 300,000 customers on Oahu and had a total generation capacity of 1672 MW. As HE's largest electric utility by KWH sales, HECO's electricity sales revenue totaled $1.380 billion in 2007, up 1.41% from 1.361 billion in 2006^[24].

• Maui Electric Company (MECO): MECO served nearly 79,000 customers in 2007 on the islands of Maui, Lanai and Molokai and had a total generation capacity of 281 MW. MECO is HE's second largest electric utility by KWH sales and had electricity sales revenues of $360.1 million in 2007, up 6.46% from $343.9 million in 2006 ^[24].

• Hawaiian Electric Light Company (HELCO): HELCO served over 60,000 customers on the island of Hawaii in 2007 and had a total generation capacity of 270 MW. HE's smallest electric utility by KWH sales, HELCO had electricity sales revenues of $349 million in 2007, up 1.52% from $344 million in 2006^[24].

American Savings Bank (17% Revenue, 39% Net Operating Income)

American Savings Bank, HEI's banking unit, provides a full range of banking and insurance services to individual and business customers through its 63 branch offices and is the third largest bank in Hawaii by total assets^[16]. It accounts for over a third of HE's net operating income and over half of HE's net income. ASB's earnings depend for the most part on net interest income, the net interest rate spread of its loan portfolio, noninterest income (fees) and its deposit liabilities and other borrowings. In 2007, the bank generated 85.4% of its revenues from interest and fees from loans and investments in mortgage-related securities, with the other 16% generated primarily through noninterest (fee) income from other financial services, deposit liabilities, and other financial products. As of 2007, the bank's loan and mortgage investment portfolio had over $6.18 billion in assets, up from the 2006 balance of just under $6 billion.

Key Trends and Forces

Hawaii's Economic Outlook is Weakening

Hawaii's extreme geographic isolation from the mainland (1,988 mi southwest of North America) forces the state to be largely self-sufficient. Since the cost of imports is so high, the islands have a relatively high cost of living with inflation outpacing the national average by 1-2% (on average) since 2003. In many ways, the need for self-sustainability has forced the state's economy to include a diverse mix of industries, though tourism remains the dominant industry followed by transportation and real estate. Since HE's operates exclusively in Hawaii, the company's future growth is closely tied to the continued growth of Hawaii's economy. That said, the outlook on Hawaii's economy is weakening, partially from the drop in tourism spending from nearly 10% in 2006 to 4% in 2007^[25]. The volume of Hawaiian real estate sales fell by 31% for single-family homes and 24% for condos, coinciding with the general down trending of national home sales^[26]. Although HE's electricity customers will continue to buy their electricity from the same source, HE's banking unit's mortgage portfolio is likely to shrink. Although HE is unlikely to lose market share to competing electrical utilities, lower demand from increased conservation on the part of consumers could adversely impact future revenues.

HE's Net Margin Depends on HE's Ability to Pass on Costs

Hawaiian Electric Industries' electric utilities are heavily regulated by several local and federal government agencies. Rate changes are approved and monitored at a federal level by the Federal Energy Regulation Commission (FERC) and locally by Hawaii's Public Utility Commission (PUC). Any rate hikes or costs which HE wishes to pass through to their customers via rate hikes must be approved by the PUC. The regulatory lag in granting these requests for any utility often means that utilities are unable to quickly recover their costs, which pressures margins. This could also force HE to rely more heavily on debt to finance their operations, which could be difficult considering the current credit crisis and HE's mediocre credit rating^[27].

Changes in Environmental Regulation & Fines Hits Affects the Bottom Line

Hawaiian Electric Industries' [[[electric utilities]], like all utilities, are also subject to considerable environmental regulation. Although the company states that state regulation on petroleum and chemical releases does not materially affect the company's financials, from 2006 to Q3 of 2007, HE's subsidiaries were required to share $1.8 million in cleanup costs for petroleum contaminated land^[28].

Not all environmental regulation is detrimental. With the growing pressure to shift from fossil to renewable energy, Hawaiian legislation is helping to transfer a part of the responsibility to homebuilders. Hawaii's current Governor has announced plans for over 70% of Hawaii's energy to come from clean sources by 2030. New legislation will prohibit any new building permits for new homes without solar water heaters starting in 2010, the goal being to curb the rise in demand for electricity that Hawaii has faced in the past 20 years. Hawaiian legislators have also provided incentives for the construction of large-scale renewable energy plants by providing financing for up to 85% of new plant construction costs^[29]. On July 15, 2008, HECO announced it was partnering with building an algae Bio Diesel plant to provide an additional 100 MW of generation capacity^[30]. Although the company has not disclosed any plans to take advantage of this legislation, these efforts by the state to aid its utilities are signs that the government is willing to work with its largest utilities.

Generating Capacity & Upgrades are Needed to Improve Margins

With only 1685 MW of firm generating capacity and 538 MW of additional capacity under contract, Hawaiian Electric Company is one of the smaller electric utilities in the United States. Unlike mainland utilities, HEI is geographically isolated and is solely responsible for delivering power to 95% of the Hawaiian islands. Normally, electric utilities can purchase electricity on wholesale electricity markets to meet unanticipated spikes and fluctuations in demand in order to avoid activating older and less efficient plants. HEI can only purchase power from local sources and thus, is extremely limited by on-island generating capacity. The company's reserve margin, or the amount of excess capacity over peak demand, was 38.6% overall and as low as 27.3% on Maui in 2007. Should HEI face a sudden surge in electricity demand, it may have trouble meeting it profitably if it was forced to activate less efficient plants. As of 2007, HEI has allocated over $151 million in utility construction costs^[31], and has plans to expand capacity by 500MW as of 2016^[14].

Interest Rate Decreases Could Decrease Bank Profitability

The subprime lending crisis, the resulting credit crunch, and the weight of recession fears has pushed interest rates to levels that, according to the company's 2007 Annual Report, may threaten HE's businesses. Increasingly tight credit markets could restrict the electric utilities ability to finance acquisitions and development of new power facilities. Should interest rate yields continue to decrease, ASB's management has stated that it could also see decreases in its net interest margin. With 84% of bank revenues generated by interest on loans and mortgage related securities, continued cuts to net interest margin would thus have a detrimental impact to ASB's net income^[32]. At nearly 39% of Net Operating Income, a decrease in the profitability of the bank would greatly reduce the profitability of HE overall, especially considering the low profit margins of HE's electric utilities.

Competition

Due to its monopoly of the Hawaiian electricity market, HEI has no true local competitors. HEI's banking unit, however, competes with several other banks in the region.

• First Hawaiian Bank The largest market share of deposits in Hawaii. First Hawaiian Bank is a subsidiary of BNP Paribas SA (BNPQY) and accounted for 31.88% of statewide deposits, or $8.345 billion as of June 30, 2008. The bank has 58 branches across the state^[11].
• Bank of Hawaii (BOH) The second largest bank presence in Hawaii, Bank of Hawaii (BOH) accounted for 27.43% of total Hawaiian deposits as of June 30, 2008. The bank has 72 branches across the state^[11].
• Central Pacific Bank The fourth largest bank by deposits in Hawaii. Central Pacific Bank is a subsidiary of Central Pacific Financial Corporation (CPF) and accounted for 15.03% of statewide deposits as of June 30, 2008. The bank has 39 branches across the state^[11].
• Territorial Savings Bank The fifth largest bank by deposits in Hawaii with 3.6% of deposits as of June 30, 2008. The bank has 24 branches across the state^[11].

References

1. ↑ Hawaiian Electric Industries (HEI) 10-K 2007 pg. 17
2. ↑ Hawaiian Electric Company (HECO) Profile
3. ↑ Hawaiian Electric Industries (HEI) 10-K 2008 pg. 1
4. ↑ American Savings Bank Profile. About us: Our History & Culture.
5. ↑ Hawaiian Electric Industries (HEI) Annual Report 2008 pg. 4
6. ↑ Hawaiian Electric Annual Report 2008 pg. 7
7. ↑ Hawaiian Electric Industries (HEI) 8-K, Feb 2007 pg. 5
8. ↑ Hawaiisenergyfuture.com press release July 18, 2008
9. ↑ Hawaiian Electric Industries (HEI) 10-K 2007 pg. 79
10. ↑
11. ↑ ^{11.0 11.1 11.2 11.3 11.4} Market Share by Deposits FDIC
12. ↑ Energy Information Association statistics for Hawaii
13. ↑ Hawaiian Electric Company (HECO) Net Energy Metering Website
14. ↑ ^{14.0 14.1 14.2} HECO Renewable Energy Profile
15. ↑ ^{15.0 15.1} Hawaiian Electric Industries (HEI) 8-K Feb 21, 2008 pg 1 (see: Utility Results)
16. ↑ ^{16.0 16.1} Hawaiian Electric Industries (HEI) Annual Report 2007 pg. 4
17. ↑ Hawaiian Electric Industries (HEI) 8-K Feb 21, 2008 pg 2 (see: Bank Results)
18. ↑ Hawaiian Electric Industries 10-K 2007
19. ↑ Hawaiian Electric Industries 10-K 2007 pg. 5
20. ↑ Hawaiian Electric Industries (HEI) Annual Report 2007 pg. 72
21. ↑ Hawaiian Electric Industries 10-K 2007 exhibit 21
22. ↑ Hawaiian Electric Industries (HEI) Annual Report 2007 pg. 54
23. ↑ Hawaiian Electric Industries (HEI) Annual Report 2007 pg. 88
24. ↑ ^{24.0 24.1 24.2} Hawaiian Electric Industries (HEI) 10-K 2007 pg. 4
25. ↑ Hawaiian economic forecast 2007 pg. 3
26. ↑ Hawaiian economic forecast 2008 pg. 3
27. ↑ Hawaiian Electric Industries (HEI) 10-K 2007 pg. 34
28. ↑ Hawaiian Electric Industries (HEI) Annual Report 2007 pg. 78
29. ↑ U.S. Dep. of Energy: Energy Efficiency & Renewable Energy news
30. ↑ Hawaiisenergyfuture.com press release July 18, 2008
31. ↑ Hawaiian Electric Industries (HEI) NOTE: Forward Looking Statements. Feb, 2008 8-K pg. 8
32. ↑ Hawaiian Electric Industies (HEI) Annual Report 2007 pg. 47