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The View from Wall Street: A Capital Markets Perspective

The View from Wall Street: A Capital Markets Perspective. Debra G. Coy Svanda & Coy Consulting 2010 Mid-America Regulatory Conference June 7, 2010. What does Wall Street think of water utilities?.

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The View from Wall Street: A Capital Markets Perspective

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  1. The View from Wall Street:A Capital Markets Perspective Debra G. Coy Svanda & Coy Consulting 2010 Mid-America Regulatory Conference June 7, 2010

  2. What does Wall Street think of water utilities? Water utilities’ stock prices have typically held up better than broader market indexes during steep downturns – but have under-performed on recovery rallies

  3. Drinking Water Investment Needs Remain High $335 Billion needed for U.S. drinking water utilities over the next 20 years to ensure compliance with existing and future water regulations ($ Billions) • Estimate of infrastructure projects needed in 2007-2026 for water systems to continue to provide safe drinking water • Emphasis is on transmission & distribution projects • Pipe replacement cycles are not keeping up with increasing deterioration Transmission & Distribution Projects $183.6 Treatment Projects$ 53.2 Storage Projects $ 24.8 Source Projects $ 12.8 Other $ 2.3 Source: EPA’s 2007 Drinking Water Infrastructure Needs Survey & Assessment

  4. Where Does the Money Need to be Spent? Investor-owned utilities operate in 9 out of 10 states with the greatest infrastructure spending needs • 4 of top 9states withgreatest spendingneeds are in MARCterritory Not shown: Alaska (Less than $1.0 billion)Hawaii (partially surveyed state) Source: EPA’s 2007 Drinking Water Infrastructure Needs Survey & Assessment

  5. Capital Spending Metrics Capital Invested per Dollar of Revenue Source: CA Turner Report, (2005)

  6. Financial Implications of Capital Intensity Water is the most capital-intensive utility • It takes > $3 in capital spending to generate ~ $1 in revenue • Replacement costs continue to rise, dramatically outpacing the book value of assets in the ground • Water infrastructure has a long asset life, with long depreciation schedules, especially for transmission pipes What does this mean? • Consistently negative free cash flow • Necessary to regularly access debt and equity markets to fund capital investments • Important to keep Wall Street comfortable with the “regulatory compact” – that fair returns will follow the needed investment

  7. Capital Spending Metrics Capital spending is very high relative to D&A and operating cash flow… Is this sustainable? Typical ratios for regulated water utilities Capital spending to depreciation & amortization 3 - 4x Capital spending to operating cash flow 1.2 – 1.5x Net plant to revenue 4 – 5x

  8. Is Current Capital Spending Sustainable? • Water utilities can sustain current levels of capital spending • Only if… • Water utilities can regularly access equity & debt markets to fund capital programs • AND, receive fair (and timely) returns on their investments • Otherwise… • By delaying non-mandated capital expenditures, the water utilities could quickly generate positive operating cash and spend closer to their depreciation rates • BUT, then they will fall further behind on needed replacement infrastructure spending

  9. Investment Risk Considerations Water utilities are supposed to be low-risk regulated monopolies… But are they really low risk? • Infrastructure replacement needs • Pressure on critical water supplies • Costly environmental regulations • High cap ex requirements & low depreciation rates • Effects of regulatory lag • Local political risk • Ability to access capital markets

  10. Importance of Regulation Commissions that work with utilities to minimize rate shock, while stimulating infrastructure investments, are viewed most favorably by the investment community. How Investors Evaluate Regulatory Treatment • Allowed ROEs and Ability to Earn the Allowed ROE – this is the bottom line • Consistent Regulatory Treatment • Timely Decision Making • Mechanisms to Minimize Regulatory Lag There is no “one size fits all” approach to regulation – and regulators must balance the needs of investors with the needs of consumers

  11. Water and the Consumer Water is still a relative small part of the overall consumer utility budget – this helps with the affordability discussion Annual Household Utility Spending Source: US Consumer Expenditure Survey Anthology, (2008)

  12. Consolidation of Small Systems Investor point of view • Pros • Opportunity for customer growth • Opportunity for additional capital spending with return on investment • Cons • High capex needs with lagging return on investment • Potential dilution to overall earned returns on equity

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