ML19326D130
| ML19326D130 | |
| Person / Time | |
|---|---|
| Site: | Midland |
| Issue date: | 02/28/1977 |
| From: | Meltz A NRC COMMISSION (OCM) |
| To: | |
| Shared Package | |
| ML19326D119 | List: |
| References | |
| NUDOCS 8006060678 | |
| Download: ML19326D130 (7) | |
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v' UNITED STATES OF AMERICA NUCLEAR REGULATORY COMMISSION BEFORE THE ATOMIC SAFETY AND LICENSING BOARD In the Matter of CONSUMERS POWER COMPANY Docket Nos. 50-329 50-330 (Midland Plant, Units 1 and 2) )
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NRC STAFF SUPPLEMENTAL TESTIMONY OF ARNOLD H. MELTZ ON APPLICANT'S AGILITY TO FINANCE CONSTRUCTION OF THE MIDLAND PLANT The ability of an investor-owned utility to finance a construction program over a future period is a function of a number of variables, the most im-portant of which is the level of profitability. Profitability can be as-sessed by referring to the return a company earns on the capital it employs in its business and comparing it to the risk-adjusted returns earned else-where in the economy. The concept of a fair rate of return on investment is deeply ingrained in public utility regulation. Whether or not an elec-tric utility can finance a construction program requiring large amounts of external financing will depend in part on its abil.ity to earn such a fair rate of return.
A fair rate of return on total capital will result in the return on comon equity being fair and reasonable, since comen equity is a component of total capital. All other things being equal, this latter re-turn is the best indication of a company's profitability and will have a substantial impact on other facets of a company's financial performance.
l Although a fair rate of return might be characterized as the most 8'O O 6 0 6 0 i
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- significant variable affecting a company's ability to finance its proposed construction program, it needs to be coupled with a reasonably balanced capital structure to be assured that senior securities will remain market-able. The average investor-owned electric utility historically has had a capital structure comprised of around 50-55 percent long-term debt,10-15 percent preferred. stock, and 30-40 percent common equity. Given a particular capital structure with its embedded costs of debt and preferred stock, the return on common equity will determine the level of interest and preferred dividend coverages. These coverages in turn will significantly affect the ratings assigned to a company's senior securities by the principal rating agencies and, consequently, the price demanded by the marketplace to pur-chase these securities. The return on common equity will also affect the expected rate of dividend growth and thus the price and attractiveness of the ccmpany's common stock. When large amounts of securities need to be sold to finance a construction program, the ability to sell common stock is the key to the maintenance of a reasonably balanced capital structure.
In addition, the return on common equity affects the level of internally generated funds through its impact on retained earnings, although the primary source of internally generated funds is depreciation.
The achievement by Consumers Power Company of an adequate level of profitability, i.e., a fair rate of return, depends in large part on the responsiveness of the regulatory authorities, primarily the Michigan 9
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. Public Service Commission. Rational regulatory policies dictate that rates be set to cover the cost of service, including the cost of capital.
Assuming rational financial planning, it is axiomatic that such rates will enable a company to maintain its credit and attract the capital neces-sary to meet anticipated construction expenditures. Given a persistent inflationary bias in our economy, it must be assumed that Consumers Power Company will be requesting rate relief from the regulatory authorities on a regular basis. Indeed, Consumers Power Company's recent common stock prospectus, dated November 9,1976, states: "The Company will nead significant and timely rate increases if revenues and income are to reach and be main-tained at levels which will result in sufficient internally generated funds to meet its operational requirements and permit external financing of its construction program at reasonable cost."
In view of the foregoing, it should be apparent that one can never be certain that Consumers Power Company, ce any other electric utility, can successfully complete a construction program stretching out over a number of years. The best one can hope to do is assess the rationality of Consumers Power Company's financial planning to determine whether its proposed construction program, which includes the Midland Plant, appears attainable, given rational regulatory policies.
A review of Consumers Power Company's recent financial history indicates a substantial improvement in its financial position since earnings per
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I i share plummeted to $1.34 in 1974 from the prior year's $2.41.
In addition to problems that were common to the utility industry during this period, Consumers Power Company's situation was made much worse by the Palisades outage. With Palisades on ifne for most of 1975 and some rate relief granted by the Michigan Public Service Connission, earnings per share rebounded strongly in 1975 to $2.65. Recently re-ported earnings for 1976 show a further improvement to a record level
$3.63 per share. The estimated 12.6% return on common equity achieved in 1976 is in line with the 12.75% authorized by the Michigan Public Service Commission in Consumer Power Company's most recens rate case and is significantly better than the average industry performance in 1976. In order to maintain or improve upon that level of profitability, Consumers Power Company will need to request further rate relief, and at the end of January it did just that, applying to the Michigan Public Service Ccmmission for a record $164.2 million annual electric rate increase. According to Consumers Power Company, as reported in the Wall Street Journal on February 1,1977, about $79.4 million of its total request deals with proposed accounting changes which, although not increas-ing earnings, will "imprese the quality of earnings by increasing the in-l ternal cash generation needed for financing the construction program."
According to the common stock prospectus previously mentioned, Consumers Power Company estimates its construction program for the five years ended i
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.i 5-1980 will cost $2.7 billion. Furthermore, the prospectus states: "In order to finance this program and to meet remaining debt maturities during this period of approximately $103.8 million, it will be neces-sary for the Company to sell substantial additional securities, the amounts and types of which have not yet been detennimed." During 1976 Consumers Power Company successfully sold over $330 million of debt and i
equity securities, about $100 million of which was represented by common stock. In addition, the November coninon stock prospectus indicates that over $120 million of internally generated cash was available for the 4
twelve months ended June 30, 1976. Since Consumers Power Company's first mortgage bonds and preferred stock are subject to earnings coverage pro-i visions, the coninon stock prospectus points out that: "The amounts of additional First Mortgage Bonds and Preferred Stock which can be issued in future years will be contingent upon increases in earnings through rate increases or otherwise."
In Consumers Power Company's response to Interrogatory 3 of " Licensee's Further Answers To Interrogatories From All Intervenors Except Dow l
Chemical Company Dated December 27, 1976." it included six projected sources and uses of funds statements with respect to Consumers Power Company's electric operations covering the period of the Midland Plant's construction, demonstrating how its total construction program might be financed. The most pessimistic projection, Attachment C-2, assumes a return on comon equity of 12.75% and no credits for the planned sales m-~+-
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. of generating capacity to certain electric cooperatives.
Implicit in these projections is a capital structure objective of 53% debt,12% preferred-preference and 35% common equity. As Attachment C-2 demonstrates, Consumers Power Company's total construction program will be covered by internal and external sources of funds, while main-taining coverage levels on mortgage bonds and preferred stock in excess of minimum requirements.
While the projections shewn on Attachment C-2 l
appear reasonable, all of the assumptions made in preparing the projections were not revealed in the response to Interrogatory 3, and net internally generated funds were not b. Aer own into their component items. Conse-quently, the projections are not as informative as they might have been.
If it can be shown that Consumers Power Company made reasonable assumptions with respect to such items as interest and preferred dividend rates, comon stock prices,. dividend growth, dividend-p.ayout ratios, and depreciation accruals, the reasonableness of the projections could be more accurately gauged. In addition, the projections assume the approval of certain ac-counting changes designed to improve internal cash generation. If not approved, while the rate of return remains at 12.75%, Consumers Power Company states that the entire construction program could not be financed "as planned." In that event, there are still options available to finance the Midland Plant, such as selling additional securities or increasing the Midland Plant's priority, since it only represents about 40% of the i
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7-total construction budget.
Conclusion Based upon our review of Consumers Power Company's recent financial history, coupled with its response to Interrogatory 3, it is our judg-ment that the financing of the Midland Plant appears attainable. Whether itwillbeattainedisnotsomethingonecananswerwithanydegreeof certainty. The construction schedule may be affected in the future by factors beyond the control of Consumers Power Company--primarily regu-latory policies and capital market conditions. This situation is not unique to Consumers Power Company, however, as such constraints are faced by all regulated investor-owned electric utilities.
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