Still No Clarity at Enron

The energy-trading giant's earnings continue to raise more questions than they answer.
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Battered energy giant

Enron

(ENE)

strove to get back in the good graces of investors Tuesday when it released third-quarter operating earnings that met estimates.

Notably, Enron also claimed its third-quarter numbers offered improved financial disclosure to investors, who have long worried about the quality of earnings at the energy trader. But earnings numbers arguably got murkier, as the company removed a key line item from its income statement and took more than $2 billion in charges and writedowns that could lead to a credit downgrade.

Equally worrying, even as European trading revenue surged, profits in the region stagnated as energy prices mostly stabilized. If this phenomenon spreads to the U.S., the company's earnings growth targets would be hard to achieve. (Enron makes most of its money by profiting off the movement of energy prices.)

Enron didn't respond to a telephone call and an email seeking comment for this piece. Its stock was up 50 cents at $33.67, though it remains 60% below its 52-week high following a year of turmoil at the Houston company.

What They Want

Enron posted third-quarter operating earnings of 43 cents a share, exactly what analysts had expected for the quarter and 26% above a year ago. Including the charges, Enron lost 84 cents per share in the quarter.

Recognizing investor frustration over disclosure, the company said its release "expands financial reporting." It does give more detail for some of its business segments. However, it still doesn't provide a balance sheet, and it removed key data on contract values for its retail business. Most important, Enron has made it even harder to get a view on a frequent contributor to profits -- asset sales.

Investors have complained that it's hard to see how much the company is relying on asset sales, as opposed to trading gains, in its dominant business segment, wholesale services. This unit reported a massive $46 billion in third-quarter revenue, equivalent to 97% of the total. Notably, wholesale services revenue posted its second sequential decline this year, following several quarters of increases.

Previously, operating earnings for wholesale services' two units -- assets and investments, and commodity sales and services (primarily trading) -- were broken out in earnings releases. However, revenues were not separated out, making it impossible to arrive at operating margins for the segments.

Now, in the third-quarter release, investors don't even get to see separate operating earnings. As a result, expect the questions over the contribution of asset sales to continue.

Is Seeing Believing?

Questions also aer swirling around the $1 billion in after-tax restructuring charges that the Houston-based company took in the quarter, as well a $1.2 billion writedown to shareholders' equity that wasn't mentioned in the press release, but came out in the earnings conference call held Tuesday morning. Both adjustments prompted Moody's to put Enron's long-term debt on review for a downgrade in its rating.

The $1 billion of charges deserve a closer look. The charges came from three sources: $287 million due to the impairment of water assets; $180 million associated with Enron's sickly broadband operations; and $544 million stemming from investments the company has made.

Of course, restructuring charges are a regular part of business. But when operating expenses are reduced markedly in the very same quarter that the charge is taken, suspicions rise that the company in question is tucking core costs into the charge.

On that note, Enron's third-quarter operating expenses of $910 million were well below the $1.03 billion recorded in the prior quarter income statement filed with the

Securities and Exchange Commission

, and even below the $929 million recorded in the year-ago period. And losses in Enron's broadband unit do look large, compared with those posted at

Dynegy

(DYN)

, for example.

Moody's said Tuesday it had put Enron's long-term debt rating of Baa1 on review for a downgrade, citing "significant writedowns and charges." Standard & Poor's and Fitch made no changes in their stances Tuesday. But they may follow Moody's if Enron takes more charges.

CEO Ken Lay said on the conference call that he expected no credit downgrades and said that if other assets had been impaired the company would've included them in third-quarter charges. However, when asked if more charges could come, he responded with what he termed "three areas of uncertainty." These were assets connected to broadband, as well as Californian and Indian businesses, he said.

Around in Circles

The $1.2 billion reduction in shareholders' equity stemmed from a "removal of an obligation to issue a number of shares," Lay said on the call. He didn't say anything more about the obligation. But it may have been part of transactions with a related party called LJM Capital. LJM has recently drawn much criticism because, until recently, it was headed by Enron's finance chief, Andrew Fastow, and because disclosure of the transactions appears to show Enron had lent the entity money to buy Enron stock.

Enron may have unwound dealings with LJM in the third quarter. The release said an undisclosed portion of the restructuring charge resulted from "early termination during the third quarter of certain structured finance arrangements with a previously disclosed entity." This could've been LJM.

Finally, European wholesale operations showed poor earnings. On Europe, Enron's release said: "The low level of volatility in the gas and power markets caused profitability to remain flat" at $53 million in the third quarter, against the year-ago period. This a stark indication that revenue can grow massively -- it was up 130% in Europe over the year -- and earnings can remain stagnant. This is because Enron does best when it can exploit volatility. If freer energy markets lead to lower volatility in the U.S., then the same flattening could occur here.

Know any companies that the market may be misvaluing? Detox would like to hear about them. Please send all feedback to

peavis@thestreet.com.

In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.