ML19340E114
| ML19340E114 | |
| Person / Time | |
|---|---|
| Site: | Summer  |
| Issue date: | 08/31/1979 |
| From: | Wooten O SOUTH CAROLINA ELECTRIC & GAS CO. |
| To: | SOUTH CAROLINA, STATE OF |
| Shared Package | |
| ML19340E107 | List: |
| References | |
| NUDOCS 8101060441 | |
| Download: ML19340E114 (22) | |
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i DIRECT TESTIMONY OF OSCAR S. WOOTEN SOUTH CAROLINA ELECTRIC & GAS COMPANY 1 4 PLEASE STATE YOUR NAME AND ADDRESS.
2 A. Oscar S. Wooten, 328 Main Street, Columbia, South Carolina.
3 Q. BY kHOM ARE YOU EMPLOYED AND IN WHAT CAPACITY?
4 A. I am Executive Vice President-Finance, of South Carolina Elec-5 tric & Gas Company.
6 Q. MR. WOOTEN, PLEASE DESCRIBE YOUR EDUCATIONAL BACKGROUND AND E
7 EXPERIENCE.
8 A. I am a graduate of the University of Richmond in Richmond, Virginia 9 holding a degree in Accounting, and I am also a Certified Public 10 Accountant. I have practiced public accounting and was employed 9 11 by the Atomic Energy Commission at the Savannah River Plant as an 12 audit supervisor for approximately four years. I have been employed 13 by South Carolina Electric & Gas Company since 1954 and held various
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14 positions in the Company's Accounting Department before assuming my 15 present position.
16 Q. PLEASE DESCRIBE YOUR DUTIES AS EXECUTIVE VICE PRESIDENT-FINANCE, OF 17 SOUTH CAROLINA ELECTRIC & GAS COMPANY.
t 18 A. I am directly responsible for the Company's Secretarial, Treasury, 19 Accounting and Data Processing Departments, including preparation 20 of budgets and forecasts and all financial statements issued by the 21 Company. I have the primary function of raising funds and advising 22 the Company's management on its present financial position and prob-23 lems with respect to finance. In addition, I am responsible for 24 developing and maintaining the Company's investor relations program 7 0106 0 Wit
9 9y 1 with the financial community.
2 Q. WHAT IS THE PURPOSE OF YOUR TESTIMONY IN THIS PROCEEDING?
3 A. My testimony, as chief financial officer, will deal with our Company's 4 urgent need for adequate rate relief. I consider the relief to be ,
5 essential if South Carolina Electric & Gas Company is to continue to 6 operate. It should be noted that the standard of living of our custo- .
7 mers, as well as other citizens of this state can only decline if our 8 Company is no longer able to provide reliable utility service as a 9 result of not being allowed to charge adequate prices for our services.
r 10 In addition, I will illustrate by my testimony the Company's present 11 financial condition and the resulting effect of this rate increase.
12 Because of inflationary pressures on all costs of operations, our 13 Company has been unable to earn the return previously allowed as
> 14 reasonable by this Commission. The fact that an historical test 15 period employing previously incurred costs is used in the ratemaking 16 proceedings makes it virtually impossible in times of inflation 17 for the Company to earn its allowed return. It is possible to adjust 18 for the effects of inflation through the use of an attrition allowance, 19 or by projecting income and expenses with a forward test year. How-20 ever, without the use of such adjustments it becomes even more impera-21 tive that a sufficient rate of return on equity be allowed. The 22 following tabulation shows historical earnings of SCE&G from 1968 -
23 1979.
24 25 26
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1 12 Months Earnings per Period End
-)' Ending_ Average Common Share Return on Equity 2
3 March 31, 1979 $2.00 10.70%
4 Dec. 31, 1978 $2.26 12.02%
5 Dec. 31, 1977 $2.22 12.12%
6 Dec. 31, 1976 $1.97 11.36%
7 Dec. 31, 1975 $2.09 11.86%
8 Dec. 31, 1974 $1.47 7.57%
9 Dec. 31, 1973 $1.75 9.89%
I 10 Dec. 31, 1972 $1.98 10.46%
11 Dec. 31, 1971 $1.72 10.29%
12 Dec. 31, 1970 $2.00 12.85%
n 13 Dec. 31, 1969 $1.91 13.65%
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} 14 Dec. 31, 1968 $1.78 14.38%
15 As a result of the effects of inflation on our Company, our earn-16 ings and our coverage ratios, which are the two main determinants of 17 financial stability, have seriously deteriorated. For the twelve 18 months ending June 30, earnings per average common share had declined 19 to $1.78; and period end return on equity had fallen to 9.30%. Without 20 rate relief this downward trend will continue to the point that we will 21 be unable to attract, on reasonable terms, the capital necessary to 22 complete our present construction program, or to commence new ones.
23 Also, maturing securities need to be redeemed at the lowest possible 24 cost in order to allow the cost of service in the future to be as low 25 as possible. Our customers will suffer if the continued economic 26 development of our service area is jeopardized. If we receive the
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1 rates requested, our customers will benefit by continuing to have 2 access to a reliable source of electricity and gas. In addition, the 3 new jobs created through the expansion of existing industrial plants 4 and the construction of new ones - a situation only possible when 5 in'dustry is confident that its source of electricity and gas is reli-6 able - will enhance the economic well-being of our customers and other 7 citizens of this state. As a result of the financial condition to 8 which the Company will return if the proposed rates are implemented, 9 our customers will not only enjoy reliable service, but also the 10 benefits of paying rates based on lower costs for capital than would 11 ha've been charged if our financial condition were to continue to 12 weaken.
13 Q. MR. WOOTEN, HOW CAN A COMPANY, BY SEEKING HIGHER RATES, BE ABLE 14 TO PROVIDE BETTER SERVICE TO ITS CUSTOMERS AT A LOWER COST?
J 15 A. Better service means being able to provide reliable service. We 16 must be able to build the plants necessary to satisfy the growing 17 needs of our growing customer base. To be able to build the 18 plants, we must be able to attract capital. To attract capital 19 we must demonstrate a satisfactory degree of financial integrity.
20 Better service means being able to provide electricity at the 21 most reasonable cost to the consumer. To do so we must be able to 22 obtain the raw materials necessary to provide electricity and gas at 23 the most reasonable cost, and then to convert the raw materials into 24 electricity and gas in an efficient manner. One of the basic raw 25 materials is capital. Capital is the savings accumulated by inves-26 tors. To attract capital at a reasonable cost, thereby benefiting 1 our customers, we must demonstrate a satisfactory degree of finan-2 cial integrity.
3 Q. WHAT ARE THE CHARACTERISTICS OF A COMPANY POSTESSING A SATISFAC-4 TORY DEGREE OF FINANCIAL INTEGRITY?
5 A. The company should:
6 1) have a demonstrated ability to sell common stock at a 7 price that will yield proceeds to the company at or 8 above book value; 19 2) have a high bond rating (A or better); and -
10 3) have the demonstrated ability to generate at least 50% of the i 11 cash requirements of it.s construction program internally. :
12 Now I shall discuss each of these characteristics in detail. Selling -
13 common stock at a price above book value is important because to do 14 otherwise reduces a portion of the existing shareholder's share of 15 ownership. In addition, more shares must be sold to raise a given 16 amount of equity capital than would <e been necessary at a price 17 equal to bcok value. As a result, tie sale of common below book has a 18 negative impact or the potential return to the investor, since the 19 growth rate of the company's earnings and dividend; are dampened.
20 Earnings are important because dividends are paid out of earnings. -
21 Under stable interest rate and risk conditions, common share market i 22 price will generally track the rate of growth of dividends. For this 23 reason, factors which negatively influence earnings and dividend 24 growth, such as selling common below book, cause the common stock to 25 become less attractive to the investor. When the stock becomes less 26 attractive, the market price is depressed, increasing further the
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i cost of equity and debt financing to the company, resulting in higher 2 costs to the consumer.
3 A high bond rating has become increasingly important to utilities.
4 Considering the effect of bond ratings on the cost of debt, it is well known that the higher rated, or lower risk, debt issue can be 5
6 sold at a lower cost to the company. The same holds true for pre-7 ferred stock and common equity. Concerning the effect bond ratings 8 have on the availability of capital, the Employment Retirement 9 Income Security Act of 1974 (ERISA) has caused investors to be-10 come more risk-averse, in that fiduciaries were made personally 9 11 liable for any loss resulting from a breach of their fiduciary 12 responsibilities. Consequently, investment managers have a per-13 sonal incentive to buy bonds and stocks of high quality. Further-14 more, in times of capital shortage, such as in 1974, and even in 15 recent months, the terms of securities issued by companies with 16 unsatisfactory financial integrity can only be marketed to the 17 public with adverse sinking fund requirements, non-callable fea-18 tures, shorter than normal maturities, and similar constraints 19 on the financial flexibility of the issuing utility.
20 A utility, in order to possess satisfactory financial integrity 21 should be able to generate sufficient cash to supply 50% of its cash g 22 construction requirements. The utility business is capital intensive.
23 That fact, coupled with its size, explains why the utility business 24 accounted for one half of all common stock offerings during the past 25 five years. The supply of new comon shares issued by utilities is 26 therefore large, but the industry is faced with a declining market i
r.
(j Institutional investors have largely desert-Q 1 for those issues.
2 ed the utility equity market, and the individual investor appears 3 also becoming more selective with regard to risks and return. A 4 diminished demand for utility common stock raises the question:
5 "will there be sufficient capital made available to a utility in 6 the future to satisfy the capital requirements of its construction 7 program?" Due to this concern, prudence dictates that the manage-8 ment of a soundly run utility not rely on external sources for 9 more than half of its construction requirements.
10 Q.
WHAT WAS SCE&G'S FINANCIAL POSITION AT MARCH 31, 19797 11 A. Considering the elements of financial integrity just discussed, 12 our financial position is weakening.
h 13 First, concerning.our ability to sell common stock at a price that
) 14 will yield proceeds in excess of book value, the following chart 15 demonstrates our experience since 1973.
16 17 18 19 20 6 21 22 23 24 25 26
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O 1 PUBLIC 0FFERINGS OF COMMON STOCK SINCE 1973 2 Date of Net Proceeds Percentage Public Number of to Company Book Value Over or Under 3 Offering Shares per Share per Share Book Value 4 12-12-74 2,360,000 $ 9.405 $17.405 -46.0% ,
5 7-10-75 1,500,000 $14.955 $16.281 - 8.1%
6 2-3-76 1,700,000 $17.285 $16.619 + 4.0% .
7 2-17-77 2,200,000 $18.200 $16.841 + 8.1%
8 2-1-78 1,500,000 $17.710 $17.837 -
.7%
9 4-18-79 1,000,000 $16.355 $18.499 -11.6%
t.
10 As a result of our inability to consistently sell equity at a price 11 which yielded proceeds at or above book value, in order to obtain 12 the $186 million in new equity raised since 1973, it has been nec-essary to issue in excess of 1.3 million more shares than would Q 13
) 14 have been issued had we consistently sold comon at a price which 15 would have produced net proceeds equal to book value.
16 PROCEEDS FROM THE SALE OF COMMON STOCK SINCE 1973 (A) (B) (C) (B) + (C) = (D) (A)-(D)=(E) 17 # of Shares that Number of Net Proceeds Average would have been Additional l 18 Year Shares Issued to Company Book Value Issued at Bk/Value Shares Issued 19 1974 2,489,422 $23,869,108 $17.382 1,373,208 1,116,214 20 1975 1,669,602 24,782,592 16.458 1,505,808 163,794 i
21 1976 1,928,831 33,281,418 16.862 1,973,753 (44.922) 22 1977 2,524,439 46,177,158 17.436 2,648,380 (123,941) 23 1978 2,081,259 36,913,379 18.188 2,029,546 51,713 l
24 1979* 1,318,428 21,607,128 18.313 1,179,879 138,549 f
25 Totals 12,011,981 $186,630,783 10,710,574 1,301,407
(
26 *through 6-30-79
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l 1 At our current annual dividend rate of $1.68 per share, the annual 2 dividend requirements for those 1,301,407 shares of stock which 3 were sold only because we were unable to sell at a price to yield 4 net proceeds at book value will total nearly $2.2 million in 1979.
5 This, converted to charges to customers before taxes amounts to -
6 between four and five million dollars annually.
- 7 .Second, our present bond rating, single A, is third in line, behind 8 triple A and double A, for investors seeking quality. Our current 1
9 bond rating is the lowest rating for investment grade securities in 10 that many institutional investors and individual investors, either p 11 because of legal limitations or as policy matters, will not pur-12 chase a bond with a rating below single A. p
'13 Third, we have been unable to generate half our cash construction 14 requirements internally.
15 PERCENTAGE OF CONSTRUCTION EXPENDITURES GENERATED INTERNALLY
. (A) (B) (C) 16 Year Construction Expenditures Cash Flow (B) + (A)
. (000) (000) r 17 1978 $119,930 $45,392 37.8%
18 1977 164,254 44,765 27.3%
1 1976 179,391 38,055 21.2%
l 19 1975 128,301 40,817 31.8%
l 1974 96,142 28,325 29.5%
l 20' 1973 57,973 23,652 40.8%
. 1972 88,252 22,285 25.3%-
, 21 1971 .78,872 19,690 25.0% ,
l 1970 88,854 17,528 19.7%
l 22 1969 82,643 17,554 21.2%
1968 44,018 17,356 39.4%
! 23*
24' Our cash flow has suffered from the inclusion of a non-cash credit 25 to earnings, allowance for funds used during construction (AFUDC),
26 in the return on common equity. In fact, the majority of our re-lO :
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) I ported earnings in recent years has been "non-cash." Since 1972, as 2 the following chart will demonstrate, the cash portion of our earnings 3 has' not been sufficient to cover our dividends to our common shareholder.
4 PERCENTAGE OF DIVIDENDS COVERED BY CASH EARNINGS 4
(A) (B) (A)-(B)=(C) (B)+(A)=(D) (E) (C)+(E)=(F) 5 AFUDC Cash % of EPS Cash Div. % Cash Div.
Year EPS Portion EPS Non-Cash Paid Cov. by Cash EPS 6
7 1979* $2.00 $1.28 $ .72 64% $1.62 44%
8 1978 $2.26 $1.32 $ .94 $1.605 58% 59%
9 1977 $2.22 $1.23 $ .99 55% $1.55 64% 6 10 1976 $1.97 .$1.04 $ .93 53% $1.51 62%
11 1975 $2.09 $ .64 $1.45 31% $1.48 98% .,
12 1974 $1.47 $ .35 $1.12 24% $1.4675 76%
O 13 1973 $1.75 $ .54 $1.21 31% $1.4175 85%
)h 14 1972 $1.98 $ .58 $1.40 29% $1.3675 102%
15 1971 $1.72 $ .57 $1.15 33% $1.3125 88%
! 16 1970 $2.00 '$ .67 $1.33 34% $1.2425 107% -
17 1969 $1.91 $ .39 '$1.52 20% $1.1725 130%
18 1968 $1.78 $ .13 $1.65 7% $1.1025 150%
19
- Twelve months ending 3-31-79 l 20 The return on equity we have been allowed to earn is calculated g 21 after including the non-cash credit, AFUDC. As a result, our re-i 22- . ported earnings do not include sufficient cash earnings, and we ,
23 have had to resort to other-sources for our cash dividend payments.
24 Those sources of cash have been depreciation and deferred taxes.
25 It may be necessary for any company, from time to time, to pay i
26 cash dividends out of these sources. However, to do so on a g .
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O 1 consistent basis, as we have been forced to do for seven of the 2 last eight years, is not indicative of a healthy financial situ-3 ation. Depreciation exists to provide for the replacement of 4 obsolete equipment. Deferred taxes exist primarily because of .
S the federal government's desire to boost productivity by encour-6 aging investment in new plant and equipment.
7 Q. WHAT WAS SCE&G'S CAPITAL STRUCTURE AT MARCH 31, 19797 A. . Amount Capitalization Total As Capitalization 8 Per Books Ratios Adjusterents Adjush Ratios 9 Long-Term Debt $651,625,605 51.60% $35,000,000 (3) $686,625.60$ 53.791 b
10 Short-Term Debt 52,269,300 4.14 (37,516,000)(4) 14,753,300 1.15 11 Preferred Stock 153,951,000 12.19 - 153,951,000 12.06 12 Comon Equity 404,948,221 (1) 32.07 16,275,000(5) 421,223,221 33.00 s
13 Total $1,262,794,126 100.00% 13,759,000 11,276,553,126 100.005 O 14 (i) co oa equity 418.o27.s78
) 15 16 Investment in Subsidiary 13,079,357 (2) 404,948,221 17 (2) Cost at March 31, 1979.
18 (3) $35,000,000 bond issue at April 1, 1979.
19 (4) Reduction to bank notes and commercial paper through April, 1979.
20 (5) 1,000,000 shares common stock April 7, 1979.
21 Q. IS THIS A REASONABLE CAPITAL STRUCTURE?
m 22 A. Certainly not by current industry standards. Since 1974, the electric 23 utility industry has moved in the direction of a capital structure 24 which relies less on debt and more on equity. We have also moved in 25 this direction, but our capital structure still contains a smaller 26 proportionate cushion of equity for the senior security holder than does p
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2 CAPITALIZATION RATIOS 3 December 31, 1978 4 Weighted -
Industry
- 5 Average SCE&G 6 Debt ** 51.5% 55.2%
7 Preferred Stock 12.2% 12.2%
8 Common Stock 36.3% 32.6%
9 Total 100.0% 100.0%
i 10
- 75 major electric utilities 11 ** includes short-term debt and current portion of long-term debt, 12 and nuclear fuel trusts O 13 Meay industry ebservers.feei thet 40% of ea eiectric utiiity's ceP i -
) 14 talization should be made up of common equity. I believe that, as 15 the minimum, a 40% equity ratio should be the objective of any pru-16 dently managed electric utility that expects to be able to finasce 17 future construction on reasonable terms. It is certainly our 18 objective, and it has been for a number of years. In light of the 19 incident at Three Mile Island, a 40% equity ratio may soon be con-20 sidered to be insufficient.
i t-21 Q. WHAT ARE THE COMPANY'S PROJECTED CAPITAL REQUIREMENTS?
22 A. As Mr.-Summer testified, the Company's construction expenditures 23 for the period 1979 through 1983 are expected to be approximately 24 $519 million, excluding nuclear fuel. Nuclear fuel expenditures 25 are projected to be an additional $95.1 million during this five
) 26 year period. I will only review the first two years of the period
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1 (1979-1980).
2 The Company's cash requirements for its construction program and 3 for retiring maturing securities in 1979 are estimated to be $196 4 million, of which $46 million will be provided by intr.rnally gen-5 erated funds made up of the portion of our earnings we will retain, 6 and non-cash charges such as depreciation and deferred income taxes.
7 The balance of the funds needed in 1979, some $160 million, will be 8 raised through short-term borrowings, the sale of bonds, preferred j 9 stock and common stock.
i 10 In 1980, the Company's total capital requirements are ex- '
0 11 pected to be approximately $207 million, of which 72% will have to 12 come from outside sources. During this period the Company will .-
13 sell bonds, preferred stock, and common stock, and will rely on 14 short-term borrowing. The exact timing and types of securities 15 actually sold will be decided on the basis of the Company's 16 ability to meet its coverage ratio requirements, and its ability 17 to attain a reasonable capital structure. The nature of the 18 capital markets in those years will also be a factor.
- 19 Q. CAN THE COMPANY RELATE A SOUND FINANCIAL CONDITION TO THE INVESTORS 20 50 THAT IT WILL BE ABLE TO OBTAIN THIS ADDITIONAL CAPITAL UNDER
- 21 CURRENT FINANCIAL CONDITIONS? 4 22s A. Our Company is in direct competition for investment funds with 23 every other utility, and with every industrial, financial, and 24 governmental organization. The only way we can sell our Company's 25 securities is to make them sufficiently attractive. To make them 26 ' attractive we must be able to earn and pay a competitive return.
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O We must also be able to convince the investing public that our
] 1 2 financial condition is sound, and will continue to be so. The way to 3 relate a sound financial condition today and tomorrow, is by demon-4 strating to the potential investor that we have a steady, predictable 5 ability to earn him a fair and reasonable return on his investment in 6 our Company. In these inflationary times, that is an impossible task 7 if we must base our prices on out-of-date, historical costs. Since 8 1970, our Company has been hard hit by inflation, and during this 9 decade timely and adequate rate relief has been required. Until our k 10 nation comes to grips with inflation, that need will remain. This is 11 true because our industry is especially susceptible to the ravages of -
12 inflation: first, our prices are based on historical costs; second, O 13 we'must provide service in spite of the current cost of doing so; and 14 third, we are in a capital intensive business. The impact of infla-15 tion on a utility's operating and capital costs render ineffective the 16 utility's and its regulatory authorities' efforts to set revenue j 17 requirements that will produce a just and reasonable return on equity, i M so long as those revenue requirements are based on historical operating l 19 and capital costs.
l 20 Q. MiY IS RETURN ON EQUITY IMPORTANT? e 21 A. New capital is attracted on the basis of the total return that i
can be earned on the investor's equity. By " total return" I
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22 l 23 mean that the investor is not only looking at the dividend yield
! 24 currently available, but also at the growth in dividends he c.an 25 O 26 14-
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O 1 expect. Such dividends should be paid out of earnings, leaving part of
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2 the earnings to be retained in the business. Historically, utilities 3 have been able to increase earnings by the plowback factor, which is 4 the increment to earnings from the amount of earnings retained by the .
5 business. If a company pays out 70% of its earnings, retains 30%, and 6 earns a 13% return on equity, the plowback factor would be 3.9% (30% X 7 13%). Earnings for the company would grow at the rate of 3.9% per 8 year, so long as it retained 30% of its earnings and earned 13% on its 9 equity.
P 10 Today, our Company's debt ratio is already above the industry average; 11 consequently the use of more leverage as a means of increasing earnings 12 must be ruled out. The sale of common equity above book value has not f}; 13 been possible in over a year. The plowback factor cannot be properly
/ 14 utilized so long as investors, by virtue of their present concern 15 for getting their return "up front", in order to compensate for 16 their lack of confidence in our Company's future earnings growth, 17 insist on higher and higher current dividend yields.
18 In such an environment, an increase in the earned rate of return 19 on equity is the only way a utility can show growth in earnings.
20 The higher the return on equity the investor can reasonably expect 21 to earn, the faster will be the growth in earnings, and consequently, 22 dividends. By having reason to expect an improved growth in earnings, 23 the investor will be satisfied with a lower current dividend 24 yield, meaning a higher ratio of price to dividends, resulting in a ,
25 26
I higher market price for stock.
2 The sale of common stock at a higher market price will f avorably 3 affect our Company's future, since the dilutive effects on earn-4 in'sg per share and return on equity of selling common below book 5 value will have been minimized, if not eliminated entirely. A 6 higher return on equity will therefore facilitate our sales of 7 additional common equity, since new investors would not have cause 8 for concern about the dilutive effect on earnings per share and 9 return on equity of sales of new common below book value. To be 10 able to sell senior securities, which provide the majority of the t 11 fu'nds used in construction, we must be able to sell common stock.
12 Q. MlY IS THE COMPANY'S ABILITY TO SELL COMP. N STOCK ESSENTIAL TO THE 13 SALE OF OTHER SECURITIES?
14 A. Coinmon stock is the foundation upon which all senior financing is 15 built. The protection offered to the bondholder and the preferred 16 stockholder by the common stockholder's investment is essential in 17 their investment decision. To be able to market additional bonds 18 and preferred stock, the Company must be able to market common 19 stock, which is the cushion needed by the senior security holder.
20 Not only is an improved return on equity essential to the Company's 21 chances for being able to market additional common stock in the f 22 future without contributing to a situation which results in the confiscation of a portion of the existing stockholder's invest-
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23 24 ment, but an improved return on equity is necessary if we are to 25 to be able to market new senior securities. To be able to sell 26 new senior securities, certain fixed charge coverage ratios must be
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Oj 1 met. The earnings on common equity, or the return on equity, pro-2 vides the support for meetin'g those minimum coverage ratios.
3 Q. WHAT 00 YOU MEAN BY THE TERM " FIXED CHARGE COVERAGE"?
4 A. Fixed charge coverage is a number which defines the number of .
b times earnings (after all operating and income deductions except 6 income taxes and fixed charges) cover the fixed charges tne Company 7 must pay. " Fixed Charges," by definition in our borrowing con-6 tracts include (1) interest on all debt, (2) amortization of debt 9 premium, discount and expense, and (3) allowance for rental pay-t 10 ments.
11 The fixed charge coverage ratio is important, not only because it u
12 determines whether the Company is legally able to issue new senior 13 securities, but also because it is one of the primary indicators 9 14 used by a potential investor to evaluate the quality of the secur-15 ities of a company and to measure the risk he is assuming. Senior 16 secur1ty investors are interested in the yield on a security in 17 relation to the risk that the interest or dividend will not be paid 18 and, in the case of bonds and debentures, the risk that the prin-19 cipal will not be repaid when due. The adequacy of the Company's 20 fixed charge coverage and the soundness of the Company's financial 6
21 position provide a large measure of the assurance the investor is 22 seeking.
23 Q. WHAT HAS HAPPENED RECENTLY WITH RESPECT TO SCE&G'T COST OF DEBT?
24 A. In recent years inflationary pressures have pushed up the inter-25 est rates we must offer on new issues of long-term debt. Since 26 the rates paid on new issues are higher than those on the Com-
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1 pany's outstanding issues, our embedded cost of long-term debt 2 has increased nine of the past ten years. As shown below, the
-3 embedded cost of long-term debt has increased from 4.66% to 7.89%
4 since year-end 1968. As a result of this 69% increase in our ;
5 embedded cost of long-term borrowing, the Company is currently 6 paying $21 million in additional annual interest charges on our 7 outstanding long-term debt solely because of a higher level of 8 embedded interest rates than in 1968.
9 Embedded Cost Fixed Charge Year of Debt Coverage Ratio (SEC) t 3
10 T979 (as of 3-31-79*) 7.89% 2.41x 1 1978 7.76% 2.67x 11 1977 7.62% 2.78x 4
1976 7.70% 2.58x -:
12 1975 7.38% 2.79x 1974 6.95% 2.22x 13 1973 6.60% 2.36x 0- 1972 6.47% 2.54x 2.39x
) 14 1971 1970 6.33%
6.06% 2.63x 15 1969 5.51% 3.60x 1968 4.66% 4.75x 16
- Adjusted for April 1979 $35,000,000 bond sale.
17 As a result of the higher fixed charges brought about by higher 18 interest rates, the Company's fixed charge coverage ratio has dropped 19 dramatically. In 1968, as the table above shows, our fixed charges 20 were covered 4.75 times. The ratio fell to a low of 2.22 times in ,
t 21 1974. As of June 30, our fixed charge coverage was only 2.28 times.
22 Our calendar year end coverage has not been this low since 1974. Not ,
23 only does a declining coverage ratio place our bond rating in jeopardy, 24 but it sets at risk our ability to issue new bonds. Under our bond 25 indenture, the issuance of additional bonds is conditional upon our O 26 having achieved a level of earnings which will cover fixed charges a 3
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1 minimum of two times. Reduced earnings affect our ability to sell 2 additional bonds, new common stock, and new preferred stock, as well.
3 Q. WHAT ROLE DOES PREFERRED STOCK PLAY IN THE COMPANY'S FINANCIAL
/! STRUCTURE?
L. A. Preferred stock provides protection for debt holders over and above 6 that provided by common stock. Non-payment of preferred stock 7 dividends will not put a company into bankruptcy. However, such 8 an event would cause the company to forego payment of dividends to 9 common stockholders, since preferred stockholders have, by defini-t 10 tion, a " preferred" status over common stockholders.
11 Q. WHAT HAS HAPPENED TO THE EMBEDDED COST OF PREFERRED STOCK 7 12 A. Due to the same influences that have affected the cost of our long-13 term debt, the embedded cost of preferred stock has increased over
) 14 the years.
15 16 I!
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() 1 Embedded Cost of Preferred Coverage after 2 Year Preferred Stock Income Tax 3 1979 (as of 3-31-79) 8.16% 1.55x i 4 1978 8.04% 1.61x I
5 1977 7.91% 1.58x 6 1976 7.89% 1.53x 1
7 1975 7.78% 1.57x 8 1974 7.18% 1.33x 9 1973 7.22% 1.57x 10 1972 7.22% 1.66x f 11 1971 7.08% 1.66x 12 1970 6.56% 1.94x 13 1969 5.12% 2.05x 14 196h 5.12% 2.13x
) 15 For the period ending June 30, our preferred coverage after income 16 tax had dropped to 1.44 times. The higher costs the Company must pay 17 for its long-term debt and preferred stock, coupled with the extremely 18 high interest rates we are currently paying for short-term borrowings, 4
19 have been two of the primary reasons for our sharp decline in earnings.
20 II. WHAT RETURN ON COMMON EQUITY ARE YOU ASKING FOR IN THIS PROCEED-j 21 ING7 g 22 A. We are7 seeking rates designed to cover all our costs, and we are i 23 attributing 13% annual cost to the use of our common shareholders'
- 24 money.
25 Q. DO YOU CONSIDER THIS TO BE A FAIR AND REASONABLE RETURN? -
26 A. As I have been organizationally given the responsibility of over-
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1 seeing the obtaining of external capital by the Company for the past 2 twelve years or more and have been in constant contact with the 3 investing public and underwriters and independent advisors, I believe 4 that the investors consider a return of 13% on equity to be inadequate. ,
5 The reason the Company is requesting only a 13% return is that we are 6 attempting to do what we can to operate on the barest essentials 7 during this period of high rates of inflation. I would certainly consider 8 that under today's conditions, a 14% return on equity is a minimum 9 fair and reasonable return; however, we feel t, sat our request is truly t
10 a " bare bones" request considering that it is the same granted by the 11 Commission's Order in December 1977, and considering that new elements 12 of risk have been assumed by the common stockholder since that date. I 13 am referring to the risk borne by the shareholders of all utilities
/ 14 which employ, or soon will employ, nuclear energy as a fuel for the 15 generation of electricity; as well as to the risk that high rates of 16 inflation have become part of this country's way of life.
17 Q. PLEASE StiMMARIZE THE REASONS FOR YOUR REQUEST FOR INCREASED RATES.
18 A. The proposed increase is the bare minimum needed to restore our 19 indicators of a sound financial condition, among them earnings 20 and coverage ratios, to reasonable levels. The return on equity a
21 on which the increase is based is the same return the Commission 22 found just and reasonable in its most recent order pertaining to the 23 Company. Since that time, the perceived risk in owning the stock of a 24 utility which derives, or will soon derive, a significant portion of 25 its generation from nuclear energy has grown. This higher degree of risk 26, is reflected in the reduced value placed on the ownership of such shares
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i by the investing public, as measured by the price paid for common 2 stock. Since the risk borne by our shareholders is higher, a higher 3 return should be granted to compensate them for the additional risk.
As a bare minimum, the same return as previously found just and reason-4 5 able should be allowed.
6 If we are not allowed to increase our rates to reasonable levels, 7 we will be subjecting our rustomers to the risk that our ability 8 to provide adequate service will be diminished; the indicators of a 9 sound financial condition will continue to show deterioration; and i 10 the coverage of our fixed charges will fall to a point that we will be 11 unable to raise capital under reasonable terms. If we should become ,
12 unable to raise capital, we could no longer be able to fulfill our 13 responsibilit y to meet our service area's needs for electricity and 14 gas. If that were to happen, South Carolina Electric & Gas Company 15 would have become an impediment to the future economic development of 16 our state and to the future economic well-being of its citizens.
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