"The company has continued to be affected by circumstances and events industry. Basically, these include inflation, particularly as evidenced by higher construction costs and fuel prices, the effects of energy conservation, uncertainties as to nuclear regulation and nuclear fuel, difficulties in obtaining an adequate return on invested capital and increased construction costs due to regulatory delays and environmental considerations. Further uncertainties are created by potential regulatory requirements to convert additional oil-fired generating units to coal and by the possible outcome of energy legislation now pending in the congress."
The company that began the prospectus for its latest public offering with that ominous assessment of industry trends was Virginia Electric & Power Co., which this week will sell a $150 million bond issue to the public.
Vepco's warning could apply to almost any electric utility, says Carl Seligson, managing director of the Merrill Lynch White Weld Capital Markets group and the man in charge of raising money for utilities for Merrill Lynch, Pierce, Fenner & Smith, the largest securities firm in the country.
Seligson likes to quote such caveats to investors - once regarded only as boiler plate - to emphasize the difficulties power companies face in raising funds to build new power plants.
Merrill Lynch is the nation's biggest fund raiser for utilies, and the lead underwriter for Vepco's $150 million bond issue, which exhibits many of the symptoms of the industry's capital ailments.
Not only is the utility industry facing unprecedented uncertainties about its business, it also is raising unprecedented amounts of new capital.
In the five years from 1963 to 1967, Seligson, says, utilities raised $22 billion to build new plants. From 1968 to 1972 capital requirements rose to $51 billion and from 1973 to 1977 to $84 billion. In the next five years, he estimates utilities will need $129 billion of expansion funds.
Power companies can probably generate $51 billion of that internally but will need to raise $78 billion in public capital. That will require issuing an estimated $21 billion worth of new common stock, $11 billion of new preferred stock and $46 billion of new bonds, plus another $8 billion to refund bond issues that will mature.
To raise that kind of money in a market where interest rates already are high, competition for funds is tough and uncertainty makes investors skittish, the utilities are offering near record returns on the securities.
In the past year yields on top rated utility stocks have increased by 0.7 percent to 1 percent - 70 to 100 basis points in Wall Street parlance - and yeilds on bonds have increased slightly less, noted Donald Tulis, the utility industry specialist at Loeb Rhoades, Hornblower & Co.
As a result yeilds on utility stocks and bonds today are virtually the same, ranging from about 9 percent to 9 1/2 percent, with bonds generally paying one or two tenths of a percentage point more than comparable stocks.
The narrow and sometimes nonexistent spread between stock and bond yields is a phenomenon that's occurred only once before in the past 18 years, Tulis said. As a result, Loeb Rhoades, Bache Halsey Stuart Shields and other brokers are counseling their customers to invest in utility stocks rather than bonds, taking advantage of what Tulis calls, "a unique opportunity to restructure utility portfolios in favor of equities."
Bache recently began issuing quarterly projections on electric utility dividends, noting that, "investor reemphasis on yield is not a passing trend.
"High current income with the potential for regular dividend increases continues to be the basis for investments in the electric utility industry," Bache said. "Investors who are primarily concerned with capital gains should be wary."
Predicting the majority of utilities will be forced to raise their dividends this year to attract investors, Bache forsees dividends increasing by 3 to 5 percent for the next five years. Among the electric companies which already have raised their dividend this year is Potomac Electric Power Co., which ear boosted its common stock payout by 6 cents per share to $1.34 a year.
Counting the dividend increases and assuming some capital gains, Tulis figures the total yeild on many utility stocks amounts to 12 or 13 percent per year.
That's good news for investors, but not so good for utility companies or their customers, who have to pay higher electric bills when the power company pays higher rates to borrow money.
Ironically, consumer opposition to electric rate increases is one of the factors forcing up the cost of capital for utilities. When state or local regulators turn down or delay requests for higher rates it hurts the utility's credit standing and often makes the company pay higher interest rates, which in turn leads to new requests for higher electric rates.
"Regulatory climate" is the euphemism utility industry sources use to describe public pressure to hold down rates, and from the industry's point of view the climate is not good in Maryland, Virginia or the District of Columbia.
Noting that Richmond-based Vepco has a $246 million rate increase pending in Virginia, Tulis commented, "what kind of a deal can they get in Virginia in an election year?"
Maryland's public service commission recently rejected a Pepco request for higher rates, instead ordering the utility to cut some of its charges. The Maryland agency also turned downa Baltimore Gas & Electric Co. plan to restructure rates.
"I would say that in the minds of a great many analysts (the Maryland commission decision) caused some shift in their attitude toward pepco," complained Stanley Bright, pepco's comptroller.
Seligson, who frequently charges state regulators are to blame for utilities falling out of favor with investors, says utility company executives are afraid to criticize the regulators who rule on their companies' applications for higher rates.
The companies have another public relations problem. On one hand, they want to appear as prosperous as possible to convince investors to buy stocks or bonds at favorable interest rates. But on the other hand, they want to be poor enough to convince regulators that electric rates should be raised.
How a utility attempts to serve its two masters is indicated by Vepco's $150 million bond offering, which will be sold to the public next Thursday. The money will be used to pay off $136 million in short term borrowings that Vepco has used to finance part of its construction this year.
The interest rate Vepco will have to pay will not be known until Wednesday, but the company's offering statement assumes it will be close to 9 1/2 percent.
The rate will be relatively high not only because of Wall Street's displeasure with the state's refusal to give Vepco higher rates, but also because of other factors considered by investors. These factors, according to Loeb Rhoads, Hornblower, include the mix of fuels a company uses to generate its power (coal and nuclear plants are favored) the amount of new construction the company has planned (the less, the better) and the amount and quality of earnings the company has to cover its dividend and interest payments.
With 25 percent of Vepco's power coming from its three atomic power plants and more than 40 percent more of its electricity generated by coal, the company's fuel mix gets a favorable rating, analysts generally agree.
But Vepco plans to spend $2.1 billion on new plants in the next five years and to finance 60 to 65 percent of that through new securities offerings. The company's growth forecast of 5.3 percent per year is above average as is the portion that will have to be raised publicly.
This year alone, Vepco is pouring $600 million into new plants and going to the market for $454 million. The big Virginia utility has raised $102.2 million from notes, $55 million from bonds, $35.5 million from preferred stock and minor millions from other sources. In addition to the $150 million bond sale, Vpeco plans an $80 million common stock offering later this year.
Vepco's massive construction program is a major reason why Vepco stock is not on the Loeb Rhoades "buy" list. pepco is regarded more favorably because its shopping list for construction and financing is shorter and its projected growth rate of 2.3 percent for the next five years is lower.
Potomac Electric has about $865 million worth of construction planned for the next five years and needs about $1 billion in capital including refinancings. It says it expects to be able to raise "a substantial portion" of that internally, probably at least 50 percent.
Pepco's only public offering this year will be a $30 million preferred stock issue.