Competitive utilities have been under pressure due to their lower wholesale power prices. In such a scenario, these utilities resort to debt to maintain their liquidity. Let’s see which utilities in our review could be approaching concerning leverage levels.
The largest utility in our analysis, Exelon Corporation (EXC), had net debt of $34 billion at the end of 3Q16. EXC has a net debt-to-EBITDA[1. earnings before interest, tax, depreciation, and amortization] ratio of 4.5x, slightly above the industry average.
The net debt-to-EBITDA ratio is often used to measure a company’s ability to repay debt using its EBITDA. It is commonly used by rating agencies to determine a company’s credit rating, and a lower ratio is better than a higher ratio.
In comparison, FirstEnergy (FE) had net debt of $22.1 billion at the end of 3Q16. It net debt-to-EBITDA ratio was 4.7x. Public Service Enterprise Group (PEG) had net debt of $10.5 billion at the end of 3Q16, and its net debt-to-EBITDA ratio was 2.9x. At the end of 3Q16, utilities had leverage levels near 4x. Public Service Enterprise Group appears to have the least risky leverage level in this group.
Impact of interest rate normalization
Utilities’ debt levels significantly increased during the last seven to eight years, mainly to take advantage of the near-zero interest rates. Debt levels nearly doubled in many cases, particularly in large-cap utilities due to their interest in mergers and acquisitions. However, as the Fed has started to normalize interest rates in the US, utilities’ leverage may stabilize.