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debra@svanda-coyconsulting.com301-854-0471

The View from Wall Street:A Capital Markets Perspective

Debra G. CoySvanda & Coy Consulting

2010 Mid-America Regulatory ConferenceJune 7, 2010

What does Wall Street think of water utilities?

Water utilities’ stock prices have typically held up better than broader market indexes during steep downturns – but have under-performed on recovery rallies

Drinking Water Investment Needs Remain High

Treatment Projects

$ 53.2

Other

$ 2.3

Storage Projects

$ 24.8Source

Projects$ 12.8

Estimate of infrastructure projects needed in 2007-2026 for water systems to continue to provide safe drinking water

Emphasis is on transmission & distribution projects

Pipe replacement cycles are not keeping up with increasing deterioration

Transmission & Distribution

Projects $183.6

($ Billions)

$335 Billion needed for U.S. drinking water utilities over the next 20 years to ensure compliance with existing and future water regulations

Source: EPA’s 2007 Drinking Water Infrastructure Needs Survey & Assessment

Where Does the Money Need to be Spent?

Investor-owned utilities operate in 9 out of 10 states with the greatest infrastructure spending needs

Not shown: Alaska (Less than $1.0 billion) Hawaii (partially surveyed state)

Source: EPA’s 2007 Drinking Water Infrastructure Needs Survey & Assessment

4 of top 9states withgreatest spendingneeds are in MARCterritory

Capital Spending Metrics

Source: CA Turner Report, (2005)

$3.45

$1.61

$1.11

$1.32

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

Water Electric Telephone Gas Dist.

Capital Invested per Dollar of Revenue

Financial Implications of Capital Intensity

• It takes > $3 in capital spending to generate ~ $1 in revenue• Replacement costs continue to rise, dramatically outpacing the book value of

assets in the ground• Water infrastructure has a long asset life, with long depreciation schedules,

especially for transmission pipes

What does this mean?• Consistently negative free cash flow• Necessary to regularly access debt and equity markets to fund capital investments• Important to keep Wall Street comfortable with the “regulatory compact” – that fair

returns will follow the needed investment

Water is the most capital-intensive utility

Capital Spending Metrics

Capital spending is very high relative to D&A and operating cash flow…

Is this sustainable?

Typical ratios for regulated water utilities

Capital spending to depreciation & amortization 3 - 4x

Capital spending to operating cash flow 1.2 – 1.5x

Net plant to revenue 4 – 5x

Is Current Capital Spending Sustainable?

Water utilities can sustain current levels of capital spending

Only if…

Water utilities can regularly access equity & debt markets to fund capital programs

AND, receive fair (and timely) returns on their investments

Otherwise…

By delaying non-mandated capital expenditures, the water utilities could quickly generate positive operating cash and spend closer to their depreciation rates

BUT, then they will fall further behind on needed replacement infrastructure spending

Investment Risk Considerations

– Infrastructure replacement needs– Pressure on critical water supplies– Costly environmental regulations– High cap ex requirements & low depreciation rates– Effects of regulatory lag– Local political risk– Ability to access capital markets

Water utilities are supposed to be low-risk regulated monopolies…

But are they really low risk?

Importance of Regulation

Commissions that work with utilities to minimize rate shock, while stimulating infrastructure investments, are viewed most favorably by the investment community.

• Allowed ROEs and Ability to Earn the Allowed ROE – this is the bottom line

• Consistent Regulatory Treatment

• Timely Decision Making

• Mechanisms to Minimize Regulatory Lag

There is no “one size fits all” approach to regulation – and regulators must balance the needs of investors with the needs of consumers

How Investors Evaluate Regulatory Treatment

Source: US Consumer Expenditure Survey Anthology, (2008)

Annual Household Utility Spending

Water and the Consumer

Water is still a relative small part of the overall consumer utility budget – this helps with the affordability discussion

Consolidation of Small Systems

• Pros– Opportunity for customer growth– Opportunity for additional capital spending with return on

investment

• Cons– High capex needs with lagging return on investment– Potential dilution to overall earned returns on equity

Investor point of view