January 28, 2004 Fixed Income Research Recommendation: Market Perform Credit Trend: Improving Jacob P. Mercer, CFA Senior Research Analyst 612-303-1609 jacob.p.mercer@pjc.com Mark D. Churchill Associate Research Analyst 612-303-0553 mark.d.churchill@pjc.com Disclosures (see last page for details): (#) Market Maker (^) Beneficial Interest (@)Underwriter (>) Investment Banking Services (~) Employee/Director (+) 1% Firm Ownership Xcel Energy (Baa3/BBB-) Xcel Energy reports stronger than expected fourth quarter results and continues its focus toward regulated operations. EARNINGS SUMMARY On January 28, 2004, Xcel Energy (#@>+) reported fourth quarter and year-end results. At the same time, management reaffirmed 2004 guidance of $1.15 to $1.25 per share. Our estimate for earnings from continuing operations for 2004 is $524 million or approximately $1.23 per share. Xcel Energy s fourth quarter pro-forma results from continuing operations were earnings of $147 million compared with earnings of $111 million for the same period in 2002. Twelve month pro-forma results from continuing operations were earnings of $510 million compared with earnings of $528 million. The earnings were above the Company s earlier guidance of approximately of $456 million to $479 million and our estimate of $463 million. Core utility operations in 2003 were $565 million compared with $596 million in 2002. Results in 2003 were hurt by higher operating costs and unfavorable weather conditions. Year end EBITDA totaled $1,863 million compared to 2002 results of $1,932 million. The 2003 EBITDA came in slightly below our projections of $1,912 million. The vast majority of the difference was a result of depreciation and amortization expense which dropped $31 million in the fourth quarter. The drop in depreciation and amortization was a result of the Minnesota Public Utilities Commission and the Colorado Public Utilities Commission extending the useful lives of certain plant, property, & equipment. Utility operating and maintenance expenses for the fourth quarter of 2003 increased by approximately $30 million, or 7.2%, compared with 2002. Full year operating and maintenance expenses increased $96 million, or 6.5%. The increase was a result of higher employee benefit costs related to performance based compensation, restricted stock unit grants, higher medical and health care costs, and lower pension credits. Piper Jaffray & Co. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decisions. This report should be read in conjunction with important disclosure information, including an attestation under Regulation Analyst Certification, found at the end of this report or at the following site: http://www.piperjaffray.com/researchdisclosures 1 Piper Jaffray Fixed Income Research Xcel Energy
Interest and financing costs for the fourth quarter (including preferred stock dividends) was $112 million. This was $23 million lower than the same period last year. The interest expense benefited from refinancing a number of high coupon debt issues. Xcel expects interest costs to continue to fall in 2004 by an estimated $15 million. After restatements to 2002 (to exclude NRG and other discontinued operations), interest coverage ratios decreased for the last twelve months. The EBITDA/interest coverage ratio dropped from 4.53x to 4.08x approximately in line with our 4.13x estimate. Non-regulated results were a loss of $.01 per share for the quarter and a loss of $.12 for the year. Seren Innovations, Inc. continued to improve over last year s numbers with a loss of $.04 for the year. This compares to a loss of $.07 a year earlier. At December 31, 2003, Xcel Energy s investment in Seren was approximately $265 million. This is up $10 million from last year. Xcel expects Seren to be selffunding in 2004 and sees very little, if any, equity contributions this year. The Board of Directors has approved the sale of both Xcel International and e prime. Xcel International primarily consists of power projects in Argentina and e prime provides non-regulated natural gas trading and marketing. The book value of Xcel International has been written down to $39 million. We would view a sale of both the subsidiaries as a credit positive despite very minimal proceeds, as the Company continues to focus on its core regulated operations. Total debt (including preferreds) is approximately $6.8 billion. This is a decrease of roughly $150 million from the third quarter 2003. Total debt/ebitda is approximately 3.65x and total debt/total capitalization stands at 57%. Management stated in the quarterly conference call that no debt issuance is planned during 2004. Capital expenditures for 2004 are still projected at $1.2 billion. With NRG s emergence from bankruptcy in December 2003, Xcel Energy has divested its ownership in NRG and expects to realize approximately $1.1 billion of cash savings from tax benefits through a refund of taxes paid in prior years and reduced taxes payable in future years. Xcel Energy used $130 million of these tax benefits in 2003 and expects to use $470 million in 2004. RECENT EVENTS On January 13, 2003, Xcel Energy announced a definitive agreement to sell its Cheyenne Light, Fuel & Power (CLF&P) subsidiary to Black Hills Corporation. CLF&P serves approximately 38,000 electricity customers and 30,000 natural gas customers in Cheyenne and several surrounding communities in southeastern Wyoming. The sale needs regulatory approval from both the Federal Energy Regulatory Commission and the Wyoming Public Service Commission. We expect no major regulatory issues as the asset is very small for Xcel and Black Hills is already an established operator in the state of Wyoming. The purchase price was not announced, but Xcel did mention that it expects to record a one-time gain of approximately $.01 per share upon completion of the transaction. Our estimate for the transaction including debt assumption is $85 million. The sale will have a minimal impact on earnings and allows management to focus on larger opportunities. This event should be viewed as credit neutral and marks the exit for Xcel Energy of all operations in the state of Wyoming. We believe management will continue this trend of selling non-core assets in states where the Company does not have a significant presence, including Kansas and Michigan. 2 Piper Jaffray Fixed Income Research Xcel Energy
OPINION We maintain our Market Perform recommendation. Fourth quarter earnings were stronger than our expectations and the Company continues to improve its credit profile. With the NRG situation out of the way, investors can now focus on more typical utility questions such as capital expenditure plans and the common dividend. Xcel does have some state regulatory issues pending such as the Minnesota Combustion Turbine Proposal and the PSCo Capacity Cost Adjustment Rider both of which are expected to be decided in 2004. In April, Xcel will file its resource plan in Colorado which management has indicated may contain plans for building a coal plant. The common dividend decision will be revisited in July and we continue to expect a 10% hike. Management mentioned the need to balance any shareholder enhancement such as a dividend increase with the prospects of growing earnings in the form capital investments in the conference call. We are pleased management is looking at regulated utility operations to grow earnings. The Company continues to be one of our favorite utilities from a pure credit improvement play. The Xcel 5.5% of April 1, 2014 is currently quoted 75/65 basis points over the ten year Treasury. DESCRIPTION Xcel Energy is a major U.S. electricity and natural gas company, with operations in 11 western and midwestern states. Xcel Energy provides a comprehensive portfolio of energy-related products and services to 3.2 million electricity customers and 1.7 million natural gas customers through its regulated operating companies. In terms of customers, it is the fourth-largest combination natural gas and electricity company in the nation. Company headquarters are located in Minneapolis. Cheyenne Light, Fuel & Power is a utility serving approximately 38,000 electricity customers and 30,000 natural gas customers in Cheyenne and several surrounding communities in southeastern Wyoming. CLF&P was acquired by Public Service Co. of Colorado, a predecessor of Xcel Energy, in October 1923. 3 Piper Jaffray Fixed Income Research Xcel Energy
Important Research Disclosures Analyst Certification Jacob P. Mercer, CFA The views expressed in this report, including the Opinion section in particular, accurately reflect my personal views about the subject Company and the subject securities. In addition, no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report. Research Disclosures The following disclosures apply to securities mentioned in this report if and as indicated: (#) Piper Jaffray was making a market in the Company s securities at the time this research report was published. Piper Jaffray will buy and sell the Company s securities on a principal basis. (^) A Piper Jaffray analyst who follows this Company or a member of the analyst s household has a financial interest in the Company s securities. (@) Within the past 12 months, Piper Jaffray was a managing underwriter of an offering of, or dealer manager of a tender offer for, the Company s securities or the securities of an affiliate. (>) Piper Jaffray has either received compensation for investment banking services from the Company within the past 12 months or expects to receive or intends to seek compensation within the next three months for investment banking services. (~) A Piper Jaffray analyst who follows this Company, a member of the analyst s household, a Piper Jaffray officer, director, or other Piper Jaffray employee is a director and/or officer of the Company. (+) Piper Jaffray and its affiliates, in aggregate, beneficially own 1% or more of a class of common equity securities of the subject Company. Rating Definitions Investment Opinion: Investment opinions are based on each security s return potential relative to its industry group, not on an absolute return. Outperform: Expected to outperform its industry group average over the next 3 to 6 months. Market Perform: Expected to perform in line with its industry group average over the next 3 to 6 months. Underperform: Expected to underperform its industry group average over the next 3 to 6 months. Credit Trend: Credit trends are designed to provide the firm s opinion on the credit trend of a company over a 12 month time horizon. Due to market volatility it is possible that spreads on a company s bonds can move contrary to the trend in credit fundamentals for the company. Because a company s credit position is made up of a number of factors including, but not limited to, leverage, interest coverage, cash flow, competitive position and strengths of management, credit trends are based on the overall credit profile of the company and do not reflect a forecast of a single credit factor. Improving: The company s credit fundamentals are expected to strengthen over the next 12 months. Stable: The company s credit fundamentals are expected to remain stable over the next 12 months. Declining: The company s credit fundamentals are expected to deteriorate over the next 12 months. Developing: Currently pending changes at the company have the potential to influence the credit trend, either positively or negatively, and these pending changes make current credit trends uncertain. 4 Piper Jaffray Fixed Income Research Xcel Energy
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