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PPL stock is down, but not out
Swept up in an industry downturn, the energy company also has problems of its own.

By Christian Berg
Of The Morning Call

February 3, 2002
Last graph could be good pullout quote: “PPL is better positioned than a lot of companies,” Patterson said. “Considering the storm that's out there, the ship is holding up pretty well.”

PPL Corp.'s stock price gained lots of momentum over the past eight months.

Unfortunately for shareholders, it's been downhill.

Since closing at $58.82 the week of May 28, PPL investors have watched their holdings in the Allentown energy company tumble 44 percent. PPL stock is now hovering at about $33 a share, not far from its lowest 52-week close of $31.19.

PPL executives and financial analysts say the company's stock slide is a combination of several factors, not the least of which is waning investor enthusiasm for energy companies.

“They are in an area that right now isn't very attractive to investors,” said Paul Patterson, an ABN Amro analyst who tracks PPL. “As a result, their [stock] has been hit.”

The Standard & Poor's 500 Electric Utilities Index has fallen 25 percent since peaking in May. The index measures the stock performance of 29 large energy companies, including PPL.

Other index members include Exelon, down 31 percent since May, Reliant Energy, down 48 percent, and AES Corp., down 71 percent.

“All you have to do it look at what's happened in the industry, and you'll see it's not unique to us,” John Biggar, PPL's chief financial officer, said last week. “It's happened to all companies across the board.”

In August, when PPL shares were still trading in the mid-$40s, top PPL executives sold more than 328,000 shares of company stock for almost $13 million.

William F. Hecht, PPL's chairman, president and chief executive officer, sold more than 140,000 shares for $6.4 million. Biggar sold more than 36,000 shares for $712,373.

Biggar said the company's relatively high stock price was a factor in his decision to sell some of his PPL stock. But he said the main reason was to diversify his investment portfolio. Prior to the sale, Biggar said essentially all of his assets were tied up in PPL.

Despite the stock sales, Biggar said PPL's top executives retain sizable holdings in the company and are motivated to get the stock price back up.

“We have multiples of our [annual] base compensation at risk,” Biggar said. “There is a very strong incentive for us to get the stock price as high as possible.”

The energy stock slide coincides with a decline in wholesale electricity prices, which had soared to record levels in late 2000 and early 2001 as California struggled with power shortages and mandatory blackouts.

PPL and other power generators made huge profits selling electricity during the power crunch. When prices came back down, many energy companies were forced to reduce their earnings forecasts, prompting investors to re-think the value of energy stocks.

Wholesale energy sales accounted for 77 percent of PPL's record-breaking $498 million profit in 2000. But last year, PPL's revenue from wholesale energy sales dropped 18 percent, and Biggar said wholesale prices remain at least 20 to 30 percent below their peak.

Patterson said low wholesale prices are “the biggest issue confronting PPL,” and it will continue to impact PPL's stock price.

“We're going to continue to see some volatility in the price of electricity,” Biggar said. “The company's earnings will reflect the level of wholesale energy prices, and…you would expect that the company's stock price would [move] accordingly.”

That's the big picture. But PPL is also struggling with several internal challenges that highlight how much more complicated the company's operations have become over the past several years.

PPL announced last week that it earned $179 million in 2001, down sharply from its record $498 million profit in 2000. During the fourth quarter ended Dec. 31, PPL lost $312 million.

Much of that decline was the result of unexpected losses from things such as lower wholesale prices, a drought in Brazil and the collapse of Enron Corp., formerly the nation's largest energy trader.

“There are risks associated with being in the competitive energy markets,” Biggar said. But “with those risks comes the opportunity to create significant benefits for shareholders.”

In other words, the same deregulated environment that helped PPL make a $498 million profit in 2000 led to the $312 million fourth-quarter loss in 2001.

Prior to the deregulation of Pennsylvania's power industry in 1997, PPL was a relatively small electric utility that generated electricity and distributed it to 1 million or so customers throughout the state.

That was pretty much it. PPL's customer base and energy needs were basically the same from year to year, creating a stable business with predictable annual profits.

But since deregulation, PPL has established a global presence by buying electric utilities in Latin America, South America and Great Britain. The company has also expanded its domestic generation assets by buying power plants in Montana and building others in Connecticut, Long Island and elsewhere.

In 2000, those new assets helped PPL enjoy record profits. But in 2001, unexpected struggles at home and abroad wiped about 70 percent of PPL's operating profits off the books.

The biggest hit came from Companhia Energetica do Maranhao (CEMAR), PPL's electric distribution company in Brazil. A drought caused a severe power shortage in Brazil, because most of the country's electricity is produced at hydroelectric plants.

That forced the Brazilian government to implement power rationing, which drastically reduced CEMAR's revenue. PPL officials said CEMAR also wasn't paid for excess power it sold to other power companies because of problems in the Brazilian wholesale energy market.

As a result, CEMAR is near bankruptcy. In the fourth quarter of 2001, PPL wrote off $217 million of its $317 million investment in CEMAR.

PPL plans to write off the remaining $100 million during the current quarter. Company officials said they might sell CEMAR if they can't work out a deal with Brazilian utility regulators that allows the company to recoup the money it has lost.

Another major blow to PPL's 2001 earnings came in England and Wales, where the company operates electric utility Western Power Distribution.

PPL officials expect British utility regulators to reduce electric rates, which will decrease future revenues at Western Power. As a result, the company wrote off $117 million of Western Power's value.

Biggar said the CEMAR and Western Power situations highlight the new regulatory risks PPL faces as its operations grow.

PPL also faces the possibility of more regulatory problems.

The Pennsylvania Public Utility Commission and U.S. Justice Department recently launched investigations into last year's high wholesale electricity prices in the Mid-Atlantic region.

And in Montana, voters could approve a measure this fall that would allow the state to buy PPL's 11 hydroelectric dams there and operate them as a source of cheap public power.

Patterson, the financial analyst, said PPL must continue to navigate the political waters both at home and overseas.

“Those are the politics you have to deal with being a part of the power business,” Patterson said. “It's a fundamental public necessity, and its price and availability are big voter issues.”

In addition to the international woes, lower U.S. wholesale energy prices forced PPL officials to re-think the company's aggressive power plant construction program. Eventually, they decided wholesale prices didn't justify all the new plants. PPL took an $88 million write-off to cancel six construction projects around the country.

Adding more drag to PPL's 2001 earnings was the collapse of Enron. That took another $28 million off PPL's 2001 earnings, because the company had to write off the value of its long-term energy contracts with Enron.

Without the unexpected write-offs, PPL would have reported 2001 earnings of more than $610 million from its core operations.

Biggar said it's better for PPL to take the write-offs now and hope for better results in the future.

“The write-offs are a risk management action,” Biggar said. “Rather than continuing to pour good money after bad, you take the charge, you get it behind you and grow the company.”

Patterson, the analyst, said write-offs aren't that big a deal.

“Wall Street often doesn't pay all that much attention to one-time write-offs or gains, because they're not seen as an ongoing economic impact,” Patterson said.

In a conference call with financial analysts last week, Hecht pointed out that PPL's core businesses — retail electric sales in Pennsylvania and long-term wholesale energy supply contracts — remain solid despite last year's struggles.

PPL predicts 2002 profits of about $492 million. Hecht noted that more than two-thirds of that profit is already accounted for by retail electric sales to Pennsylvania customers and existing long-term wholesale contracts.

“We think the earnings security is very high,” Hecht said.

Hecht told analysts he expects PPL's international operations to contribute more than $27 million to this year's earnings.

“I don't see a reason to exit” the international markets, Hecht said. “In fact, our operational results have been very strong.”

Hecht also announced last week that PPL is increasing its annual dividend by 36 percent. PPL will pay stockholders $1.44 a share annually, up from $1.06.

A dividend increase is something many investors asked for at last year's annual shareholder meeting.

“We're increasing the dividend in recognition of our strong cash earnings from core operations, and our belief that those earnings will grow over time,” Hecht said.

There are also some new growth areas where PPL is enjoying success, including a new retail electricity supply program for large industrial customers and a growing mechanical engineering business.

Hecht said the engineering business, which offers power plant construction and maintenance services, should add more than $7 million to PPL's bottom line this year.

Patterson, who has a “hold” rating on PPL stock, said he believes the company is in relatively good shape, especially considering low wholesale electric prices.

“PPL is better positioned than a lot of companies,” Patterson said. “Considering the storm that's out there, the ship is holding up pretty well.”

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