Utilities borrowed heavily in the post-financial crisis in order to take advantage of the near-zero interest rates. As a result, the leverage of utilities increased significantly after the crisis. But their earnings didn’t increase in line with the debt because of the falling demand for energy.
The chart below shows the leverage of selected utilities as of December 31, 2015.
Net debt-to-EBITDA ratio
Duke Energy’s (DUK) debt pile nearly doubled after 2012. Its annual interest expenses amount to nearly 30% of its total annual operating income. As of December 31, 2015, its net debt-to-EBITDA (earnings before interest, tax, depreciation, and amortization) ratio stands at 4.7x, which is higher than Southern Company’s (SO) at 4x. PG&E’s (PCG) and Dominion Resources’ (D) net debt-to-EBITDA ratios are 4x and 5.5x, respectively.
Net debt-to-EBITDA ratio is often used to measure a company’s ability to repay debt using its EBITDA. It’s commonly used by rating agencies to determine a company’s credit rating. A lower ratio is considered better from a credit perspective.
More highly regulated operations are credit positive according to rating agencies due to comparative earnings stability. Duke Energy and Southern Company both have credit ratings of “A-” and a “negative” outlook from Standard & Poor’s. Dominion Resources has a “stable” outlook and a “BBB+” rating. PG&E has a “BBB” rating with a “positive” outlook. At the end of the fourth quarter of 2015, utilities (IDU) overall had a credit rating of “BBB+” from Standard & Poor’s.
To learn more on credit rating, read Credit ratings: Another bubble in the making?
In the next part, we’ll see why regulated utilities are trading at a discount to historical yields.