Updated from 10:50 a.m.
is ready for its long roller-coaster ride to end.
After peaking with the merchant energy boom -- and plunging with its collapse -- Duke is stepping off the growth-stock machine and seeking safety as a stable utility again. It is keeping its rich dividend, currently deemed "higher than desirable" even by management, and sacrificing rapid growth instead. It plans to sell some of its most distressed power assets and take a $3.3 billion hit in the process. And it will finally join a parade of struggling peers by winding down the trading operation that helped power its rise and fall.
Clearly, turnaround CEO Paul Anderson -- a motorcycle enthusiast known to like a thrill -- is seeking a calmer road ahead for Duke investors.
"Having considered our shareholder base, current capital structure, investment opportunities and earnings potential, we have adopted an investment proposition of income with modest growth as opposed to a high-growth/low-income strategy," Anderson wrote in a letter to shareholders on Wednesday. "Consequently, we are maintaining an annual dividend of $1.10 per share. ... The dividend is one issue that impacts your investment in Duke Energy so explicitly, and has garnered so much attention lately, that we thought on this occasion direct communication with you was appropriate."
Anderson's long-awaited announcement came just one day after a prominent Wall Street analyst predicted that Duke would cut its dividend as early as next week. The forecast by Steve Fleishman of Merrill Lynch pushed Duke's shares down 1.4% to $20.03 on Tuesday. The stock bounced 6% to $21.24 Wednesday morning after the dividend remained intact. But Wall Street -- which had counted on a dividend cut as part of Duke's recovery -- has already warned that serious challenges lie ahead.
Cutting to the Chase
Fleishman was hardly alone in expecting, and even welcoming, a dividend cut.
Dan Eggers of Credit Suisse First Boston predicted a dividend cut of up to 60% -- double Street expectations -- just a few weeks ago. He also assumed that Duke would avoid selling domestic merchant energy assets at the bottom of the market.
Instead, Duke has laid out plans to shed power plants in perhaps the most glutted region of the country. It will sell power plants, representing one-third of its merchant portfolio, located in the Southeastern United States. Previously, Duke had shied away from merchant sales after fielding bids of "20 cents on the dollar for state-of-the-art facilities."
Questioned by analysts about the change of heart, Anderson said the company had determined it was better to sell the assets now than to "hold on to them and hope for something better" down the road. He pointed out that Duke would enjoy overhead savings and "significant" tax benefits as a result. But he also acknowledged that the company will weather huge impairments in the process.
"The book values of certain of these merchant power plants must be written down," Anderson said. "We have adopted a strategy of reducing our exposure in this area by committing to a sale of our plants in the Southeast U.S., reducing our exposure in our deferred plants and winding up our trading and marketing joint venture with
That venture, Duke Energy Trading & Marketing, has worried some observers for a while. Its credit has been dangling just one notch above a junk rating that would trigger expensive collateral calls and threaten the rating of Duke subsidiary Duke Capital, and possibly even the parent itself.
Duke's decision to shut down DETM doesn't come as a total surprise. Although dismissed by Duke as untrue, rumors have been circulating that ExxonMobil -- the more creditworthy partner in the venture -- has already stopped funding DETM. And some believed that Duke, threatened by an expensive DETM downgrade, might eventually do the same.
But others felt that Duke would remain committed to its giant trading shop. Prudential analyst Carol Coale asked management on Wednesday whether Duke had simply been shifting its trading business from DETM to merchant division Duke Energy North America, where it could carry out trades on its own. And Duke did indicate that its trading days are not really behind it.
"We will not be totally exiting trading," management said, adding that it will instead halt the speculative and financial trading carried out by the DETM joint venture. Indeed, the company said that "the majority of positions have been sold off or eliminated" at DETM already, and the remainder should wind down over the next year or so.
Anderson described the DETM exit as a "cash-positive" decision for the company.
Still, analysts clearly remain worried about Duke's credit rating. Right off the bat, they questioned Anderson about whether the ratings agencies had seen -- and responded to -- the company's plans. The new CEO offered reassurance. And interim CFO David Hauser insisted that the company's debt-reduction strategy supports current credit ratings that should only strengthen in the future.
"We're very comfortable with where we are and what they'll do," Anderson said of the ratings agencies. But "we'll be dealing with them further."
To be sure, Anderson's plans differ vastly from those expected by Wall Street.
In a "to-do list" published for Anderson shortly after the CEO's arrival, for example, Fleishman warned that maintaining the current dividend would be "a real stretch" if Duke hopes to slash debt and, thus, protect its credit. Instead Anderson hopes to use operating cash flow and proceeds from asset sales to cut debt by up to $4 billion this year. Still, the company does plan to shed some of the assets Fleishman originally suggested. In addition to power plants at Duke Energy North America, Duke intends to sell its international assets in Australia.
Eggers, who also predicted the Australian sales, has estimated that Duke could pick up between $500 million and $1 billion for the assets Down Under. But he also sees the company taking a big charge, ranging from $200 million to $500 million, in the process.
Duke announced a pretax charge of $280 million that falls at the lower end of that range. But the company will take far bigger charges, totaling $2.8 billion, at the DENA unit.
Still, Fleishman has already indicated that he would be comfortable with even larger impairments. He calculated, more than two months ago, that Duke could afford charges of up to $6 billion without triggering any of its bank covenants.
Duke confirmed on Wednesday that it risks no violations.
"There is no covenant test that is at any risk with this set of decisions," management said.
Even so, Duke said the charges will lead the company to a 2003 loss of $1.45 to $1.50 a share. Excluding the special items, the company expects to meet its reduced full-year guidance of $1.20 to $1.25 a share.
Duke expects DENA to drag down earnings "for the next year at a minimum," with the unit losing $300 million in 2004 alone. But its new 2004 guidance of $1.20 a share continues to match consensus estimates.
Senior management will receive no short-term bonuses if Duke misses that target by more than a dime.
"To demonstrate our commitment to this proposition, the management incentive plan has been designed to provide no payout at the most senior level if the company's earnings per share fall below the dividend objective of $1.10 a share," Anderson said. "Target earnings for the incentive plan have been set at $1.20 per share, which reflects a realistic base from which we can re-establish earnings momentum."
Still, some analysts questioned whether that arrangement simply keeps the company's dividend safe for just another year. Duke itself said it hopes to achieve a 70% payout -- requiring earnings of $1.50 to $1.60 a share -- in the future. But it stopped short of guessing when it might regain the earnings power needed to reach that goal.
"This company can clearly get to that position," Anderson pledged. "I think we've accomplished a hell of a lot and put a strong base in place.
But the last thing I want to do is hang out numbers ... that I'm going to have to live with" long down the road.
Anderson plans to offer a more detailed long-range plan for the company next month.