Gabelli & Company, Inc.

Transcription

1 One Corporate Center Rye, NY Tel (914) Fax (914) March 13, 2003 Gabelli & Company, Inc. Great Plains Energy (GXP--$ NYSE) Buy High Yield & Low Risk FYE PMV (1) EPS P/E 2004P $32 $ x Dividend: $1.66 Current Yield: 7.3% 2003E Shares O/S: 69.2 million 2002A Week Range: $ $ A (1) Private Market Value per share. Investment Summary Great Plains Energy is the holding company that owns the regulated electric utility Kansas City Power & Light Company (KCP&L). The regulated utility operations of KCP&L serve 475,000 customers in portions of Missouri and Kansas, two states that have no plans to move toward utility deregulation. Great Plains also owns 89% of Strategic Energy, a fee-based energy management company that sells electricity under long-term contracts to large customers in deregulated markets. Strategic Energy is not an electricity trader. A third, and smaller subsidiary is KLT Gas Inc., that specializes in coal bed methane exploration and development. Great Plains Energy also has several investments in affordable housing limited partnerships that are owned by its KLT Investments subsidiary. For the full year 2002, about 75% of net income was derived from the regulated electric utility KCP&L while Strategic Energy provided about 25%. Essentially, the common stock of Great Plains Energy is a good way for investors to own an old-fashioned regulated electric utility with a relatively high, safe current yield (around 7%), but also participate in the upside from the strong earnings growth that appears likely to continue at Strategic Energy. Opinion We believe that in an environment of slower economic growth and more modest stock market returns, the yield on a stock carries greater importance. Furthermore, bond yields are at their lowest levels in forty years. With this backdrop, a stock like GXP with a relatively secure 7%+ yield deserves more attention from investors. Great Plains Energy common shares appear undervalued on a relative yield basis and on a relative P/E basis. GXP common shares have a current yield of 7.3% versus the average electric utility stock that yields only 5.0%. Similarly, GXP looks cheap on a relative P/E basis, with a 2003 P/E of only 11.7x compared with a 12.5x average P/E ratio for utility stocks that have little or no merchant energy operations. Key Investment Considerations: High safe yield of more than 7% Low-risk business mix Utility operations are regulated with no prospect for becoming deregulated Earnings growth should accelerate from expansion of Strategic Energy s business into additional states Solid balance sheet following 6.9 million share offering in November 2002 Much higher natural gas prices create opportunity for positive surprise from coal bed methane properties In the long run, a utility the size of GXP, could become a takeover target The Chairman, President and CEO of GXP, Bernie Beaudoin, announced on March 13, 2003 that he plans to retire. Mr. Beaudoin said he will stay with GXP until his successor is hired. We do not expect any change in GXP s fundamentals to occur as a result of Mr. Beaudoin s retirement. -Please refer to important disclosures at the end of this report-

2 Gabelli & Company, Inc. Table 1. Great Plains Energy Components of Annual EPS 2002A 2003E 2004P 2005P Kansas City Power & Light $1.64 $1.50 $1.55 $1.60 Strategic Energy KLT Gas (1) 0.00 (0.05) (0.03) 0.00 KLT Investments Other (0.25) (0.10) (0.09) (0.10) Total EPS Continuing Operations $2.04 $1.95 $2.10 $2.25 (1) Earnings from KLT Gas are transaction driven and could be much higher than the estimates shown in the table if the company sells any coal-bed methane producing properties. Source: Company data and Gabelli & Company, Inc. estimates. Table 2. Great Plains Energy Private Market Value Model 2000A-2004P ($ in millions, except per share data) 2000A 2001A 2002A 2003E 2004P Total Revenue $1,115.9 $1,462.0 $1,861.9 $2,056.7 $2,277.2 Utility EBITDA Multiple Value $2,902.4 $2,604.0 $2,688.0 $2,752.0 $2,832.0 Non-Utility EBITDA $31.5 $62.0 $107.1 $115.2 $123.5 Multiple Value $157.5 $310.0 $535.5 $576.0 $617.5 Plus Value of Coalbed Methane Assets $47.7 $43.4 $45.4 $70.0 $70.0 Total Value $3,059.9 $2,914.0 $3,223.5 $3,328.0 $3,449.5 Less: Net Debt & Preferred 1, , , , ,306.6 Less: Net Options Payments (1) Private Market Value $1,726.8 $1,367.0 $1,856.1 $2,035.4 $2,211.2 Shares outstanding (2) 69.2 (2) 69.2 PMV $28 $22 $30 $29 $32 Discount to PMV 18% -3% 23% 22% 29% Source: Company data and Gabelli & Company, Inc. estimates. (1) Payments to buy out options holders at PMV, net of taxes. (2) Reflects the impact of the sale of 6.9 million shares of common stock in November

3 Gabelli & Company, Inc. KCP&L is a Strong, Low-Risk Regulated Utility By far, the largest business owned by the holding company GXP is the electric utility, Kansas City Power & Light (KCP&L). The utility serves the city of Kansas City and surrounding counties in western Missouri and eastern Kansas. Neither of the two states has shown any interest in moving toward utility deregulation. KCP&L is one of the smaller utilities in the U.S. serving approximately 475,000 retail electric customers. The utility has relatively low rates due to its fleet of low-cost base-load generating plants. The fuel mix is approximately 23% nuclear, 75% coal and the remaining 2% from oil- and gas-fired peaking units. The company s cost of coal consumed in its power plants is among the lowest in the U.S. due to its proximity to abundant cheap lowsulfur coal from mines in the western United States. Current contracts with coal suppliers are projected to provide about 95% of coal requirements in 2003 and 55% for 2004 and KCP&L owns 47% of the Wolf Creek nuclear plant, which has been one of the top performing nuclear plants in the world since it began operations in In June 2001, the utility completed the rebuilding of its largest coal-fired generating unit, Hawthorn Unit 5, a 565 MW generating unit. With its new boiler, Hawthorn Unit 5 is ranked as the cleanest coal-fired power plants in the U.S. The utility expects to add five new combustion turbine peaking units, with a total capacity of 385 MW, during This would complement KCP&L s system that is presently heavily weighted toward baseload power plants. Regulatory matters are settled in both Kansas and Missouri for KCP&L: KCP&L has a regulatory settlement with the state of Kansas that runs through In early 2002, the Kansas Corporation Commission (KCC) approved a plan that creates a rate moratorium until 2006 in exchange for KCP&L s agreement not to seek recovery of $16.5 million of ice storm costs. In addtion, KCP&L agreed to a rate cut of $12.4 million effective January 1, In August 2002, the Missouri Public Service Commission (MPSC) approved a plan to allow KCP&L to defer and amortize $20.1 million through 2007 that relates to costs from a major ice storm in January In October 2002, the staff of the MPSC completed a review of KCP&L s earnings and concluded that there was no need to either increase nor decrease the current rate levels. We expect the utility operations of Kansas City Power & Light to grow earnings at a relatively steady rate of 2% to 3% a year. In addition, we expect the utility to be net cash flow positive and to remain fully regulated. In the past few years, not a single state in the U.S. has moved toward utility deregulation (even though 24 states are deregulated). During the years , when the movement to deregulate utilities was at its peak, states with relatively low electric rates like Kansas and Missouri showed no interest in following the trend. They are even less likely to deregulate now. KCP&L has been targeted in the past as a takeover target. A few years ago, Western Resources (now known as Westar Energy) outbid another neighboring utility, UtiliCorp (now known as Aquila Corp.) to acquire Kansas City Power & Light Company. However, by the end of 1999, when the merger was still awaiting regulatory approvals and with the value of Western s stock sharply lower, KCP&L exercised its option to terminate the merger. Table 3. Great Plains Energy - 3 -

4 ($ millions) Sources Of Cash Cash Flow Projections 200A 2004P Gabelli & Company, Inc. 2000A 2001A 2002A 2003E 2004P Cash Flows from Operating Activities Net for common from continuing oper. $103.4 $69.0 $127.4 $134.9 $145.1 Depreciation and amortization Deferred income taxes, net (33.8) (4.6) Other cash flow from operating activities Net cash provided by operating activities $231.5 $299.7 $320.8 $304.9 $319.1 Cash Flows from Financing Activities Issuance of new long-term debt $500.4 $249.6 $228.9 $50.0 $50.0 Issuance of short-term debt, net Issuance of trust preferred securities Other financing activities (5.9) (6.9) Issuance of common stock Total cash flow from financing activities $494.5 $383.4 $380.7 $50.0 $50.0 Proceeds from asset sales $226.0 $66.5 $7.8 $25.0 $25.0 Insurance recovery proceeds $50.0 $30.0 $0.0 $0.0 $0.0 Total Sources Of Cash $1,002.0 $779.6 $709.3 $379.9 $394.1 Uses Of Cash Uses of cash for investing activity Construction expenditures $413.2 $271.2 $131.2 $137.0 $144.0 Acquisitions and other investments Loan to DTI Other investing activities Net cash used for investing activity $513.2 $487.7 $157.9 $172.0 $179.0 Uses of cash for financing activity Retirement of long-term debt Retirement of short-term debt Redemption of preferred stock Common stock dividend payments Net cash used for financing activities $467.4 $297.4 $515.1 $214.9 $219.9 Total Uses Of Cash $980.6 $785.1 $673.0 $386.9 $398.9 Beginning cash & temporary investments $13.1 $34.5 $29.0 $65.3 $58.3 Increase (decrease)in cash and temp. inv (5.5) 36.3 (7.0) (4.8) End of period cash & temp. investments $34.5 $29.0 $65.3 $58.3 $53.5 Source: Company data and Gabelli & Company, Inc. estimates Strategic Energy Is Poised For Strong Earnings Growth Strategic Energy Incorporated (SEI) is not a power marketer. SEI provides fee-based services to large consumers of electricity and natural gas. SEI provides load aggregation and power supply coordination services. It is one of the largest retail energy providers in the U.S. even though SEI operated in only six states in 2002 and is expanding into two additional states in SEI is both earnings positive and cash flow positive. During 2002, SEI operated in six states that have deregulated electricity markets: California, Texas, New York, Pennsylvania, Ohio and Massachusetts. In 2003, SEI is expanding into two additional states Michigan and New Jersey. SEI s customers are primarily large commercial locations and institutions. Nearly half of SEI s business is with commercial establishments such as office buildings, big-box retailers and other commercial locations. Most of the other half of the business is with government facilities, educational institutions and healthcare facilities. About 5% of SEI s business is with small manufacturing plants. The service that SEI provides is to essentially shop for power objectively for customers that are located in states that have deregulated electricity markets. SEI operates a real-time Energy Management Center that shops for power 24 hours a day, year-round, from hundreds of power suppliers

5 Gabelli & Company, Inc. SEI aggregates its customers to obtain economies of scale in shopping for wholesale power. It can use its presence and knowledge of the markets to obtain better deals for customers. SEI also enables customers to sell off energy that they do not need, thereby lowering their net cost of power. SEI s business is fee-based. Customers pay a fee, similar to a brokerage fee, to SEI in return for SEI s services. SEI rarely goes long on electric power in any market, except for small amounts when SEI enters a new market The typical method of expansion is for SEI to first sign up the customer to a long-term contract and then to procure the electric power for the customer. The average contract length for SEI is 2 ½ years. SEI has only touched the tip of the iceberg in terms of earnings potential, in our opinion. SEI currently has over 33,000 customers in just six states. SEI is one of only about 5 or 6 multi-state retail electricity marketers. There are approximately 14 million commercial customers in the U.S. and approximately half of them are in the deregulated states where customers are allowed to choose their supplier. In the early years of deregulation, most of the attention by power marketers was focused on the huge industrial customers because they consume such large amounts of electricity in one location. Commercial customers (which also include most institutions like universities and hospitals) received much less attention from marketers. There are many reasons why we think that SEI can growth rapidly for several more years: SEI has the back-office infrastructure in place to expand into new markets. SEI operated in only in 6 of the 24 deregulated states during SEI has an experienced team of sales personnel that can be moved to new markets when SEI decides it is the right time to make a marketing push. SEI has built regional relationships with several large companies that have the potential to become superregional and eventually national accounts (see example below regarding McDonald s restaurants). SEI already has regional relationships with large national retail chains and large supermarket chains. There are few other profitable retail electricity marketers that operate in more than one state. SEI and its few competitors do not have to fight over market share. There is a huge untapped market for selling power to commercial customers. SEI has experienced about a 95% customer retention rate. Recent big contract with McDonald s restaurants is a good example of SEI s potential. In November 2002, SEI reached an agreement with McDonald s Corporation to be the electricity supplier to more than 600 McDonald s restaurants in the state of California. This is SEI s first big relationship with McDonald s. It could lead to similar relationships with hundreds of other McDonald s restaurants in several other states. GXP s Coal-Bed Methane Properties are a Hidden Asset It appears to us that the stock market is not giving Great Plains Energy any credit in its valuation to reflect the value of the company s 220,000 acres of coal-bed methane development properties in four basins in the Midwest and Rocky Mountains. GXP has experience in the exploration and production of coal-bed methane. In the past several years, GXP has been successful in acquiring, developing and then divesting coal-bed methane properties. The more than doubling of the price of natural gas over the past year has significantly increased the value of GXP s holdings. In 2003, GXP plans to drill several pilot wells on its coal-bed methane acreage. At the present time, most of GXP s coal-bed methane properties are carried on the balance sheet at book value of approximately $45 million because there is not yet much production. If and when successful wells are drilled, GXP is likely to be able to sell these properties for a bigger mark-up than it received a few years ago when it sold productive acreage at a time when natural gas prices natural gas prices were much lower. During 2001, GXP sold coal-bed methane producing properties for $42.3 million, resulting in an after-tax gain of $12.0 million. Resolution of DTI Bankruptcy Might Provide a Small Payment to GXP A subsidiary of Great Plains Energy, KLT Telecom, is both an equity investor and a creditor of DTI Holdings. DTI owns a multi-state fiber-optic network and it filed for Chapter 11 bankruptcy on December 31, GXP wrote down its entire equity investment in DTI to zero at the end of GXP is a creditor of DTI and thus has filed a claim with the bankruptcy court. In December 2002, DTI entered into an agreement to sell substantially all of its assets to CenturyTel Fiber Company II, LLC for $38 million, and in February 2003 the bankruptcy court approved the asset sale. It is now up to the court to decide how much of the sale proceeds will be allocated to each creditor of DTI

6 Table 4. Great Plains Energy Earnings Model 2000A-2004P Gabelli & Company, Inc. ($ millions, except per share) 12/31 fye 2000A 2001A 2002A 2003E 2004P Revenue Electric sales revenue $1,063.8 $1,363.5 Electric revenues - KCP&L $1,009.9 $1,019.7 $1,040.1 Electric revenues - Strategic Energy $788.3 $982.0 $1,182.0 Natural gas Other Total Operating Revenue $1,115.9 $1,462.0 $1,861.9 $2,056.7 $2,277.2 Operating Expenses Fuel $153.1 $163.8 $159.7 $163.2 $166.5 Purchased power - KCP&L $47.2 $48.2 Purchased power - Strategic Energy ,050.0 Gas purchased and production expen Other operation Maintenance Depreciation & depletion General taxes Total Operating Expenses $854.0 $1,233.3 $1,570.4 $1,755.8 $1,964.0 Operating income before interest and taxes $261.9 $228.7 $291.5 $300.9 $313.2 Other income, net (28.0) (29.8) (25.1) (25.0) (25.0) Total income before interest & taxes $233.9 $198.9 $266.4 $275.9 $288.2 Interest expense $75.7 $103.3 $89.1 $85.0 $83.0 Income before income taxes $158.2 $95.6 $177.3 $190.9 $205.2 Income tax expense Net income $105.0 $70.6 $129.0 $136.5 $146.7 Preferred dividend requirements $1.6 $1.6 $1.6 $1.6 $1.6 Net available for common $103.4 $69.0 $127.4 $134.9 $145.1 Average common shares outstanding (1) 69.2 (1) 69.2 Earnings Per Share $1.67 $1.11 $2.04 $1.95 $2.10 EBITDA $394.3 $387.5 $443.1 $448.9 $465.2 (1) Reflects the impact of the sale of 6.9 million shares of common stock in November Excludes nonrecurring items. Sources: Company data and Gabelli & Company, inc. estimates Barry M. Abramson, CFA (914) Gabelli & Company, Inc ONE CORPORATE CENTER RYE, NY GABELLI & COMPANY, INC. TEL (914) FAX (914) Gabelli & Company, Inc. ( we or us ) attempts to provide timely, value-added insights into companies or industry dynamics for institutional investors. We do not have any formal ratings system for our research reports, and we do not undertake to upgrade or downgrade ratings after publishing a report. We generally write reports on securities that we believe to be undervalued and do not issue any sell ratings. Thus, virtually all of our reports containing recommendations would be considered buy ratings. We prepared this report as a matter of general information. We do not intend for this report to be a complete description of any security or company and it is not an offer or solicitation to buy or sell any security. All facts and statistics are from sources we believe to be reliable, but we do not guarantee their accuracy. We do not undertake to advise you of changes in our opinion or information. Unless otherwise noted, all stock prices reflect the closing price on the business day immediately prior to the date of this report. We do not use price targets predicting future stock performance. We do refer to private market value or PMV, which is the price that we believe an informed buyer would pay to acquire 100% of a company. There is no assurance that there are any willing buyers of a company at this price and we do not intend to suggest that any acquisition is likely. Additional information is available on request. In the last 12 months we have provided investment banking services as a syndicate or selling group member of underwritten offering to approximately 2% of the companies that were the subjects of our research reports (all of which would be considered buy ratings). Our affiliates beneficially own on behalf of their investment advisory clients or otherwise approximately 0.59% of Class A common stock of GXP. Because the portfolio managers at our affiliates make individual investment decisions with respect to the client accounts they manage, these accounts may have transactions inconsistent with the recommendations in this report. These portfolio managers may know the substance of our research reports prior to their publication as a result of joint participation in research meetings or otherwise. The analyst who wrote this report may receive commissions from customers transactions in the securities mentioned in this report and may receive compensation that is based upon (among other factors) our revenues from acting as a syndicate or selling group member in underwritten offerings - 6 -