NOTE: Highlighting represents updated material.
Overview
Analysts agree that AVA is a 2005 story stock, with a ‘Neutral’ consensus rating and $19 target price.
Strengths / Opportunities
/ Weaknesses / Threats* Resolution by the FERC resolving all issues in the investigation of the trading practices of Avista Utilities and Avista Energy during 2000 and 2001. / * $9 million dead-band on the power cost tracker
* Gas rate relief / * Unanticipated changes in interest rates
* Progress continues on the company's major transmission system upgrades. / * * Potential negative impact due to poor hydro conditions
* Reduced non-utility losses, going forward / * Unexpected changes in inflation
* Increasing regulatory visibility / * Wholesale power sales & margin environment
* AVA’s Board of Directors raised the dividend by 4% / * The outcome of the pending rate filing in Idaho
* The lawsuit by the Port of Seattle was dismissed / * Changes in the regulatory environment for retail natural gas and electricity delivery
* AVA filed suit against the manufacturer of the malfunctioning transformer at its Coyote Springs 2 plant / * Weather conditions
* the utility received regulatory approvals for debt offerings of up to $250 million / * The Washington 2005 rate filing
* Management reaffirmed with confidence its FY’04 EPS guidance range of $1.00-$1.20 / * Year-over-year rise in debt-to-capitalization ratio
* Improving balance sheet fundamentals
* Potential for a rate increase in Idaho
* The roll-off of expensive gas purchased power contracts
* Reduced interest expense, going forward
Avista Corporation (AVA) distributes both electricity and natural gas, which account for 60% and 32%, respectively, of its 2003 revenue. The company provides electricity and gas in Washington, Oregon, California, and Idaho. Electricity is generated in eight hydroelectric power plants, one wood-waste generation station, and two natural gas fired combustion turbine units. The four primary business segments of the company are: Avista Utilities (90% of 2003 revenue), Energy Marketing and Resource Management (6%), Avista Advantage (2%), and other services (2%). The non-regulated operations of the company include electricity and gas marketing and trading activities in 11 western states. Avista Advantage provides Internet-based cost management, billing, and information services to customers in North America.
Future growth prospects appear bright given that the company is generating more than 90% of its revenue from its stable regulated gas and electric operations. The fact that AVA’s electric and gas customers are growing at a steady rate is another positive for the future. Moreover, management is making significant investments to expand and upgrade its transmission infrastructure, which will enable the company to meet the growing demand for electricity in Washington. AVA has also filed a rate case with the Idaho Public Utilities Commission (IPUC), seeking an increase in its electric and gas rates by $18.9 million and $4.8 million, respectively. Since the company last filed for an increase in its Idaho rates in 1998, it is likely that its request will be met. In 2003, the company received regulators’ approval for a 10% increase in its natural gas rates in Oregon. At that time, AVA and the Oregon Public Utilities Commission (OPUC) decided that a portion of the increase associated with higher gas costs would be postponed until the spring of 2004 in order to lessen the effect of a rate increase during the 2003-04 winter heating season. AVA now seeks that delayed rate increase.
Income seeking investors find AVA shares appealing given the 4.2% increase in payout in August 2003 and the current attractive dividend yield of 2.8%.
Despite the previously mentioned bullish factors, there are certain issues which continue to remain a cause for concern. The Washington Utilities and Transport Commission (WUTC) recently announced that natural gas is to be procured by Avista Utilities, instead of Avista Energy. Until recently, the company had been realizing cost efficiencies due to asset optimization, as Avista Energy was meeting the Utilities’ natural gas requirements. This decision may weigh heavily on AVA’s future earnings. There is also concern over the 19.4% electricity surcharge currently being collected by Avista in Idaho. Though the IPUC had granted the company a temporary extension, it is yet to authorize Avista to continue with the surcharge. If the surcharge is disallowed, future earnings would be significantly impacted. Additionally, the IPUC staff is suggesting disallowance of the $5.85 million loss incurred by Avista due to the sale of natural gas fuel. The company had entered into a contract for the purchase of gas for its Coyote Spring 2 gas fired generating plant, but since the plant became operational a year later, the gas had to be sold in the market at a loss. If the IPUC disallows AVA from recovering the loss, it would negatively affect the company’s earnings going forward..
On January 28, AVA reported earnings for Q4’03 and FY’03. Operating earnings of $0.31 per share in Q4 were slightly above expectations and higher than $0.24 earnings reported in Q4’02. Lower interest expenses and higher contributions from Avista Utilities led to the earnings incline. While increased retail usage and higher electric wholesale prices led to an 8% increase in electric revenue, a larger customer base, as well as the collection of higher natural gas prices from customers, led to a 15% increase in natural gas revenue.
Management reiterated FY’04 EPS guidance in the range of $1.00 to $1.20, with the utilities expected to earn in the range of $0.75 to $0.90 per share and the Energy Marketing and Resource Management segment expected to earn in the $0.25 to $0.35 per share range.
On January 15, the Company’s Coyote Spring 2 faced an internal arcing problem in its step-up transformer. Repair costs are covered by the manufacturer’s warranty and the plant is expected to be operational by the end of June.
Sales
AVA generates revenue through four primary business segments: 1) Avista Utilities; 2) Energy Marketing & Resource Management; 3) Avista Advantage; and 4) Other.
The AVA Street consensus model of five brokerage analyst models forecasts total revenues of $1.1 billion in FY’04 and $1.4 billion in FY’05. This represents an estimated compound annual growth rate of 10.8% from realized FY’03 revenues. This is also consistent with yr/yr sales growth of +0.4% in FY’04 and +22.4% in FY’05.
($ in millions) / FY'03A / FY'04E / FY'05E / Est. CAGREst. Total Revenues / $1,123 / $1,128 / $1,380
YoY Growth / +0.4% / +22.4% / +10.8%
For more color on AVA’s revenue by segment, reference the ‘Consensus Model’ tab of the AVA spreadsheet.
Margin
AVA’s corporate outlook calls for the continuation of current business strategies, focusing on improving cash flow and earnings, controlling costs and reducing debt while working to restore investment-grade credit ratings.
AVA's credit ratings outlook was upgraded to stable from negative by Moody's in March 2004, mirroring the ratings outlook of Standard & Poor's and Fitch Inc.
The (Goldman) analyst observes that AVA’s debt/cap ratio was 59.4% at FYE’03 versus 54% in ’02. The analyst partially attributes the increase to (1) the reclassification of $100 million of Avista Capital I and Avista Capital II "preferred trust securities" to "long−term debt to affiliated trusts", and (2) the addition of about $55 million of Lancaster debt to the balance sheet. S&P and Moody’s have assigned AVA corporate credit ratings of BB+ (Stable outlook) and Ba1 (Stable outlook), respectively. AVA is targeting $50 million in debt reductions in FY’04 and FY’05 and a long−term debt ratio of 50%. Goldman remains encouraged by the resolution of several key credit risks in ’03 (power price manipulation investigation & divestiture of Avista labs), however they believe that a return to investment grade ratings will require more substantial debt reduction efforts.
For more color on AVA’s margins, reference the ‘Consensus Model’ tab of the AVA spreadsheet.
Earnings per Share
AVA management reiterated its FY’04 consolidated corporate EPS guidance of between $1.00 and $1.20 per diluted share, with the outlook for Avista Utilities in the range of $0.75 to $0.90 per diluted share and for the Energy Marketing and Resource Management segment in a range of $0.25 to $0.35 per diluted share. It is expected that Avista Advantage will have break-even to slightly positive earnings for FY’04, and in the Other segment, the company anticipates a lower earnings drag than in FY’03.
As compared to company earnings guidance of $1.00 - $1.20 in FY’04, the Street consensus EPS estimates are $1.11 in FY’04 and $1.33 in FY’05. This is consistent with yr/yr recurring EPS growth of +11.2% and +20.1%, respectively. Consensus estimates indicate a +15.6% compound annual growth rate.
(US$) / FY'03A / FY'04E / FY'05E / Est. CAGRConsensus EPS estimates / $1.00 / $1.11 / $1.33
YoY Growth / +11.2% / +20.1% / +15.6%
Low est. / $1.10 / $1.25
High est. / $1.14 / $1.50
FY’04 EPS estimates come in at a low of $1.10 (AG Edwards, Goldman and Merrill) and a high of $1.14 (Davidson). FY’05 EPS estimates come in at a low of $1.25 (Goldman and Merrill) and a high of $1.50 (Davidson).
Regarding the historical accuracy of analysts following AVA, based on the average number of months per year (from 2000 through 2003) that AVA analysts beat the Street consensus estimate, the (A.G. Edwards) analyst has the most accurate record at 5.0 months, followed by the analyst from (Davidson) at 4.7 months, (Pershing) at 3.5 months, and (Merrill) at 2.8 months.
The (Goldman Sachs) analysts observe that AVA has achieved positive steps toward lowering the risk profile of its core utility business by diversifying its resource mix, pursuing rate relief, and reducing its large deferred energy cost balance. Despite forecasts of utility earnings improvement in FY’05, (Goldman) believes there is significant room for expansion before AVA reaches its full earnings potential. The following table reflects the analysts’ estimated EPS by business segment:
2003A / 2004E / 2005EAvista Utilities / $0.72 / $0.90 / $1.05
Energy Marketing & Resource Management / 0.43 / 0.28 / 0.28
Avista Advantage / (0.03) / 0.00 / 0.00
Other / (0.10) / (0.08) / (0.08)
TOTAL OPERATING EPS / $1.02 / $1.10 / $1.25
Source: Company data and (Goldman Sachs) research estimates.
For color on EPS forecasts by individual brokerage analysts, reference the ‘Consensus Model’ tab of the AVA spreadsheet.
Target Price/Valuation
Of the five Street analysts following AVA, all maintain a Neutral rating on the stock. The average target price is $19. The low TP comes from (Davidson) with a valuation of $18 per share. The highest price target of $20 comes from the (Pershing) analyst.
Rating DistributionPositive / 0%
Neutral / 100%
Negative / 0%
Avg. Target Price / $19.00
Low TP / $18.00
High TP / $20.00
For more color on valuations & ratings by individual analysts, reference the ‘Valuations & Ratings’ tab of the AVA spreadsheet.
Long-Term Growth
The analyst consensus model indicates an average long-term growth rate forecast of 4.3% for AVA, as compared to an estimate of 5.3% for the electric utilities industry.
AVA Management expects the utility business to continue its modest – yet steady – customer growth of 2.0% to 3.0% in both the electric and natural gas businesses.
Events Calendar
Date / Event / Comments22-Mar-04 / AVA upgraded to ‘In-Line’ by (Goldman Sachs)
28-Apr-04, Before Market Opens / AVA Q1’04 Earnings Release
28-Apr-04,10:30AM / AVA Q1’04 Earnings Conference Call
13-May-04,1:00PM / Avista Corporation Shareholders Meeting
18-May-04 / AVA upgraded to Neutral by (DA Davidson)
19-May-/04 / EEI Annual Finance Meeting May 2004
26-May-04,12:00PM / Avista Corporation Analyst Meeting / Business Update / Webcast / New York
12-July-04 / Rebuttal testimony expected in Idaho PUC rate case
July 19, 26, & 27, 2004 / Idaho PUC rate case hearings to be held
September, 2004 / PUC rate case decision expected
Individual Analyst Opinions
POSITIVE RATINGS (0%)
None.
NEUTRAL RATINGS (100%)
Pershing – Neutral ($20): Rate Increase Granted. (No current comment.)
D.A. Davidson – Neutral ($18): “Raising EPS Estimates and Target Prices. Maintaining NEUTRAL Rating.” 6/4/04: With the stock near $17, Davidson analysts reiterated a Neutral rating, while raising their risk-adjusted target price to $18 (from $16), or 13.6x the average of their FY’04 and FY’05 EPS estimates. One point of this target price increase is due to higher FY’04 & FY’05 earnings estimates; another point increase in the target is attributed to the value now place on the company’s business process outsourcer, Avista Advantage, which is starting to become earnings accretive and may become attractive to a strategic buyer. In addition to the 12-18 month target price of $18, Davidson maintains a 5-year target price of $23 per share. “Upgrading Stock Rating on Recent Price Drop. Raising Rating from UNDERPERFORM to NEUTRAL.” 5/17/04: The Davidson analyst maintains a risk-adjusted target price of $16, or 12.8x the average of their FY’04 and FY’05 EPS estimates. Analyst upgrades rating from UNDERPERFORM to NEUTRAL, noting with AVA stock below $16, the share price is down 14% year-to-date, compared to a 2% decline by the Dow Jones Utility Index. After re-working their earnings model, following the filing of the AVA’s Q1’04 results, Davidson maintains earnings forecasts of $1.10 per share in FY’04 and $1.40 per share in FY’05. Analysts notes that their confidence in the FY’04 forecast is not high, which is reflected in the relatively low multiple accorded the stock. Davidson’s FY’05 forecast assumes a return to more normal weather and streamflows, reasonable rate relief in a general rate case in Idaho that should be decided in September, and expiring gas contracts are economically replaced by new contracts.
A.G. Edwards – Hold/Aggressive (NA): “Idaho PUC Staff Rate Case Testimony In Line With Expectations” 6/23/04. Due to the potential for EPS improvement over the long-term, AGE analysts rate AVA shares HOLD despite the high P/E on FY’04 estimated earnings. AVA shares trade at 16.4X AGE’s FY’04 EPS estimate of $1.10 versus an integrated, regulated power company median of 13.8X (an 18.8% premium). However, the analysts note, FY’04 earnings will be depressed by the Washington State settlement that requires AVA to absorb the first $9 million annually of fuel and purchased power costs that are above the level in base electric rates. Utility earnings are expected to improve in FY’05 and FY’06 with a full year of higher electric and gas base rates in Idaho and the potential for more normal levels of hydroelectric generation. Over the long-term, AGE analysts project that fuel and purchased power rates will be reset in Washington State, reducing or eliminating the prospect that AVA will have to absorb the first $9 million of such costs noted above.