Oct. 13, 2000(Financial Times)Moody’s Rating Agencies shows that the Proportion of top graded European utilities has dropped from 100 per cent to less than half in the last 10 years.
The driving force behind the change will be the speed at which competition drives down electricity prices, squeezing profit margins and forcing utilities to seek growth through mergers and acquisitions.
Competition in the electricity market has increased thanks to the wider enforcement of a European Directive to gradually open up the power market. In Germany power prices for some users have dropped by 30 per cent.
As companies seek to fund external growth while earnings from power generation come under pressure, corporate bond issuance by the sector is likely to pick up.
This year continental European energy groups issued euro-denominated bonds worth around 6bn around 6 per cent of all corporate euro-denominated issues. By the end of the year that proportion is likely to rise to 10 per cent as utilities turn to the bond market to fund growth.
“Debt issuance is likely to increase as a result of corporate activity,” says Michael Dolan, utilities analyst at Bank of America. “But it’s unlikely to reach the proportions we’ve seen in the telecoms sector and it’s more difficult to estimate because it’s about predicting a lot of corporate activity.”
Unlike the situation in the telecoms sector, where the auctions for the third generation mobile licences and related investments needs have led to fairly predictable financing needs at the winning companies, there is no single event boosting bond issuance by utilities.
There is, however, evidence that the sector is on the way to consolidation.
Germany’s RWE, the result of a merger between the Ruhr-based utilities RWE of Essen and VEW of Dortmund, has announced the acquisition of UK water utility Thames Water, financed with 4bn in cash and 3.1bn in bonds. Italian electricity group Enel said this week it was buying Infostrada, the country’s number two telephone and internet group, for 11bn half to be raised through bonds.
And Spanish utilities Endesa and Iberdrola are in talks to merge in a deal that would create one of Europe’s largest utilities.
The extent to which mergers and acquisitions lead to increased financing needs through the bond market depends on the number of asset swaps or outright sales of assets and can reduce the need for other forms of finance.
In the case of Endesa/Iberdrola, for example, the authorities are expected to seek substantial asset disposals that would either bring in cash to finance expansion or extend the companies’ reach in Europe through asset swaps with groups eager to enter the Spanish market. Moody’s has placed Iberdrola’s debt under review for possible upgrade and Endesa under review for possible downgrade.
With analysts expecting ratings across the sector to come down, most hold a neutral to negative view of the sector. However, if the current turmoil in the corporate bond market persists, utility bonds may come back in favour.
Corporate bond spreads have been hit by credit concerns after a series of earnings warnings. Issues by telecoms groups which have accounted for the bulk of corporate bond issuance this year have been worst hit, but this week fears spread to other sectors. In such an environment, utility bonds could become seen as a shield from more volatile industrial sectors.
“There is a possibility that if the market really turns ugly regardless of the fundamental aspects which are negative, utilities could outperform,” says Chris Melendes, fixed income utilities analyst at Morgan Stanley.
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