Fallout from Enron driving energy stocks down, analysts say

In the wake of Enron Corp.’s bankruptcy, the energy merchant trading sector continues to be pressured by investors moving stocks down and bond yields up, analysts said.

Some companies have reacted to the more conservative capital requirements imposed by the ratings agencies last week and announced plans to shore up balance sheets in an effort to rebuild investor confidence.

Dynegy Inc. announced a capital restructuring plan this morning in reaction to a ratings downgrade. But the plan did not stop the slide in its stock price. Dynegy’s stock fell 12% to $22/share shortly before the market closed on earnings warnings for 2002 this morning.

“This is collateral damage Chapter 2,” said John Olson, analyst with Sanders Morris Harris in Houston. “Any company with a leveraged balance sheet and a business subject to credit ratings (like Enron) is being marked down.”

El Paso Corp. also announced a capital restructuring plan last week in reaction to tougher capital requirements being enforced by the ratings agencies. But El Paso’s ratings were not downgraded. Nevertheless, El Paso’s stock continued to fall steadily from $48/share on November 27 to $38.84 in late afternoon trading today.

Any similarity to the now bankrupt Enron is driving much of the negativity associated with this sector, analysts said.

Investors worry that there is another Enron out there, even though their fears are probably unfounded, said Jon Cartwright, analyst with Raymond James & Associates. “It’s like comparing Casper, the friendly ghost, and the Ghostly Trio. The market just sees a ghost.”

Investors are worried that the same thing that happened to Enron could happen to another energy merchant company, said Michael Heim, analyst with A.G. Edwards in St. Louis.

“Uncertainty is still there,” he said.

The market keeps acting “scared” about buying the securities of these companies, said Cartwright.

“This is mostly unfair,” he said. “The energy trading and marketing business is sound because producers of electricity and natural gas and buyers need to match up and the best way to provide the lowest prices is with a market. Marketers and traders provide that market.”

While the basic business may be sound, its contribution to earnings will be lower next year, said Heim.

Higher financing costs as more capital is required to support the trading operations, the basic energy supply and demand problems in the economy, and the pumping of more assets on the markets at the same time will drive earnings down, he explained.

Many of these companies sell assets to increase earnings each quarter. But with so many assets sales announced, that may be more difficult now, he said.

Things will get better for the sector as the Enron bankruptcy proceedings progress and the uncertainty level declines, said Heim.

The capital markets will start evening out for these companies in the next several quarters as portfolio managers become willing to buy the undervalued securities, said Cartwright.

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