ML20009C980
| ML20009C980 | |
| Person / Time | |
|---|---|
| Site: | Callaway  |
| Issue date: | 05/27/1981 |
| From: | Shackelford R MISSOURI, STATE OF |
| To: | |
| Shared Package | |
| ML20009C973 | List: |
| References | |
| NUDOCS 8107220277 | |
| Download: ML20009C980 (67) | |
Text
-. -.
t PREPARED TESTIMONY of Ronald L. Shackelford f"
ta
"~
Office of Financial Analysis t
Missouri Public Service Commission I
UNION ELECTRIC COMPANY Case Number ER 81 180 Q.
Please state your name.
r A.
My name is Ronsid L. Shacke Mord.
Q.
What is your mailing address?
A.
My mailing address is P.O. Box 360, Jefferson City, Missouri,
's 1 65102.
L Q.
Wnat is your present occupatics?
A.
I am the Assistant Director, Utility Division, Financial Analysis, a staff group of the Missouri Public Service Comission concerned l
primarily with financial analysis of public utilities operating under the l
jurisdiction of the Missouri Public Service Commission.
Q.
What is your educational background?
l A.
I received my Bachelor of Science Degree in Business Adminis-tration from the University of Kansas and a Master of Business Administration Degree from Lincoln University.
Q.
What has been your experience in the field of public utilities?
l A.
I was err. ployed for about ten yet.rs as an accountant with Kansas' City Power & Light Company.
For the past twelve years, I have been employed 8107220277 810717 PDR ADOCK 05000483 I
PDR;
b by the Missouri Public Service Commi';sion and have submitted rate of return testimony in varicus cases for the past nine years.
l Have you made an analysis of a fair rate of return which, in your opinion, Union Electric Company shculd hrte the opportunity to earn in its business?
t_
A.
Yes, I have.
Q.
I hand you what has been marked for purposes of identification, Staff Exhibit No.
, consisting of 23 schedules titled "An Analysis of the Rate of Return for Ur.f on Electric Company, Case Number ER 81-180", and ask you if this was prepared by you or under your supervision?
A.
Yes, it was.
Q.
Is it true and correct to the best of your knowledge and belief?
A.
Yes, it is.
Q.
What are the sources of the information shown in your exhibit?
A.
Moody's Investor Services, Inc., Standard & Poor's Corporation, annual reports of Union Electric Company and financial periodicals were the major dati sources used in the preparation of this exhibit.
Q.
After your analysis, have you formed an opinion as to the rate of return required by Union Electric Company on lts jurisdictional rata base?
i l
(_
A.
Yes. My analysis leafs me to conclude that Union Electric Com-pany should be allowed to earn 10.66 percent to 10.80 percent on an original l
cost net investment year-end rate bcse.
I.
Rationale for Reculation Q.
~
What is your rationale for the regulation of a public utility?
A.
Generally speaking, public utilities are allowed to operate as I
,6
natural monopolies.
By that is meant, that a single company is allowed to
~
provide to a specified area, service such as water, sewce, electricity, gas or telephone.
If several firms were allowed to provide the same service, facilities would be duplicated, such as electric distribution lines and poles, water and gas mains, etc., which would result in higher unit costs for all t-firms in that particular area.
If one firm is aUowed an exclusive right to serve a partiet ar area, the pcssibility exists that it may reap monopolistic profits without a
any form of competition.
In this regard, ragulatic' acts as a proxy for the price mechanism in protecting the interest of both the consumer and the pro-ducer.
Regulation accomplishes this mainly by four activities:
1.
Control of entry into market areas, 2.
Setting prices by the determination of revenue requirements, 3.
Establishing standards relating to the quality of conditions of service, and 4.
Requiring the firm to serve all applicants for service under reasonable condi* ions.
U Q. Within this regulatory framework, what approach have you taken in determining a rate of return for Union Electric Cornany? '
A.
My approach to th determination of tha recommended rate of return for Union Electric Company (UE) ha. been guided by the
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Supreme Court rul enc in the Bluefield Waterworks and Improvement Company case, L
in which the Court ruled that the return allowance should reflect the recogni-tion of returns generally laing made at the same time and in the same part of the country on investments in ather business undeMakings which u.
accompnied by corresponding risks and uncertainties; but it has no constitutional right to profits such as are anticipatc i in highly profitable or speculative ventures.
[;
Because of the national scope of the capital markets and the accessibility of e
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4 market information, it is my opinion that to look only at regional returns
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7s no longer a criterion. Additionally, the returns should be reasonably sufficient to assure confidence in the financial soundness of the utility a.:.
r-should be adequate, under efficient and economical management, to mainttin and i
support its credit and enable it to raise the money necessary for the proper discharge of its public duties. A rce of return may be reasonable at one time, and become too high or too low by changes affectir.g opportunities for inve-tment, the money market, and business conditions generally. The Bluefield case was augmented by the Hope Natural Gas case, in which th Court also stated 1
that the return to the equity owner should be cc' nensurate with returns on investments in other enterprises with :orresponding risks, and that the return should bc sufficient to assure confidc ce in the financial i +:egrity of the enterprise, so as to maintain its credit and to attract capital. The Court stated that the tixing of just and reasonable. rates involves a balancing of the consumer interests. The Hope case also established what is referred to as the "end result" concept.
It is my opinion that these decisions indicace that the regula-tory prJcess should weigh the interests of both the ratepayers and the owners.
},
And wtile the return allowed should be high enaugh to protect the financial l
l soundness of the utility, it s buld not be excessive to the point of providing monopolistic profits to the owners.
Therefore, my underlying approach to the determination of a fair rate of return for Union Electric Company considers the interests of both the l
ratepayers and'the owners.
Q.
Would you please explain Schedule 2 of your exhibit?
A.
Yes. Schedule 2 shows two equations.
Equation 1 states that l
the revenue requirement.; of a public utility is equal to its cost of service.
Equation 2 is the same as Equation 1, with the exception'thht the cost of service components arc shown symbolically.
a-Q.
What part of the revenue requirements was of primary concern to s
you?
I E
A.
My analysis was directed toward the part of cost stated as (V-D)R.
My primary interest was the determination of R, the rate of return a utility should earn on tue net valuation of the property used and useful in providing service. The components of R are: The embedded cost of debt weighted by the proportion of debt of the capital structure; embedded cost of preferred stock 3
weighted by the proportion of preferred stock in the capital struce>re; and the I
return on common equity weighted by the proportion of common equity in the cap-
~
ital structure.
With the a,.,.opriate variables isolated in this form, it is possible to utilize a cost of capit-1 approach in the determination of R.
Q.
How is the recommended rate of return develcped from this framework?
5 A.
The purpose of this testimony is to develop the fair rate of re-turn for the Missouri jurisdictional propertie of UE under considert.* ion in t
[
these proceedings. The findings of the Hope case suggested the return on the
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properties shou'd allow for:
1.
Earnings comparable to those on similar investments, J
2.
Maintenance of financial integrity, and 3.
Ability to raise required additional capital.
The above list suggests an analysis wnich includes:
l.
An evaluation of the capital structure of the company, l
2.
A determination of the embedded cost of long-tenn debt, 3.
A determination of the embedded cost of preferred stock, if any, and 4.
The determination of a return on common equity that enables the firm to maintain its financial integrity and also a/ fords l
it the ability to raise additional equity capital.
i o
l
[
II.
Current and Historic Market and Economic Conditions Q.
Please discuss current and historic market and economic con-ditions.
r-i A.
Schedule 3 graphically presents Moody's average public utility bond yields on a monthly basis from 1972 to present. Schedule 3A lists the value for each month's yield.
Yields began rising in mid-1973, peaked in late 1974, and then gradually began to decrease.
In 1978, yields began rising again and peaked in March, 'r
, subsequently declined and then rose again.
l' The much higher level of bond yields since the third quarter of 1979 us partly due to actions by the Federal Reserve when it began raising tv discount rate from 91/2 percent to 12 perent. On February 15, 1980, the dircount rate was increased to 13 percent and then on May 28, June 12 and July 28 1980 tSe discount rates were lowred to 12 percent,11 percent and 10 percent respectively. On September 26, 1980, the Fed raised the discount rate to 11 percent; on November 17 it was raisd to 12 pcNent; en December 4 it was in-
\\
l creased to 13 percent; and on May 5,1981, it was increased to a record high purposely de-i of 14 percent. These changes in the discount rate by the Fed a-l signed t.o restrain excessive growth of money available and also make credit more i
costly to obtain in c" der to reduce the rate of inflation. Apparently, the Fed-eral Reserve Board is content co let interest rates fall where they may, and is more interest'ed ir limiting the growth of money and credit.
Besides the dis-count rate charged, the Fed can also controi the supply of money and credit by s
purchases and sales of Federal securities. When bond yields were high in 1974, i
the discount rate in ef:'ect was 7 3/4 percent to 8 percent.
Another example of current and historic market conditions is the
~^
prime rate. The prime rate represe.;ts the short-term interest rate i
0
~
E charged by large commercial banks to their best borrowers.
Schedule 4
['
presents the movement of the prime rate from 1972 to present and Schedule 4A lists the monthly average prime rates. Like long-term bond yields, the prime rate was at its highest in 1974, in March,1980, reached 21 1/2 percent in December, i980 and currently is about 201/2 percent.
As far as interest rates are concerned, the market currently is in an " inverse-yield curve" condition. Normally, short-term rates are lower than long-term rates due to the time risk associated with long-term I'
ma2urities.
Schedule 5 displays a graph which plots the prime rate and the average yield of Moody's Public Utility Bonds.
It can be seen that the inva.se-yield curve condition was present in late 1973 and 1974.
For most of 1975, j~
all of 1976,1977 and most of 1978, long-term rates exceeded short-term rates until late in 1978. Since late 1978, long-tenn rates, with the exception of a l
(
short period in mid 1980, have teen icwer than short-term rates. Currently, the prime rate exceeds lonp-term rates. This condition reflects a very vola-tile market situation with investors' expectations changing rapidly.
Schedule 6 presents a plot of the movement of th'e rate of infla-t tion af measured by the Consumer Price Index (CPI). The CPI attempts to pro-l l
vide data regarding the current cost of various consumer goods and services i
indexed to the cost for the same goods and services in 1967. The movement of s
this-index is supposed to measure the rate of inflation consumers experience.
But this rate of inflation is not equally experienced by all consumers.
l s.
For. example, mortgage rates on conventional mortgages, food
?
l prices and energy orices significantly influence the CPI.
In December, 1979, mortgage rates represented 8.7 percent of the CPI but those consumers who did l
I
r- --
e e
a o
rot obtain conventional financing or any hem mortgage financing were not affected by this component of the CPI. Also, the mortgage rate enters the financing component of the CPI with almost a two-month lag. Home finance I
charges included in the June,1980 CPI reflect the mortgage rates in effect p
during the first week in May, when those rates were at or near their cyclical r
peaks.
Food prices are a random factor that influence the overall CPI and. in December,1979 re' resented 17.7 percent of 1.he CPI.
In the past, food p
prices have added over 6 sercent to the index in one month a.d then a couple months later, didn't contribute anything. The drought experienced in the mid-t west this summer is expected to increase the pr1ce of certain frods. But con-l sumers who change their buying habits can avoid the increased prices of certain foods by substituting other foods in their place.
\\L.
Energy is another important component and in December,1979, j'
represented 10.3 percent of the CPI.
During the first quarter of 1980 when the CPI had its most rapid rise, energy prices spurted ahead and contributed r
. Fuel oil, coal 5.4 percent of that quarter's overall 18 percent CPI change.
f
\\
and bottled' gas are included in the energy component of the CPI. Consumers b.
who do not purchase fuel oil,. coal or bottled gas do not exoerience any infla-tion from these elements.
In general, the CPI is a ver) broad measure of consumer prices and does not reflect changes in consumer consumption patterns due to changing pr'ces.
Regardless of its faults, the CPI is a much referred to measure of (s
inflation and consequently is considered by many investors in determining their return requirements. An example of the relationship between the rate of j
inflation and bond yields is shown in Schedule 7.
Here the average yield for
.3
_g.
I Moody's public utility bonds is plotted with the rate of inflation. As the rate of inflation increased, bond yields also increased.
Recent forecasts for the economy and the market, in general
[
anticioate a slowing of economic growth and decreases in the levels of interest rates.
For 1980, the rate of inflation as measured by the C.P.I. averaged 4
t' 13.5 percent. Argus Research is forecasting an average inflation rate for s-1981 of 11.1 percent, ar.d for 1982, 7.4 percent with quarterly forecasts of 11.7,11.5, 9.8, and 8.5 percent for 1981 and 8.5 and 7.5 percent for the first two quarters of 1982. Paine Webber Mitenell Hutchins is predicting a 10.4 cnd 8.2 percent rate of inflation for 1981 and 1982 respectively, with i
quarterly forecasts for 1981 of l'. 2, 9.4, 8.9 and 9.2 percent.
In the p
April 27,1981 issue of Forbes Magazine, it forecast a rate of infiction of 8 percent by year-end and long-term interest rates at 10 percent.
In the l
April 6,1981 issue of the Wall Street Journal, A. Gary Shilling, President of A. Gary Shilling & Co., a New York-based economic consultina firm, was
[
recommending that, whenever possible, companies should delay borrowing plans l-
'until later this year because he expects interest rates to tumble. Mr. Gordon B. Pye,, Senior Vice President of Irving Trust Co., New York, forecasted in the April 20, 1981 issue of the Wall Street Jou'rnal that the prime rate will i
fall to around 15 percent this sumer and wil1 sink to around 10 percent by i
year-end.
Other economists have stated that interest rates may increase
?
slightly in the near term and then decrease to lower levels depending upon actions of the Federal Reserve Board.
Q.
Do investors view industrial and utility stocks similarly?
A.
No.
In general, utility stocks are priced by investors to 1
l
/
k l
.-e w
av., - _ -
e
,,a m
4 provide relatively higher current yields.
It has not always been so,
but the combination of hiah interest rates and caDital reouirements made investors chance their views reoardino the growth opportunities of utilities.
I Stock market movements are displayed in Schedule 8 which plots the stock price indices for New York Stock Exchange's Industrials and Util-d.'
ities. These New York Stock Exchange indices are much more inclusive than i'
either the S&P 400 or the S&P 40, and consequently are more representative
~
of hat the stock market in general has done. Both indices display similar f
patterns but the utility index does not exhibit as much fluctuation.
Schedule 9 displays the plots of S&P's Industrial and Utility I
stock yields and Moody's average public utility bond yields. The yields on I
S&P's industrial stocks are much lower than the yields on S&P's utility
(.
stocks whereas the yields on S&P's utility stccks tend more to approximate I
long-term debt yields, although the utility stock. yields are generally lower.
This indicates the interest rate sensitivity of utility stock prices and the r
apparent expectation of greater capital gain potential from industrial stocks.
The interest rate sensitivity of utility stocks is further 11-lustrated by the graph shown in Schedule 10. Moody's average public utility l
band yields (reference left edge) are plottert with the average market-to-book values (M/B) for Moody's electric utilities (reference right edge). M/Bs are t
calculated by dividing market price per sharu by year-end book value per share.
l i,
When bond yields increased, M/Bs decreased indicating that stock prices had been bid b
- t -
I
lower.
But they were bid lower in order to achieve stock yields that more
[^
closely approximated bond yields.
Many investors are using utility stocks in their portfolios as substitutes for fixed-incone securities, and consequently when bond yields increase, stock dividends must increase or stock prices must decrease in order for stock yields to be competitive to yields on fixed-income 1
securities.
f III. Union Electric Company Q.
Please briefly discuss the operations of Union Electric Company.
1 L
A.
Union Electric Company and its utility subsidiaries (Missouri Edison Company, Missouri Power & Light Company and Missouri Utilities Com-
- k. -
pany) furnish regulated utility services including electric, natural gas, water and steam heat to parts of eastern, central, southeastern, northeastern and northwestern Missouri as well as small portions of Illinois and Iowa.
UE, b
the consolidated entity, is the one that common stock investors look to as far i
{
as financial results are concerned. UE, corporate only, is the entity which O
is of importance to this proceeding.
In 1980, UE's corporate revenues were r
l l
88.6 percent of consolidated revenues ind corporate operating income was 90.7 percent of consolidated operating income. As these figures indicate, UE's corporate operations dominate the consolidated results.
Curren'tly, UE's construction program includes two nuclear gener-ating units, one estimated for commercial operation in 1983 and a like size f
unit estimated for commercial operation in 1990. The estimated cost of the first unit is $1.59 billion with a total of $958 million invested through 1980.
L For the next two years, UE's external capital requirements will be large until i -
l the first nuclear unit begins operation. Construction expenditures will begin i
s.
1.
- e. - e increasing again in 1985 as work on the second nuclaar unit continues.
{-
At present, UE's bonds are rated BBB+ by Standard & Poor's and Baa by Moody's Investors Service. The company received these reduced ratings I
just recently in late January,1981. At the same time, Standard & Poor's
(
lowered UE's preferred stock rating to BBB-from BBB due to the "relatively I
agressive use of preferred stock in the capitalization". Also, Standard &
i Poor's lowered the company's commercial paper rating to A-3 from A-2, "reflec-ting the weakening cash flow and substantial external financing requirements".
l Moody's Investors Service rates UE's preferred stock baa and its commercial paper P-3.
According to company projections, internally generated funds as a
!i percent of net construction expenditures should increase to 74 percent and 86
[-
percent in 1983 and 1984 from an average of about 10 percent for 1981 and 1982.
IV.
Capital Structure Q.
What capital structure have you used for Union Electric Company to develop the capitalization ratios for your recommended rate of return?
A.
Before discussing the capital structure I will use for UE in I
computing a rate of return, it should be noted that the capital structure I l
will use is not consolidated but is corporate only. Also, the amount of debt
[
I will use in UE's corporate capital structure will not agree with any published reports of the company. This is due to the fact that for regulatory purposes one reported obligation (nuclear fuel lease) has been eliminated entirely.
Even though the company is unconditionally obligated to reimburse the lessor for all expenditures for nuclear fuel, interest and related costs, obligations
(,,
under this lease will not beceme current until such time as the nuclear fuel is engaged in heat production at the company's Callaway Nuclear Plant. The other obligation shown in published reports in the amount of $60 million, re-l s
lates to environmental improvement series bonds of 1980. This entire amount has not been issued at present but is being issued as pollution control facil-ities at the company's Meramec Power Station are comptated. To answer your 3
i.
question regarding UE's capital structure, it is my uhderstanding that the
[
historical test year used by the accounting staff in this case is December 31, 1980, updated for known and measurable changes to June 30, 1981, and that a f'
true-up audit will be made after the formal hearings in the case are completed.
Consequently, I have developed a pro-forma capital structure at June 30, 1981 based upon UE's actual capital structure at March 31, 1981 and adjusted for
- )
budgeted changes in debt and cc: mon equity during the three months of April, May and June, 1981. The development of this pro-forma capital structure at
}
June 30, 1981 is shown in Schedule 11.
The increases in long-tenn debt reflect the additional amount of $30,000,000 of First Mortgage Bonds by July 15, 1981. When th'is issue of First Mortgage Bonds was sold on February 15, 1981, the agreement stipulated that the proceeds from $120,000,000 principal amount was to be received imme-l detiately and a delayed delivery of $30,000,000 principal amount would occur t.
no later than July 15, 1981.
Since the amount of the delayed delivery is so l'
near the end of the known and measurable period, I decided to include this amount in the long-term debt to be outstanding.
l.
e e9 r-
. - -. - ~,
-r-
m The additional $9,00',000 in 1980 series pollution control bonds 0
to be taken-down during the period April through June,1981 is an estimate furnished me by the company. This particular series of pollution control bonds pertains to the company's Meramec generating station and, as the pollution control facilities are completed, bonds will be issued in like amounts. The increase in common equity is detailed in Schedule 11 and the amounts are based entirely on budgeted figures furnished to me by the company.
The resulting capitalization ratios are: 50.72% long-term debt;
)s 13.94% preferred stock; and 35.34% comon equity. As I said previously, this capital structure is subject to change pending the true-up after fonnal hearings have been concluded.
V.
Embedded Cost of Lona-Term Debt Q. What is the embedded cost of UE's long-term debt?
(
A.
Schedule 12 displays my computation of the embedded cost of UE's 4
First Mortgage Bonds, Pollution Control Bonds, and intermediate term loan.
The embedded cost computes to be 8.825 percent.
t Q. Have you included any future financings in your embedded cost i
l computation?
l 4
l l
A.
A $75 million issue of pollution control bonds is projected for i
the summer of 1981, but this will occur after the end of the known and measur-able period and the cost of issuance is unknown at this time.
Therefore I have not included this projected issue of debt in my embedded cost computation.
V1. Embedded Cost of Preferred and Preference Stock Q.
What is the embedded cost of UE's preferred stock?
[
. A.
Schedule 13 displays my computation of the embedded cost of UE's preferred stock. The embedded cost computes to be'7.83 percent.
a n
y - + e y
Q.
Have you included any future financings in your embedded cost f
computation?
A.
No. Originally the company planned a $75 million issue of pre-f~
[
ferred stock in May,1981, but withdrew its issuance partly because of the high dividend rate that would have to be offered and partly due to its im-s proved cash flow conditions.
It is still projected that preferred stock will i
be issued later in 1981 but its timing and dividend rate is unknown at this time.
VII. Cost of Common Equity Q.
How did you determine a cost for the common equity of Union Electric Company?
A.
In using the cost of capit:1 approach to determine a rate of return for the rate base of a utility, the weighted costs of capital invested L.
(debt, preferred stock and common equity) are determined by t.omputing the t{
embedded costs of debt and preferred stock and estimating a cost for common equity. The embedded costs of debt and preferred stock can be deter-I mined fairly easily because these forms of capital have stated interest and s
s dividend rates and their issuance costs are ascertainable. Common stock has il no contractual dividend payments and its claim on the earnings of a firm is residual.
Consequently, co:nnon stock L./estment is considered to have a higher risk than either debt or preferred stock and its cost should be higher than either of the former.
Because ccmmon stock does not have the cost ascer-tainable characteristics of debt or preferred stock, its cost is estimated by I
the use of various approaches. To estimate a cost for the common ec,Uity of UE.
I used market-related approaches and comparable earnings approaches.
t Q.
What market-related approaches did you use?
5 W.+"...
A.
I used a discounted cash flow (DCF) approach and a multiple f
regression model.
Q.
Please explain the discounted cash flow approach.
,) _
A.
The discounted cash flow approach (DCF) is a model based upon the valid concept of the time value of money. That is, a dollar today is not
}
i worth as much in some future period and an investor will require some kind of compensation (his discount rate) for its use.
1 As far as the valuation of common stocks is concerned, t..Se DCF
)
is based upon the generally accepted financial theory that stock prices are dependent uNn expected future dividends and the perceived risk of receiving
(-
those dividends.
In other words, the current price of a share of stock is cal-i' culated as the present value of future dividends plus the erding price of the stock, or in other words, a stream of earnings.
In order to persuade an inves-tj tor to forego consumption of a dollar today for a dollar at some. future time, he expects some type of compensation for allowing someone else to use his money.
I' This is rather straightfonvard when one is referring to bonds and preferred stocks because the interest payments and preferred dividends ar'e known with relative certainty.
But with common stocks, the return the investor receives is the dividends he receives while he holds the stock plus the price he re-ceives when he sells it, minus the cost of his criginal investment.
l The formula used to estimate the investor's required return and l
likewise the cost of equity to the firm is:
0 k
y + g, where
=
(--
k the investor's discount rate or required return,
=
D tne indicated dividends per share,
=
P the price per share of c'ommon stock, and
=
- g the growth rate in dividends and earnings per share.
=
.-c.
y
.,_.-r
. _.--.. -,, ~,
.--g-
As the title of this approach denotes, an investor's interest
~
lies in the cash flows he can reasonably expect to receive from his 'nvest-
,I ment. Dividends are norm 11y receiveci quarterly and the investor knows that at any timo h'e can sell the stock. Of course, it is difficult to imagine that
[
any investor will hold a stock for infinity, but the DCF assumes that there is a continuous stream of income from dividends and price that is ccmon to all investors; not just one who may have a specific time frame in mind. Therefore, the return that a company must earn is one that satisfies all potential investors.
A summary of the assumptions and relationships implied in the i
use of the DCF fomula is as follows:
1.
The formula assumes that dividends and earnings will con-l tinue to grow at the rate g in perpetuity, 2.
The dividend payout will be less than 100 percent; otherwise if the fim paid out everything it earned, then the formula would suggest that the growth rate of earnings in.subsequrint periods would be zero, given a constant rate of return on book equity, i
1 3.
If we assume that dividends and earnings will grow at the same rate, the dividend payout ratio will remain constant, I
4.
If a constant growth rate is assumed, the Price / Earnings (P/E) ratio at the time of purchase and sale will be the same, 5.
Implicit in the formula is that when r (the earned return) = k, the market price of the stock will equal book value.
i In using the DCF approach to determine a required rate of return, what must be kept in mind is that the growth rate being estimated is a long-term f
rate.
But many analysts only estimate growth rates for three to five years into the future.
Since the discount ug process is continuous, the growth rate l
i part of the formula should be one t' at reasonably reflects long-run growth.
Likewise, the yield portion of the DCF model should also reflect some average l
1 l
1evel market mndition so that when combined with the grcwth rate, a long run
!l~
required return results. A particular current investor may only have an l
anticipated holding period for a stock of one or two years, but that inves-
~
tur intends to sell at the end of his holding period to another investor I
l l
. who also has a definite holding period at the end of which he intends to sell to another investor, etc. Even though between different holding periods dif-ferent returns may result, the DCF model's intent is to produce a long-run 7
return that will satisfy all investors, current and prospective.
In determining the proper growth rate to use, historic growth covering long time periods should be observed for both dividends and earnings.
3 Even though cash flows are derived from dividends, it would be illogical to use a dividend growth rate that exceeded earnings growth.
Dividends cannot continue to grow faster than earnings because to do so, the dividends paid would eventually be greater than earnings. What must also be considered are i
changes in growth rates which can be determined from observing the direction of the raw data.
If earnings' growth has decreased in recent periods, you can:.ot looically expect some historically computed growth rate which is higher
,f,
to contiruc.
The dividend yield portion of the DCF also requires the use of reasonableness that reflects an average expectation; not one that may reflect
~
a yield for a particular point in time such as a month or more vhen market conditions were abnormally low. To do so would be overstating that portion i
l of the formula and result in a cost of equity capital in excess of what can reasonably be expected. Therefore, the DCF approach basically requires two values to be determined for its fomula; thedividendyieldportion(h)and the growth rate portion (g).
& DCF computation of UE's cent of common 4
equity raust be te-pered by judgment in order to determine a long-term earninas rate that will satisfy investor requirements.
Q.
How did you arrive at the dividend yield portion of the DCF formula for UE?
A.
The key to the attractiveness of most utility stocks is their yields relative to alternative returns on fixed-income investments. As the
yield requirements on fixed-income investments fluctuate, so will the yield requirements for utility stocks change. Schedule 10 displayed this relation-ship and indicates the interest rate sensi'.ivity of utility stock prices.
Ii Forecasting what level long-tenn inte est rates may be in the future is no easy task, given the fluctuations in interest rates over the past five years.
But if one assumes that the next five years may emulate some average of the past, then observations of the more recent past may lead to reasonable expec-tations for the future.
I.
Although UE's recent market yield has been about 14 percenc,1 j
believe that the current price of its stock is depressed and therefore, its m erent yield is overstated. A more reasonable approach would be to observe f
'E coric market yield of UE's stock and determine a yield that more ac-curately indicates investor appraisal for average market conditions.
To pro-vide me with an estimate of a more realistic market yield for dE's stock, I developed Schedule 14. This schedule displays the indicated dividends per share, I
the end-of-month market prices per share and the resulting market yield for i
UE's comon stock for each month for the period 1979 through April,1981.
Dur.
ing this period, market yields for UE's stock have ranged from 9.9. percent to 14.5 per::ent. The average yield for 1979 was 10.73 percent; for 1979 and April, 1980 chrough August,1980 was 11.14 percent; and for 1979 and 1980 averaged i
j 11.88 percent.
i~
Q. Why did you look only at average yields for 1979 and 19807 1
A.
On October 6,1979, the Federal Reserve Board increased the dis-(
count rate to 12 percent. Looking at Schedule 14, you can see that UE's yield increased from the end of September to the end of October and remained at a relative 1/ higher yield for the rest of 1973. On February 15, 1980, the Fed i
m..
~
again raised the discount rate, this time to 13 percent. The yield on UE's v.
stock increased from the end of January,1980 to the end of March,1980. Late in April,1980, the prime rate was reduced by as much as 300 basis points at
!I some banks and other banks reduced their prime rate 250 basis points from a i~
record high of 20 percent.
Later in 1980, the discount rate continued to be
(,
increased and on May 5,1981 was placed at a record high of 14 percent. The
(
change in the price of UE's stock reflects these changes in interest rates.
Considering the data contained in Schedule 14, it is my opinion l
that with more normal market conditions the yield on UE's stock would range from about 10.73 percent to 11.88 percent. Therefore in my DCF computation, i
I will use dividend yields in the range of 10.73 percent to 11.88 percent to represent the f portion of the DCF formula for UE.
Q.
Howdidyouarriveattheg(growth)portionoftheDCFfonnula for UE?
{
A.
The growth portion of the DCF formula must also be tempered with judgment as to what investors can reasonably expect,. Jched'ule 15 dis-olays earnings per share and dividends per share'.
~
Earlier in my testimony, I stated that one of the assumptions I
of the DCF was that the payout ratio would remain constant and that earnings are also assumed to grow at some constant rate so trat dividends will also 1
l grow at a similar rate.
In reviewing UE's earnings per share data, it has l
l j
displayed erratic up and down movements since 1970. That is, no consistent year-l to-year increases. Trended and compound growth rates for the latest five-year i
period have averaged about 3.1 percent. A graph of UE's earnings per share is l
shown in Schedule 15A.
Observing UE's dividends per share, it can easily be scan that i
l L
e
. l only since 1975 has there been consistent year-to-year increases. Prior to that time, dividends remained at tne same level for more than one year before f_.
they were increased. Therefore, investors would base future dividend in-creases on the more recent dividend policy.of the company in forming expecta-tions regarding the future.
Trended and compound growth rates for the more s
i i
recent period have averaged about 2.75 percent. A graph of UE's dividends per share is shown in Schedule 15B.
Q.
Using the yields and growth rates you have determined for UE, s
i, what do you compute to be the company's cost of common equity based.upon the DCF approach?
A.
I have determined that yields in the range of 10.73 percent to
~
1-1.88 percent would be representative for the common stock of UE under more average market conditions and that growth rates from 2.75 percent to 3.1 per-cent would be reasonable for investors to expect. When the;a yields and growth 1
rates are incerted into the DCF formula, the resulting cost of common equity computed is only applicaule to internally generated equity funds. The cost of externally or market obtained equity funds is higher due to iss'uance costs associated with selling new common stock.
In order to allow for this addi-tional cost when common equity is mcrket obtained, the DCF formula is adjusted as follows:
0 p()_7) g where k
=
=
percent of flotation costs F
=
Schedule 16 displays data regarding the last five common stock issues of UE.
i In reviewing these costs of issuance, it appears reasonable to conclude that i
a flotation cost adjustment of 4 percent would be adequate to cover these costs t
in order to provide net proceeds from common stock issues that equal or exceed 9
p.-
c
~
book value per share.
Using my previously determined yields and growth rates e
and a flotation cost adjustment of 4 percent, the following costs of common equity are computed:
I 3
k
.1118 +.0275 (j
)
.1393
=
=
=
=
.1 3
k
.1118 +.031 (j
)
.1428
=
=
=
=
(j[I Ih4 k
.1160 +.0275
.1435
=
=
=
=
)
'#4 k
.1160 +.031
.1470 (j
=
=
=
=
k
.1238 +.0275
.1513 (j
=
=
=
=
i (fl
- =
- =
.1 8
k
.1238 +.031
.1548
=
=
)
Q.
Please explain your multiple regression model and the cost of common equity for UE you detemined by use of tMs model.
A.
Regression analysis is the study of the relationship of variables with the major purpose of the study to predict one of the variables based upon the other variables.
In simple regression analysis, only two variables are studied.
For example, an attempt might be made to predict the number of new housing starts based on the number of marriages.
Intuitively, there are other factors influencing the number of new homes built such as the interest rate, employment, and income. Multiple regression analysis includes the influence of many independent variables on the one dependent variable; in this example, housing starts.
The purpose of the electric utility regression study was to determine those characteristics of electric utilities (independent variables) that investors consider most significant to them in arriving at the values
they place on electric utilities' common stocks (dependent variable).
Since stock prices vary widely from one utilit/ to another, the term used to ex-press investors' valuatit, of electric utility common stocks is average market-to book value (AVMBV), which is computed by averaging the annual high and low f
- market price per share for a stock and dividing by its year-end book comuon equi'y per share.
In statistical terms then, AVMBV will be the dependent c
(
variable and all other variables will be independent variables, i.e., those variables that best explain the value of the dependent variable.
i The input data for this multiple regression analysis was eb-tained from the Compustat II data base, Moody's Investors Service and Duff
& Phelps. Besides the input data for the dependent variable, AVMBV, input data for 28 independent variables, for 79 companies for the seven years 1973 through 1979 were set up in a separate data base.
In order to select those l
independent variables that were most significant in determining the value of the dependent variable, the stepwise regression procedure of the SAS 79 pro-gram package was used. A significance level of.01 was designated for accep-r tance of an independent variable. The operator has no control over which in-dependent variables are selected for inclusion in the model; the program in-ternally makes the mathematical :.asts on each variable.
l The 28 independent variables and their assigned names were:
U
/
e
m Number Variable Name 1
EQRAT Cormon equ'+v ratio 1
ROE Return on yemr-end common equity 1
PRECOV Pre-tax interest : overage 1
COVEXL Pre-tax interest ; overage excluding AFDC 1
PSCOV After-tax intereu; and praferred dividend c'varage 1
PAYOUT Dividend payout ratio 1
EFFTAX Effective income tax rate I
1 RETCAP Return on total capital i
DPS5 5 year dividend per share growth 1
EPSS 5 year earnings per share growth 1
KWH5 5 year kwh growth g
1 AFDPCT Ratio of AFDC to income for common 1
LDFAC Load factor 1
DIVCSH Ratio of cash dividends to total carh flow 1
BKYLD Boux yield 1
RRATE Reciprocal of Moody's Electric Utility stock yields 2
DPHI & DPLOW Duff & Phelps regulatory ranking; high equals 1 and 2; low equals 5 and 6 1
DPSCOV Dividends per share coverage j
5 DUM1 - DUM5 Geographic location 1
DBRB Moody's bond rating of Baa or lower and no rating 1
DBRAA Moody's bond rating of Aaa or Aa 2
REVHI & REVLOW Operating revenues. classified as righ (over$700,000) and low (under $10],000) c 28 Independent Variables i
i e
1 9
s 4
e Q.
What were the results of the stepwise regression analysis?
I A.
Regressing on the dependent variable AVMBV and designating a t..
significance level of.01, the stepwise procedure tenninated its selection
(
with the following multiple regression equation:
Variable Name Coefficient p
Y Intercept
-1.0561 r
PSCOV
.1265 I
KWH5
.4182 BKYLD 10.4136
(
RRATE 6.9257 DPHI
.0594 l
DPSCOV
.0191 DUM4
.1062 DUM5
.0642 DBRAA
.0372 In effect, this resulting equation is saying that, of tie 28 independent variables tested, these nine variables are most statistically sig-t nificant at the.01 significance level in explaining the value of the de-t pendent variable, AVMBV. That is, this equation produces the "best fit" of f.
the data for all the observed values determined to be significant. The statistic known as R-squared, the coefficient of determination, is computed to be.863, which is very high considering the number of observations tested.
A R-squared of 1.0 would indicate a perfect relationship between the depen-l
~ dent variable and the independent variables which seldom, if ever, occurs.
Schedt:1e 17 lists the 79 utilities and their actual average l
market-to-book values for 1979 in ascending order. Also are listed the pre-dicted AVMBVs.
e b
6 A
r E
Q.
Would you please give an example of how the predicted average market-to-book value is computed?
A.
Yes. Using t}e appropriate data for Union Electric Company fur the year 1979, the following AVMBV is predicted:
AVMBV for UE for 1979 = -1.0561 +.1265 (PSCOV) +.4182 (KWH5) p
+ 10.4136 (BKYLD) + 6.9257 (RRATE)
+.0191 (DPSCOV)
'~
For UE for 1979 the values for the above variables were:
1.68 PSCOV
=
j '
.034 KWH5
=
.0909 BKYLD
=
I RRATE
.0967
=
2.30 DPSCOV a
Inserting the above valuas into the equation results in the following pre-dicted AVMBV for UE for 1979 as follows:
Predicted AVMBV for UE for 1979 = -1.0561 +.1265 (1.68)
+.4182 (.034) + 10.4136 (.0909)
+ 6.9257 (.0967) +.0191 (2.30)
Predicted AVMBV for UE for 1979 = -1.0561 +.2125 +.0142
+.9466 +.6697 +.0439 Predicted AVMBV for UE for 1979 =.831 1
i The actual AYMBV for UE in 1979 was.812.
^
Q.
How is your recomended return on comon equity for U't. Jeter-mined from the multiple regression equation?
A.
The input value for the independent variable BKYLD (book yield)
I is computed by dividing dividends per share by book value per share. BKYLD can also be computed by multiplying return on comon equity by dividend pay-out ratic Likewise, BY,YLD divided by dividend payout ratio equals return on comon equity. So you can see the mathematical relationship that exists between BKYLD and return on common equity. Consequently, if values are assigned to the L
I dependent variable, AVMBV, and all the independent variables except BKYLD, the model or equation can be solved algebraically for return on common equity by dividing BKYLD by a dividend payout ratio.
t Q.
What values did you assign for all the variables except book r
yield?
A.
I used the following values for UE in solving the equation:
I AVMBV 1.04
=
1.8 PSCOV
=
l' KWH5
.033
=
2.5 DPSCOV
=
1/10.34%
RRATE
=
1/10.63%
i RRATE
=
RRAT~
~
1/11.195%
=
l
~
Explanation of values assigned:
i 1.
For the dependent variable AVMSV, the value 1.04 repre-sents a target value that is intended to provide a sufficient cushion above book value so that net proceeds realized from the j
[
sales of comon stock will equal or be greater than book value.
l 2.
For PSCOV, the value assigned of 1.8 is what.has been experienced by UE on average during the period 1973-79 and which can reasonably be expected by investors to be realized by UE on I
l average in the future.
i 3.
Fcr KWH5, I have assigned a growth rate of 3.3 percent.
s Schedule 15 displays total company kwh sales for the period 1963 through 1980. There is a noticeable decrease in kwh growth rates for various periode are shown and range from 3.16% to 5.23%. Con-centrating primarily on the period beginning in 1975, it would appear that a 3.3% growth would be reasonable for investors to expect.
4.
DPSCOV is computed by dividing cash flow per share by dividends per share. This represents the number of times cash divi-dends are covered by cash income.
For UE on average, a DPSCOV of
.t 2.5 times can reasonably be expected to be experienced by the company.
5.
For the variable RRATE, I examined recent yields of Moody's Electric Utilities' stocks.
Schedule 18 displays these stock
,t yields annually for the period 1970 through 1980 and monthly for
,the years 1979 and 1980. Annual yields have ranged from 5.7% to 12.05%. Monthly yields for 1979 and 1980 have ranged frcm 9.5% to
+
13.1% and I believe this is the time period from which values should e
be developed for the RRATE variable.
l 4.
l
. -.. ~. ~,
.-.-..,,....m r,,.
.,__,,,,-.-r-,,.-y.
.4-.,-,..,
,,,,m~
-, _, -.,..., ~ ~ - -, -. -. -.,,, - -,
Earlier in my testimony I referreo to the interest rate sensitivity of utility stocks. The period 1979 and 1980 dramat-ically reflect this reintionship as well as another significant event; that being the Tnree Mile Island accident which occurred late in March, 1979. You will note the significant increase in i '
stock yield in April, 1979 that resulted and then a gradually de-crease thereafter until the increases in the Federal discount rates in late 1979 and early 1980; the decreasing yields from March,1980 to mid-1980 as the discount rate was lowered; and the increase in e
yields that occurred in late 1980 as the discount rate was again increased.
At the bottom of Schedule 18 I have computed average yields for three different time periods that I believe reflect nonnal market conditions during the period 1979 and 1980.
Those average yields are 10.34%, 10.63% and 11.195%. These three yields are the ones I.will use as assigned values for i
the variable RRATE.
i Values for the other variables found significant by the regression i
would be zero, as far as UE is concerned. For example, UE does not have a Moody's bond rating of Aaa or Aa; Missourt does not have a regulatory ranking of 1 or 2; and UE does not geographically operate in areas 4 or 5.
s Q.
Using your assigned values for the variables applicable to UE, t
explain how a return on common equity is derived.
A.
Lines 1 through 7 of Schedule 19 display the mathematical cal-culations using my assigned values for the independent variables relevant to UE. Column 2 is the coefficient term and Column 3 is the assigned value.
Columns 4, 5 and 6 display the result of multiplying Column 2 times Column 3.
l Line 8 is the total products of the independent variables using three stock yields. Line 10, Columns 4, 5 and 6 is the algebraic value that results from combining the total values of the independent variable with the dependent
{
variable, AVMBV. The figures on line 10 are then divided by the BKYLD co-i efficient to solve for its value, or required book yield as shown on line 12. -
The next proceda,e is to divide the required book yield (line 12) by an appro-t l
priate pa'yout ratio.
For the period 1973 through 1979, the 79 companies' l
i.
l
29 payout ratio averaged about 73 percent. Accordirg to an electric utility industry report by Salomon Brothers, dated April 14, 1981, the average pay-r out ratio of 100 electric utilities was 79 percent. Since investors require I
a high current yield, it is, important that officers of electric utilities recognize this desire and provide a dividend that will maximize the value of their comon stock. On average, a dividend payout ratio from 75 percent to s
r 77.5 percent would appear to be appropriate for the industry to fulfill desires of investors and at the same time, provide sufficient coverage for the cash dividend.
Line 14 of Schedule 19 reflects the resulting required returns F
i on common equity using payout ratios of 75 percent and 77.5 percent. These range from 14.09 percent to 15.21 percent, depending upon the payout ratio used and the stock yield reciprocal used.
{
Q. How did you conduct your comparable earnings analysis?
A.
From the 79 electric utilities used in the regression analysis, t
I selected those companies that never experienced average market-to-book valuer less than 00 percent during the period 1973 through 1979. Eleven of the 79 companies met this criterion. Averages for each year were computed for AYMBV, ROE, BKYLD, PAYOUT, EQRAT, PSCOV and DPSCOV. This data is displayed in Schedule 20, as well as the samt data for UE.
For the eleven company group, AVMBVs averaged less than one f -
only in the year 1979 and, even in that year, it was only slightly less than one, indicating that, on average, these eleven companies had the opportunity F
to sell comon stock above book value during the entire period.
If 1980 data i
were available I suspect that AVMBVs would ve '.ower due to the poorer market conditions that existed.
During the same period, ROES averaged 12.5 percent and rangdd from 11.7 percent to 13.2 percent; BKYLDs averaged 9.6 percent and t.
..w.
y=
w w
e ranged from 9.4 percent to 9.8 percent; PAYOUTs averaged 76 percent and ranged from 70 percent to 83 percent; EQRATs averaged 34 percent an'd ranged from 32 percent to 36 percent; PSCOVs averaged about 2 times and ranged from 1.9 to i
2.3 times; and DPSCOVs averaged 2.6 times and ranged from 2.3 to 2.8 times.
In comparison, the AVMBVs for UE averaged 90 percent for the period 1973 through 1979 and, with 1980 included, averaged 88 percent, indica-i I
ting that UE had few opportunities to issue ccamon stock above book value ex-4 cept possibly in 1973 and 1977.
For UE, ROES averaged 10.4 percent and, in-(
citding 1980, averaged 10.6 percent with ranges from 8.1 percent to 12 percent; r
BKYLDs averaged 8.7 percent and ranged from 8.3 percent to 9.4 percent; PAYOUTs l~
averaged 79 percent and 78 percent respectively with ranges from 70 percent to f
93 percent; EQRATs averaged 31.4 percent and 31.8 percent respectively and ranged from 29 percent to 34.4 percent; PSCOVs averaged 1.7 times and ranged i
from 1.53 to 1.86; DPSCOVs averaged about 2.5 times and ranged from 2.0 to
,,i 2.9 times.
Why have tnese eleven utilities, on average, received better market appraisal of their common stocks than has UE? Comparing the six l
financial ratios of the eleven utilities with those of UE does reflect cer-tain significant differences, those being ROE, BKYLD and PSCOV.
The ROES of UE have averaged about 200 basis points less than n
those of the eleven companies. This is probably a contributing factor to-
/
UE's lower AVMBVs, not so much by itself, but because the lower returns have L
l constrained UE's ability to increase dividends and thereby increase BKYLD, l
r L
which has averaged about 100 basis points less. A utility's ability to main-tain a high dividend policy, i.e., one that provides a yield competitive with fixed income securities and one that provides annual increases to maintain that l
high dividend policy results in more favorable investor valuation in good F
markets and helps support a utility's stock price at a comparatively higher L
level in poor markets.
r The PSCOVs of the eleven utilities have averaged more than UE t
primarily because of the higher level of ROE. The DPSCOV of UE has averaged r
b-about the same as those of the eleven utilities but this is primarily due to UE's lower dividend policy. On average, the EQRATs of UE have lower than I
those of the eleven utilities but apg.arently UE has striven to maintain a higher equity ratio in recent years.
The average PAYOUTs of UE and the eleven utility group are very U
close for the period.
But UE's payouts are a result of lower ROES and not a result of a higher dividend policy which is representative of the eleven
~'
utility group.
In sumary, it appears that the more highly valued electric
]
utilities exhibit:
1.
Payout ratios in the range of 75 to 80 percent, 2.
High book yields, indicating a high dividend policy, and p
1 3.
On average, returns on ccmon equity in the low 13 percent f
range would help support a utility's stock price but re-turns in the upper teens are not necessarily required.
~ Q.
Did you perfom any other comparable earnings analysis?
l A.
Yes.
I also reviewed the average historic earnings and market t-I l
~
values of two groups of non-regulated fims; the S&P 400 Industrials and Com-
[
pustat Industrials. No attempt was made to select companies of comparable risk to UE, the primary purpose was to compare the reasonableness of returns i
obtained from other approaches with returns earned in general in the non-regu-l lated sector. The data for these two groups of non-regulated firms were taken from the Compustat II Industrial data base.
Returns en year-end common equity t.
y
., _ _ _. _... - ~
were computed for each company and then a simple arithmetic average was cal-
"~
culated for the composite. The average market to book value was computed by dividing the average of the high and low market price per share by the year-r
[.
end book value per share for each c,ompany, and then a simple arithmetic average was calculated for each composite.
l-Schedule 21 displays the average market to book values (AVMBV)
I and the returns on year end common equity (ROE) for the total Compustat Indus-
[
trial file and also for those companies included in the S&P 400. These two f
groups were also subdivided into a non-oil component group and an oil component 7.,
group because of the influence the oil component group has had on stock price I-indices such as the S&P 400. Last year, Salomon Brothers published data that F'
illustrated the weighting effect the oil component companies had on the S&P 400
'i index.
It was as follows:
r Market Values of the Oil and Non-oil Sectors of. the S&P 400 (Dollars in Billions)
_2079_
3Q79 4Q79 1Q80 2080 Change 011
$134.1
$154~.3
$161.3
$174.3
$197.1 47.0%
'.1 Non-oil 441.1 464.1 453.0 415.5 459.3 4
L S&P 400
$575.2
$618.4
$614.3
$589.8
$656.4 14.1%
g-t.
The oil component includes about 30 companies or 71/2 per-I cent of the total 400 companies that make up the S&P 400 but, at the second quarter of 1980, the oil component represented 30 percent of the total market value.
For the year shown, the S&P 400 was up 14 percent, or $81.2 billion in total market value, with 78 percent of the improvement being provided by the L
oil component. On a nine-month basis, the " market" as measured by the S&P 400 r
excluding the oil component, was actually down, while the total S&P 400 average i
4 n
a
was up 6.1 percent, indicating that more than 100 percent of the market gain
~
during this time period was accounted for by the oil component of the index.
Referring to Schedule 21, for the period 1970 through 1979, re-r L
turns on equity have increased and average market to book values have de-creased, but they still remain at a level well above book value.
Returns for r-I the S&P 400 have been higher than the Compustat Industrials due primarily to the inclusion of larger and more well establishe.i companies. Average market to book values have also been higher for the S&P 400, i
Since 1973, the returns earned by the oil component companies have increased the total returns from 10 to 40 basis points. When the oil p,
I component companies are excluded, returns on equity for the S&P 400 have rar.ged from the mid 13 percent to the mid 14 percent in recent years with
\\
average market to book values well over book value. Returns on equity for f
the Compustat Industrials, excluding oil, have been materially lower except for the year 1979 and average market to book values have also been lower but i
still well above book value.
Q. What has your analysis indicated regarding a retu~rn on comon T
5..
equity for'UE?
11
.A.
My DCF analysis indicated a range of returns on equity from about 13.93 percent to 15.48 percent. My regression analysis indicated re-turns in tM range of 14.09 percent to 15.21 percent; the average of the high f'
and low returns from the DCF and regression analyses computes to a range of 14.4 percent to 14.8 percent. The comparable an.=1ysis of eleven more highly f
valued electric utilities indicates that earned returns of about 13. 2 percent would support stock prices in excess of book valae during most market conditions, although this analysis also indicated.that other financial ratios should be k.
i l
exhibited by the company in addition to the return on equity. Lastly, the I
non-adjusted risk returns earned in the non-regulated sector, although higher t
than the eleven electric utilities, indicate that returns in the li percent to 15 percent range are reasonable. Therefore, I conclude that returns on equity in the range of 14.4 percent to 14.8 percent represent a fair and reason-r able estimate of the cost of common equity for UE.
r Q.
Based upon your returns on common equity of 14.4 percent to 14.8 percent, what are your resulting recommended rates of return?
l A.
Schedule 22 displays the resulting rates of return using re-turns on comon equity of 14.4 percent,14.6 percent and 14.8 percent. They p.
I compute to be 10.66 percent,10.73 percent and 10.80 percent based upon the pro forma capital structure and the embedded costs of long-term debt and pre-
'~
ferred stock of UE at June 30, 1981.
I
(
Q.
Would you please relate your recomended rates of return of 10.66 percent,10.73 percent and 10.80 percent to an appropriate rate base?
l A.
My recomended rates of return should be applied to a juris-dictional original cost rate base.
If a rate base other than original cost L
is used, then my recommended rates of return would have to be adjusted to produce the same dollars as calculated using an original cost rate base.
Q. What is the relationship between the rates of return you have computed in your Schedule 22 and UE's overall cost of capital?
t A.
The rates of return shown in my Schedule 22 include UE's pre-tax cost of long-term debt and are computed in this way because of the
,f use of the revenue requirement formula shown in Schedule 2 where the rate of return is an amount designed to cover pre-tax interest charses and a return i
for the comon stockholders.
Included in operating expenses are income taxes t.
a.
.,e 1
,,-,--.-----.-,,n-,,.e
-y..-
y-g -
4,
--ca..,, - -.,
that reflect the deductibility of 1..terest expense.
However, the actual overall cost of car ital to UE is on the r'
basis of each capital component's after-tax cost. Since interest charges are i
deductible for income tax purposes, the tax savings due to the interest charges t
should be shown as a deduction from capital costs. The result is an overall i
cost of capital that reflects debt costs less its related tax savings.
t Schedule 23 shows the computation of UE's overall cost of capital that re-I' flects this tax saving. The tax factor of.51537 is the reciprocal of the effective tax rate of.48463. The computed overall costs of capital of 8.49 percent 8.56 parcent, and 8.63 percent reflect the after-tax weighted costs I
of all the capital components of UE.
r-Q.
Will Union Electric Company be able to carry out its projected l'
annual financings of external capital?
I A.
In order for UE to issue additional bonds and preferred stock, t
it must meet certain tests under its Mortgage Indenture and its Articles of 1
i Incorporation. There are no specific requirements or tests,that must be met in order for UE to sell common stock.
l t
For the issuance of bonds, the most restrictive requirement is f
the earnings coverage test or the minimum number of times net earnings must i
be greater than interest charges on bonds outstanding and then being issued.
In February,1981, UE issued $150 million of First Mortgage Bcnds at an interest rate of 15 3/8 percent.
In calculating the earnings coverage test for this issue, the company used earnings for the twelve months ended November 30, 1980, which com-plied with one of the requirements of using any 12 consecutive months within the 15 i
months preceding issue. At that time, the coverage was 3.23 times, excluding inter-l est on the proposed issue, and was sufficient to allow UE to issue an additional $356M i
l u
l
)
i of bonds at 15 3/8 percent and still. meet the minimum coverage test of two times.
Including interest on the $150 million proposed issue, coverage was i
about 2.6 times. At March 31, 1981, coverage under the indenture was about c
2.5 times, excluding interest on $30 million of bonds to be taken down later,
(
and was about 2.4 times including the interest on the $30 million of bonds.
I UE's scheduled debt financing for the remainder of 1981 has j
changed from what was originally planned. A $75 million issue of Pollution Control Bonds is now planned for the summer of 1981. This is in addition to the originally planned amount of $200 million.
If we assume that the corpor-ate earnings level at March 31, 1981 will continue and we also assume a 12 per cent interest rate on the pollution control bond issue, then pro forma coverage
~
under the indenture will be about ?. times which easily exceeds the minimum coverage test of two times and thus will enable UE to issue these bonds.
f Beyond 1981, it becomes difficult to estimate what'UE's cov-erages will be and consequently whether it will be able to carry out its pro-4 jected bond financings. Unknown variables such as the revenue increase to be awarded in this case and the future level of interest rates woUld affect future coverage computations of UE debt issues.
In 1982, the amount of bonds pro-
~
jected to be issued which would require a coverage test is $75 million. This is $150 n,.llion less than 1981.
$100 million in bonds are projected to be issued in 1983 and none in 1984.
r To issue additional preferred stock, UE must comply with a cov-erage test under its Articles of Incorporation. This test requires that net f
earnings for a period of 12 consecutive months within 15 months preceding such sale be at least 21/2 times the annual dividend requirements on its preferred i
Q ei l
stock then outstanding and to be issued.
In May, 1981, UE originally planned to issue $75 million of preferred stock but withdrew that proposed issue partly due to the high dividend rate that would have been required (about 17 percent) and partly due to a temporary improved cash flow condition. Although this preferred stock issue has currently been postponed to October,1981, the possibility exists that it may be delayed until sometime in 1982.
t At March 31, 1981, preferred dividend coverage was 4.8 times.
Assuming $75 million of preferred stock was issued at a dividend rate of 17 percent, pro forma dividend coverage would have been 3.35 times.
If we assume a continuation of the current earnings level and also assume that $75 million p
of pollution control bonds will be issued at a 12 percent interest. rate, then I
preferred dividend coverage would be about 4.5 times or still sufficient to issue $75 uillion of preferred stock at a dividend rate of 17 percent.
To summarize, it appears that UE will be able to complete its t
bond and preferred stock financings for the remainder of 1981. Beyond 1981, e
there are assumpt ;. - that would have to be nade regarding tariffs that would
(
l be in effect and the level of investors' required yields on delt and pre-L l
ferred steck.
l t
l Q.
Does this conclude your prepared testimony?
l A.
Yes, it does.
t i
1
.. ~...
.~
t l
i STAFF EXHIBIT An Analysis of the Rate of Return for UNION ELECTRIC COMPANY i
I Case Number ER 81-180 l'
t 1
i 1
Office of Financial Analysis Missouri Public Service Comission i
4 i
t i
i i
l I
i s
May,1981 I
k 1
-.-,..,,,,,..---.,,,.,,,,,-.-.,-...-n,,,-.,
..,.,,-,,_.,..,.-.,.-.,,,,-,,-,..r,,--.._-
Schedule 1
~
List of Schedules P
Schedule No.
Description 2
Public Utility Revents Requirements or Cost of Service a
~
3 Average Yield on Moody's Public Utility Bonds _(Graph) 3A Average Yield on Moody's Public Utility Bonds 4
Average Prime Rate (Graph) 4A Average Prime Rate 5
Avarage Yield on Moody's Public Utility Bonds and Prime Rate (Graph)
SA Average Yield on Moody's Public Utility Bonds and Prime Rate 6
Rate of Inflation (Graph) 6A Rate of Inflation I
7 Moody's Averi Public Utility Bond lield and Rate of 1....ation (Graph)
_8 NewYorkStockExchangeStockPriceIndices(Graph) 9 Moody's Average Public Utility Bond Yields, S&P's Industrials and Utilities Stock Yields (Graph) 10 Moody's Electrics Market-to-Book Value and l
Average Yield on Utility Bonds (Graph) l l
11 Pro Forma Capital Structure, June 30, 1981 l
12 Embedded Cost of Long-Term Debt 13 Embedded Cost of Preferred Stock 14-Common Stock Yields 15 Increase and Growth in Earnings, Dividends and KhHs i
l
.i SCHEDULE 2 Public Utility Revenue Requirements or Cost of Service The formula for the revenue requirement. of a public utility may be stated as:
~
Revenue Requirement = Cost of Service or RR = 0 + (V - D)R I
The symbols in the second equation represent the following factors:
RR = Revenue Requirement 0 = Operating Cost, including depreciation expense and taxes f
V = Gross Valuation of the property serving the public D = Accrued Depreciation (V-D) = Rate Base (net valuation)
(V-D)R = Return Amount, or earnings allowed on the rate base R = il + dP + kE (a cercentage)
L = Proportion of debt in capital structure
(
i = Embedded Interest rate P = Proportion of preferred stock in the capital structure d = Embedded cost of preferred E = Proportion of Equity in the capital structure ku Rate of return on equity s
Schedule 3 Average Yi@ld on Foody's Public Utility Bonds 4
i 15.0% -
14.0,
v a
t t
(
13.0--
i i
^
12.0
.i I
.t t :*
i a
l' 11.0
.i 4
l 10.0 "
.t.
...s 9.0
\\ ^..
. s. a!.'.
a t
l 1
1 8.0 L.
/
~
s..
s-
.t
- 7. 0, -
I t
r 1972
'73
'74
'75
'76
'77
'78
'79
'80
'81 1
i 1
1 i
1j l
l
[
T f
.{
E I
I
Schedule 3A Average Vield on MoTdy's public Utility Bonds January. 1972 to Fresent Month / Year Average Yield Moeth/ Year Averace Yield Jan/1972 7.85 Jan/1977 8.59 Feb 7.84 Feb 8.63 Mar 7.81 Mar 8.66 Apr 7.87 Apr 8.65 May 7.88 May 8.64 t
Jun 7.83 Jun 8.53 Jul 7.80 Jul 8.48 Aug 7.69 Aug 8.47 Sep 7.63 Sep 8.43 Oct 7.63 Oct 8.56 Nov 7.55 Nov 8.61 Dec 7.48 Dec 8.65 Jan/1973 7.51 Jan/1978 8.87 Feb 7.61 Feb 8.90 Mar 7.64 Mar 8.93 s..
Aor 7.64 Apr 9.05 May 7.63 May 9.19 Jun 7.69 Jun 9.33 I
Jul 7.81 Jul 9.38 l
Aug 8.06 Aug 9.21 Sep 8.09 Sep 9.17 Oct 8.04 Oct 9.37 Nov 8.11 Nov 9.58 l
Dec 8.17 Dec 9.67 Jan/1974 8.27 Jan/1979 9.85 Feb 8.33 Feb 9.84 Har 8.44 Mar 10.02 Apr 8.68 Apr 10.05 May 8.86 May 10.23 Jun 9.09 Jun 10.04 Jul 9.35 Jul 9.90 Aug 9.70 Aug "9.97 Sep 10.11 Sep 10.19 Oct 10.31 Oct 10.71 Nov 10.12 Ncv 11.37 Dec 10.02 Dec 11.35 Jan/1975 10.10 Jan/1980 12.12 Feb 9.83 Feb 13.48 Mar 9.67 Mar 14.33 13.50 Apr 9.88 Apr
' 12.17 May 9.93 May Jun 9.81 Jun 11.87 1-Jul 9.81 Jul 12.12 Aug 9.93 Aug 12.22 Sep 9.98 Sep 13.29 Oct 9.94 Oct 13.53 Nov 9.83 Nov 14.07 Dec 9.87 Dec 14.88 Jan/1976 9.68 Jan/1981 14.22 Feb 9.50 Feb 14.84 Mar 9.43 Mar 14.86 Apr 9.27 May 9.31 Jun 9.36 Jul 9.26 Aug 9.07 Sep 8.91 Oct 8.83 Nov 8.77 Dec 8.61 4
8
-e e
- - - - ~
e
,m.-
- w,-~-
y
.u Schedule 4 Average Prime Rate 20.%
18*- '
16._.
?
.g 14._
12.
a
.*..+.....I-.
e,-
=
10.
r
.I rs***
r Y.
?
t 8.
)
r*
s
=
s.
- . 7 6
.?
s 6.
r;
.. ~
.t 4._. I I
In-e 1972
'73
'74
'75
'76
'77
'78
'79
'80
'81
(
i t'
.]
?
f f
r 1
I t
s ~. e w.
e s~..
~~
t L.._.
Schedule 4A AVERAGE PRIME RATE Month / Year _
Prime Rate Month / Year Prime Rate Jan/1972 5.185 Jan/1977 6.25%
Feb 4.75 Feb 6.25 Mar 4.75 Mar 6.25 Apr 4.98 Apr 6.25 May 5.00 May 6.41 Jun 5.04 Jun 6.75 Jul 5.25 Jul 6.75
{
Aug 5.27 Aug 6.83 Sep 5.50 Sep 7.13 Oct 5.73 Oct 7.$2 Nov 5.75 Nov 7.75
('
Dec 5.79 Dec 7.75 Jan/1973 6.00 Jan/1978 7.93 Feb 6.02 Feb 8.00 Mar 6.30 Mar 8.00
/
Apr 6.60 Apr 8.00 May 7.01 May 8.27 Jun 7.49 Jun 8.63 Jul 8.30 Jul 9.00 Aug 9.23 Aug 9.01 i
Sep 9.86 Sep 9.41 Oct 9.94 Oct 9.94 g
Nov 9.75 Nov 10.94 Dec 9.75 Dec 11.56 Jan/1974 9.73 Jan/1979 11.75 Feb 9.21 Feb 11.75 Mar 8.83 Mar 11.75 Apr 10.02 Apr 11.75 May 11.25 May 11.64 g
Jun 11.54 Jun 11.75 Jul 11.98 Jul 11.75
'a Aug 12.00 Au9 12.25 Sep 12.00 Sep 13.25 Oct 11.68 Oct 15.25 Nov 10.83 Nov 15.25 Dec 10.50 Dec 15.00 Jan/1975 10.05 Jan/1980 15.25 Feb 8.96 Feb 15.63 Mar 7.93 Mar 18.31 Apr 7.50 Apr 19.77 May 7.40 May 15.57 Jun 7.07 Jun 12.63 Jul 7.15 Jul 11.48 Aug 7.66 Au9 11.12 Sep 7.88 Sep 12.23 Oct 7.96 Oct 13.79 Nov 7.53 Nov 16.05 Dec 7.26 Dec 20.35 l
Jan/1976 7.00 Jan/1981 19.75 Feb '
6.75 Feb 19.43 Mar 6.75 Mar 17.25 Apr 6.75 May 6.75 Jun 7.20 Jul 7.25 Aug 7.01 Sep 7.00 Oct 6.78 l
Nov 6.50 i
Dec 6.35 i
i
~.
..,_,.~m
Schedule 5 Average Yiold on Moody's Public Utility Bonds and Prime Rat @
- 20. 0__'
19.0 18.0_.
17.0-I 16.0 '
15.0
, Prime Rate
~
t 14.0-i:
.i 13.0-
.i-s 1 12.0-11.0-Average Yield
/
'*\\,
10.0 '.
~
l'"..*...,'".-~.*-
9.0-
?./
..~
'"'"%e" *
.,,,,,,,....~r*..*
8.0-7.0 -
t 6.0-
- 5. 0_
1972
'73
'74
'75
'76
'77
'78
'79
'80
'81 i
-4 i --
(
i __,,
i_,
.~.
i r
us
__ _15.0_
m 14.0_
Rate of Inflation 13.0_
N 12.0 1
'b 11.0 10.0 l
9.0 1
4 8.0,
i 1
- 7. 0_
4
}
6.0 i
- 5. 0_.
I t
4 t
I i
4.0,
i 1
. 3.0_
i e
i 4
^
i 1
I i
1972 t
-.. ' 7 '4
, -.' 74
.~5
- '7' -
-'8 81 i
'r'-
s 1
1 f
W" e
-o.=w.=
Schedule 6A' RATE OF INFLATf0N
~
Month / Year Inflation Rate Month / Year Inflation Rate Jan/1972 3.40 Jan/1977 5.20 Feb 3.70 Feb 6.00 Mar 3.50 Mar 6.40 Apr 3.40 Apr 6.80 May 3.20 May 6.70 Jun 2.90 Jun 6.90 Jul 3.00 Jul 6.70
,i Aug.
2.90 Aug 6.60 5ep 3.30 Sep 6.60 Oct 3.40 Oct 6.50 Nov 3.50 Nov 6.70
('
Dec 3.40 Dec 6.B0
)
Jan/1973 3.70 Jan/1978 6.80 Feb 3.90 Feb 6.40 Mar 4.70 Mar 6.50 Apr 5.10 Aor 6.60
)
May 5.50 May 7.00
("-
Jul 5.70 Jul 7.70 Jun 5.90 Jun 7.40 Aug 7.50 Aug 7.90 Sep 7.40 Sep 8.30 l
Oct 7.90 Oct 8.90 Nov 8.40 Nov 9.00 Dec 8.50 Dec 9.03 Jan/1974 9.40 Jan/1979 9.35 l
Feb 10.00 Feb 9.93
(.
Har 10.20 Mar 10.17 Aor 10.10 Apr 10.00 May 10.60 May 10.76
~~
Jun 11.00 Jun 10.90 Jul 11.50 Jul 11.28 Aug 11.00 Aug 11.77 Sep 12.00 Sep 12.09 Oct 12.00 Oct 12.13 1
Nov 12.10 Nov 12.62 Dec 12.20 Dec 13.30 Jan/1975 11.70 Jan/1980 13.92 Feb 11.10 Feb 14.15 Mar 10.30 Mar 14.68
{
Apr 10.20 Apr 13.38 May
, 9.50 May 14.39 Jun 9.30 Jun 14.31 Jul 9.70 Jul 13.7) i Aug 8.60 Aug 12.30
(
Sep 7.80 Sep 12.L7 Oct 7.60 Oct 12.68 Nov 7.30 Nov 12.06 i
Dec 7.00 Dec 12.10 f
Jan/1976 6.80 Jan/1981 11.70 Feb 6.30 Feb 11.30 Mar 6.10 Mar 10.60 Apr 6.10 s
May 6.20 Jun 5.90 Jul 5.40 Aug 5.60 Sep 5.50 i
Oct 5.30 Nov 5.00 Dec 4.80
.~
l t
a
- i..
. w_
n.
~ _ - ~ -. ~.. ~ _ - ~ _ _ _
~
Schedule 7 Moody's Averaga Public Utility B::nd Yield and Psate of Inflation i
15.0%.
.a. t 14.0 i*..
l l
i 13.0--
[ i.
/
i 12.0.
t
.4 v-t 11.0 Moody's Average Public Utility i
a
~
Bond Yields
,1 l ' ~,, i
'0 0
-t 1
)
9.0-
'v"..*
.?
8.0_
..r-
-.. ~..
/
1
.e e
- 7. 0_,<
\\
l 6.0 Rate of Inflation 5.0 q
4.0 1
3.0-
~
t
- 2. 0._
1972
'73
'74
'75
'76
'77
'78
'79
'80
'81 i
4 4
s
. ~,,
.)
s ~ 4
' ~ ~ -
%-~~
~
- ~ ~ '
^*
' " ~ '
~ ' '
~~
90.00 -
Sch:dulo 8 3
New York. Stock Exchange Stock Price Indices-
- : r 1
80.00 _
i 70.00 -
- l. \\. 4}
4
..s a : :
,. s
.?
Industrials e
I. 8
./
,. ^..d *.[
3 I,I f
0.
4 s.
.+. v. ;...
4 s.
s.
t o
.s.
s.: s.
w ie:..
-s..t l
.r
.2 p
e 50.00
- i.
l s/
N' 1
- t..,
s r
my 1.e.\\. st 4
Ut111ttes i
1 30.00 i
20.00
......................,.............................~~~,~.~~~~.~~~~~i_~~~.t>i-~~'"e" 4
t i
- 1972
'73
'74
'75
'76
'77
'78
'79.
'80 I
' ~ ~.
~,
. a., l
]
Schedule 9
- 9..
- 14. 0_.
Moody's Average Public Utility Bond Yields sgp.s Industrials Stock Yields S&P's Utilities Stock Yields
. ~.
.?
13.0-4 i
12.0 i
r p
11.0,i.
e' T.
5 10.0;.
rf.! '.
Moody's Averac e Public Utility...
h,
.g..
.,,....... ~
Bonc; Yields
,,.. * ',/ r,
,,.l y
\\
7
. j..'
\\..,.<y.. i %r' n
9.0
',,.I it
. * ~.
ll
...~ i
- / ;
s,
~-
8.0
'd A '- !
I
,p.
l
'T
",,4
?
t','.."
S&P's Utilities
',,, " "'z!
7.0-I Stock Yields r,,
- 6. 0_, '.
,,j%., ':/
5.0j,
j' 4.0 S&P's Industrials Stock Yields 3.0j
- 2. 0_. i
~
1972
'73
'74
'75
'76
'77
'78
~.~.
. ',79
'90
'R1
t
- 15. -
2.0
. _1. 9 14.
Schedule 10
_1.8 it j 3,g s.,
Moody's Electrics Market-to-Book Value and
_1.7 g
i i
Average Yteld on Uttitty Eonds.
_1.6 12._ ;
q,
- i,
_1.5 V*
11 -
g (as.1
! **s MB
-1.4
/t g Y
- 10*-
t.
?
j.3
\\.
- g./
\\
A,<1 s
,\\
9.
g
- f
-l.2 5
s%
- d i
8.
%/
)
-j,1
'.,j%
_1.0 M/B 7.
i.
.i 6.-
t,','1
...?~.
.i -m.g**,%
-.9 r's
..e
\\\\//j 1,.\\.ge-%
.8 Average Yield 1
S' i
5.
I t*.'v \\ / -
s
%.'\\
.7 s.
s t
w 4._
g.: f
_.6 3._,
_.5 i.
5 4
1 l
1 4
Jan/69 Jan/70 Jan/71 Jan/72 Jan/73 Jan/74 Jan/75 Jan/76 Jan/77 Jan/78 Jan/79 e
4
.i s
s._._
O Schedule 11 UNION ELECTRIC COMPANY i
Case Number ER 81-180 f'
Pro Forma Capital Structure, June 30, 1981 i
Amount at Increase Pro Forma Capital Comoonent 3/31/1981 Apr, May, Jun '81 6/30/1981 Ratios t,,
(
Long-term debt
$ 1,354,148,990
$39,000,000(1)
$ 1,393,148,990
.5072 383,084,5'0
.1394 0
Preferred stock 383,084,500 Common equity 952,801,057 17,851,000(2) 970,652,057
.3534
$ 2,690,034,547
$ 56,851,000
$ 2,746,885,547 1.0000
\\
i (1)
Increase in lona-term debt:
\\.
Take-down of additional pollution control bonds, series 19,80 9,000,000 l
Take-down of remaining ist Mort. Bonds issued in February'81 30,000,000 Total
$ 39,000,000 l
l (2)
Increase in common eauity:
i l
Net increase in retained earnings 5 12,959,600 Stockholder dividend reinvestment plan 4,891.400
(
l Total
$ 17,851,000 l
l r
i e
I
UNION ELECTRIC COMPANY Cas@ Number ER 81-180 Embedded Cost of Long-Tem Debt 1.
2.
3.
4.
5.
Current Principal Amt.
Net Annua 11 zed Int.
Cost C=rs.ly Annualized Cost First Mortgage 8onds of Debt Issue Proceeds on Principal Issued (3+2)
Outstanding (4x5) 3 1/4% serics due 5/1/82 30,000,000 30,271,010 975,000
.03221 30,000,000 966,300 3 3/4% Series due 7/1/86 40,000,000 40,484,836 1,500,000
.03705 40,000,000 1,482,000 4 3/8% Series due 3/1/88 35,000,000
'5,457,500 1,531,250
.04319 35,000,000 1,511,650 4 3/4% Series due 9/1/90 50,000,000 50,166,357 2,375,000
.04734 50,000,000 2,367,000 4 3/4% Series due 7/1/91 30,000,000 30,150,868 1,425,000
.04726 30,000,000 1,417,800 l
4 1/2% Series due 11/1/93 30,000,000 30.071,783 1,350,000
.04489 30,000,000 1,346,700 4 1/2% Series due 4/1/95 35,000,000 34,907,360 1,575,000
.04512 35,000,000 1,579,200 5 1/2% Series due 5/1/96 30,000,000 30,463,820 1,650,000
.M416 30,000,00n 1,624,800 51/2% Series due 3/1/97 40,000,000 40,154,749 2,200,000
.05479 40,000,000 2,191,600 7% Series due 4/1/98 50,000,000 50,488,435 3,500,000
.06932 50,000,000 3,466,000 7 3/8% Series due 5/1/99 35,000,000 35,134,009 2,581,250
.07347 35,000,000 2,571,450 2
81/4% Series due 10/1/99 40,000,000 40,152,450 3,300,000
.08219 40,000,000 3,287,600 9% Series due 4/1/00 60,000,000 60,234,864 5,400,000
.08965 60,000,000 5,379,000 7 7/8% Series due 1/1/01 50,000,000 50,115,832 3,937,500
.07857 50,000,000 3,928,500 7 5/8% Series due 4/1/01 50,000,000 50,360,503 3,812,500
.07570 50,000,000 3,785,000 8 1/8% Series due 10/1/01 60,000,000 60,327,647 4,875,000
.08081 60,000,000 4,848,600 8 3/8% Series due 2/1/04 70,000,000 70,516,283 5,862,500
.08314 70,000,000 5,819,800 10 1/2% Series due 3/1/05 70,000,000 69,196,999 7,350,000
.10622 70,000,000 7,435,400 8 7/8% Series due 9/1/06 70,000,000 68,744,806 6,212,500
.09037 70,000,000 6,325,900 5.8% Series duc 11/1/05 27,085,000 26,430,920 1,570,930
.05944 27,085,000 1,609,932 8 5/8% Series due 12/1/07 60,000,000 59,074,154 5,175,000
.08760 60,000,000 5,256,000 9.35% Series due 8/1/08 55,000,000 54,701,468 5,142,500
.09401 55,000,000 5,170,550 9.95% Series due 11/8/99 100,000,000 99,657,576 9,950,000
.09984 100,000,000 9,984,000 15 3/8% Series due 2/1/91 150,000,000 148,475,000(1) 23,062,500
.1553 150,000,000 23,295,000 Total First Mortgage Bonds
$1,267,085,000 $106,649,782 Pollution Control Bonds 1974 Series due 1989 to 2004 16,500,000 16.050,861 1,002,500
.06246 16,500,000 1,030,590 1980 Series due 2000 to 2010(2)60,000,000
.0986 34,563,990 3,408,009 Total Pollution Control Bonds 5
51,063,990 5 4,438, b~9T-Intemediate Term Loan Due 12/31/85 (3) 75,0%,000
.1581 $
75,000,000 $ 11,857,500 Total Long-Term Debt
$1,393,148,990 5122,945,881 Embedded Cost 8.825%
Estimated Average effective rate Avaraqe rata for 1080,,15 811 719-A c,P.C~. 'o rm
- 1 L
..~
u
~-
~ - >
Schedule 13 UNION ELECTRIC COMPANY Case Number ER 81-180 Embedded Cost of Preferred Stock 1.
2.
3.
4.
5.
6.
Par or stated Annual Net Cost
/. mount Annual Cost Preferred Stock value/ share Dividends Proceeds (243)
Outstanding (4*5)
$2.72 series
$ 25.00
$ 3,916,800
$ 34,402,559
.11385
$ 36,000,000
$ 4,098,600 7.44 series 100.00 4,092,000 54,300,237
.07'4 55,000,000 4,147,000 s
8.00 series of 1971 97.50 3,400,000 40,757 116
.0834 41,437,500 3,455,888
. 8.00 series of 1969 92.25 2,800,000 31,823,136
.0880 32,287,500 2,841,300 6.40 series 100.00 1,920,000 29,570,820
.0649 30,000,000 1,947,000 4.56 series 100.00 912,000 19,968,367
.0457 20,000,000 914,000 4.50 series 100.00 961,178 21,744,206
.0442 21,359,500 944,090 4.00 series 100.00 600,000 15,057,104
.0398 15,000,000 597,000 3.70 series 100.00 148,000 4,000,604
.0370 4,000,000 148,000 3.50 series 100.00 455,000 13,657,228
.0333 13,000,000 432,900 2.125 series 25.00 3,400,000 38,464,179
.0884 40,000,000 3,536,000 4.60 series 50.00 6,900,000.
74,621,888
.0925 75,000,000 6,937,500 Total
$ 383,084,500
$ 29,999,278 Embedded Cost 7.83%
Io e
L. '
L~-
L. '
L'
..)
. [0-N
Schedule 14 UNION ELECTRIC COMPANY Case Number ER 81-180 r
Comon Stock Yields r-(2)
(3)
(1)
Dividend f
~ Indicated Price Yield Mo/ Year DPS E.0.M.
(142)
Jan/79 J.44
$ 14.625 9.85%
14.25 10.11 Feb Mar 13.75 10.47 Apr 13.50 10.67 May 14.00 10.29 Jun 13.75 10.47 Jul 13.872 10.38 Aug 14.125 10.19 Sep 13.75 10.47 Oct 12.00 12.00 i
Nov 12.125 11.88 t.
Dec 12.00 12.00 c
Jan/80 11.50 12.52 Feb 10.75 13.40 Mar 10.00 14.40 Apr 11.50 12.52 May 12.75 11.29 i
Jun 12.25 11.76 Jul 1.52 12.00 12.67 Aug 12.25 12.41 Sep 11.50 13.22 l
Oct 10.75 14.14 Nov 10.625 14.31 l
Dec 10.875 13.98 Jan/81 11.00 13.82 I
Feb 11.00 13.82 Mar 10.875 13.98 Apr 10.50 14.48 l
Averace 1979 10.73%
1979 plus 4/80 thru 8/80 11.14 1979 and 1980 11.88 (4)
(5)
Average E.O.M.
Year Dividend Yield i
' ~ '
1974 11.04%
1975 10.60 1976 9.02 1977 8.72 1978 9.70 1979 10.73 1980 13.03 t,
Schedule 15 UNION ELECTRIC C0ftPANY Case Number ER 81-180 Increase and Growth in Earnings, Dividends and KWHs E.P.S.
D.P.S.
(KWH (000,000)
Increase Increase Amount (Decrease)
Amount Increase Amount (Decrease)_
1963
$ 1.26
$.99 10,407 1964 1.35 7.14%
1.03 4.04%
11,337 8.94%
1965 1.48 9.63 1.12 8.74 12,325 8.71 1966 1.53 3.38 1.14 1.79 13,707 11.21 1967 1.60 4.58 1.20 5.26 14,271 4.11 1960 1.59
( 0.63) 1.20 0
15,466 8.87 1960 1.60
.63 1.20 0
16,709 8.04 1970 1.92 20.00 1.26 5.00 17,5?'
4.94 1971 1.61 (16.15) 1.28 1.59 18,474 5.36 1972 1.35 (16.15) 1.28 0
19,350 4.74 1973 1.62 20.00 1.28 0
20,289 4.85 1974 1.37 (15.43) 1.28 0
20,246 (0.21) 1975 1.78 29.93 1.28 0
20,944 3.45 1976 1.86 4.49 1.34 4.69 21,359 1.98 1977 1.67 (10.22) 1.36 1.49 23,081 8.06 1978 2.01 20.36 1.40 2.94 23,517 1.89 1979 1,73 (12.94) 1.44 2.86 23,689 0.73 t
1980 2.10 21.14 1.48 2.78 24,795 4.67 Trended' Growth 1963-80 1.86%
1.91%
4.86%
i 1971-80 3.54 1.70 3.16 1976-80 2.78 2.56 3.24 Average Annual Compound Growth 1963-80 3.05%
2.39%
5.23%
1970-80
.90 1.62 3.53 1975-80 3.36 2.95 3.43 s.. l c.
4
Schedule 15A r
UNION ELECTRIC COMPANY
- s Case Number ER 81-180 r
m i.
Earninas Per Share f.
l
.=
\\
L $3.00 9.,_,.p.$
.+.%
f.
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u 19.63
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e D
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Schedule 15B UNION ht.ECTRIC COMPANY Case Number ER 81-180 p
.i.
Olvidends Per Share.
l s
.L
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l 1964
'66
'68
'70
'72
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'76
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I 6
t L..
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b.
Schedule 16 UNION ELECTRIC COPPANY Case Number ER 81-180 Results of Common Stock Issues Since 1975 (1)
(2)
(3)
(4)
(5)
(6)
(7)
Less:
Less:
Underwriters' Other Proceeds Flotation Date of Price to Public Compensation Expenses to Company Book Value Costs as a % of Issue Per Share Per Share Per Share Per Share PerShare(b)
Book Value 12/4/75(a) 12.875
.53
.045 12.30 15.13 3.80 3/22/77 (a) 15.50
.50
.034 14.966 15.32 3.49 I
9/19/78(a) 15.00
.48
.045 14.475 16.05 3.27 i
12/11/79(a) 11.625
.44
.032 11.153 16.09 2.93 12/9/80-(a) 10.625
.49
.041 10.094 16.20 3.28 Average 3.35 (a) Number of shares sold:
1975 = 3.700,000 1977 = 5,000,000 1978 = 4,000,000 1979 = 5,500,000 1980 = 5,500,000 (b) At end of month preceding sale i
48 a
9 9
~
~~
' ^ ^ *
- * ~
- ' ~
c Sch:dule 17 Pags 1 of 2 i
1979 Actual and Predicted Market-to-Book Values - 79 Electric Utilities
(
Comoany Actual Predicted f'
(
1 Boston Edison Company
.620
.606 2
Duquesne Light Comoany
.653
.649 3
Virginia Electric & Power
.670
.640 7..
4 Detroit Edison Company
.684
.679 L
5 Central Hudson Gas & Electric
.704
.674 6
Southern Califirnia Edison Co.
.739
.834 i
7 United Illuminating Company
.752
.775
(
8 Pennsylvania Power & Light
.752
.747 9
Public Service Electric & Gas
.754
.800
(-
10 Consumers Power Company
.756
.731 11 New York State Electric & Gas
.760
.754 12 Gulf States Utilities Company
.764
.887 13 Interstate Power Company
.766
.768
~,
l 14 Kansas City Power & Light
.769
.732 15 Florida Power & Light
.772
.790 16 Kansas Power & Light
.778
.860 f
17 Baltimore Gas & Electric
.783
.819 f
18 Pacific Gas and Electric
.784
.836 19 Potomac Electric Power
.786
.785 t
20 Caroiina Power & Light
.789
.870 21 Niagara Mohawk Power
.790
.777 22 St. Joseph Light & Power
.793
.745 23 Iowa Electric Light & Power
.795
.776 24 Florida Power Corporation
.799
.869 25 Wisconsin Electric Power
.806
.860 26 Public Service Co. of New Hampshire
.807 27 Northern Indiana Public Service
.810
.854
.852 i_
28 Delmarva Power & Light
.811
.834 29 Unfon Electric Company
.812
.832 30 Central Illinois Light
.812
.839 l
31 Orange & Rockland Utilities
.814
.842
~
32 Kentucky Utilities Company
.814
.822 1.
33 Idaho Power Company
.815
.811 34 Philadelphia Electric Company
.816
.837 35 Iowa Southern Utilities Co.
.820
.818 36 Connonwealth Edison
.822
.792 37 San Diego Gas & Electric
.825
.830 38 Louisville Gas & Electric
.830
.826 39 Madison Gas & Electric Co.
.831
.922 40 Sierra Pacific Power Co.
.832
.858 s.
G 1
.m-
. - _. _ ~
__.c Page 2 of 2 i-1 Schedule 17 r-i 1979 Actual and Predicted Market-to-Book Values - 79 Electric Utilities r
I Company Actual Predicted r
41 Duke Power Company
.834
.906 t
42 Dayton Power & Light
.837
.847 I.
43 Kansas Gas & Electric
.839
.816 44 Arizona Public Service Co.
.840
.857 t-45 Central Maine Power Company
.842
.879 46 Toledo Edison Company
.844
.821
('
47 Southern Indiana Gas & Electric
.847
.804 I_
48 Long Island Lighting
.847
.842 49 Empire District Electric Co.
.856
.900 c-50 Otter Tail Power Company
.856
.833 1
51 Atlantic City Electric
.858
.855 52 Puget Sound Power & Light
.868
.900 53 Northern States Power-Mn
.869
.926 54 Washington Water Power
.873
.907 I_
55 Public Service Co. of New Mexico
.873
.997 56 So. Carolina Electric & Gas
.876
.879 f
57 Columbus & Southern Ohio
.877
.939 58 Iowa Resources Inc.
.878
.995 59 Northwestern Public Service Co.
.879
.864 60 Public Service Co. of Colorado
.880
.959 61 Minnesota Power & Light
.881
.849 62 Cleveland Electric Illuminating
.884
.921 63 Wisconsin Public Service
.886
.986 64 Portland General Electric Co.
.894
.931 I
65 Central Illinois Public Service
.912
.957 66 Iowa Public Service Company
.916
.890 67 Cincinnati Gas & Electric
.921
.946 L
68 Pacific Power & Light
.925
.949 69 Illinois Power Company
.926 1.029 70 Indianapolis Power & Light
.932 1.004 71 Oklahoma Gas & Electric
.936
.989 72 Ohio Edison Company
.941
.993 73 Wisconsin Power & Light
.946 1.009 74 El Paso Electric Company
.958 1.070 75 Tampa Electric Company
.969
.941 76' Utah Power & Light
.982 1.019
- f' 77 Public Service Co. of Indiana
.991 1.045 78 Tucson Electric Power Company 1.006 1.006 t.
79 Southwestern Public Service Co.
1.324 1.457 I
-rw.
r w
e v-w
- -T^y-e
+--e,
=
-e ye--
p-w-M g
y_
Schedule 18 UNION ELECTRIC COMPANY Case Number ER 81-180 Moody's Electric Utilities - Comon Stock Yields
(
1970 5.94%
1971 5.70 t
1972 6.07 1973 7.04 1974 10.01
(
1975 9.70 1976 8.62 1977 8.20 i
1978 9.14 1979 10.34 1980 12.v3 Jan/79 9.49 Feb 9.77 Mar 9.88 Apr 10.50 TMI i
May 10.22 Jun 10.16 Jul 10.13 Aug 10.09 Sep 10.55 Fed discount rate increased to 11%
Oct 11.32 Fed discount rate increased to 12%
Nov 10.68 Dec 11.24 1'
Jan/80 11.82 Feb' 13.06 Fed discount rate increased to 13%
Mar 13.00 I
l Apr 11.43 May 11. 21 Fed discount rate decreased to 12%
Jun 10.95 Fed discount rate decreased to 11%
l i
Jul 11.40 Fed discount rate decreased to 10%
i Aug 11.70 l
Sep 12.26 Fed discount rate increased to 11%
Oct 12.64 Nov 12.89 Fed discount rate increased to 12%
(
Dec 12.26 Fed discount rate increased to 13%
l I
l Jan/81 12.84 i
Feb 13.02 Mar.
12.55 Apr 12.92 Average l
1979 10.34%
l 1979 and l
4/80-8/80 10.63 L
1979-1980 11.195
Schedule 19 UNION ELECTRIC COMPANY Case Number ER 81-180 r
Computed Returns on Common Eouity Using the Electric Utility Regression Model 7
L
{~
(1)
(2)
(3)
(4)
(5)
(6)
Computed Values Using Stock Yields (RPATE) of:
Variable Assigned Name Coefficient Value (1 +10.34%)
(1+10.63%)_
(1+11.195%)-
r 1.
Y Intercept
-1.0561 constant term
-1.0561
-1.0561
-1.0561 2.
PSCOV
.1265 1.8
.2277
.2277
.2277
[
3.
KWH5
.4182
.033
.0138
.0138
.0138 4.
RRATE 6.9257
.0967
.6697 i
5.
RRATE 6.9257
.0941
.6517
.6185 6.
RRATE 6.9257
_.0893 7.
DPSCOV
.0191 2.5
.0478
.0478
.0478
(
8.
Total of assigned independent variables
.0971
.1151
.1483 9.
Dependent variable AVMBV 1.04 1.04 1.04 I
L.
10.
Total of assigned variables 1.1371 1.1551 1.1883
- 11. Book yield coefficient 10.4136 10.4136 10.4136 12.
Required book yield (10411)
.1092
.1109
.1141 13.
Dividend payout ratio
.775.75
.775.75
.775.75 14.
Required return on equity (12+13)
.1409.1456
.1431.1479
.1472.1521 L.
s
(
l
.o
Schedule 20 UNION ELECTRIC COMPANY j
Case Number ER 81-180 Selected Financial Ratios - Eleven Electric Utilities and UE Eleven Electric Utilities l
Year AVMBV R0E BKYLD PAYOUT EQRAT PSCOV DPSCOV 1973 1.436
.1318
.0952
.704
.351 2.325-2.566 1974 1.107
.1225
.0960
.789
.319 2.024 2.331 1975 1.090
.1212
.0964
.760
.331 1.949 2.623 1976 1.229
.1259
.0952
.735
.341 1.994 2.789 1977 1.229
.1317
.0943
.711
.343 2.049 2.'i35 1978 1.106
.11f8
.0963
.827
.357 1.939 2.602 1979
.979
.122
.0979
.799
.358 1.943 2.356 4
Average 1.168
.1247
.0959
.761
.343 2.032 2.572 I
Union Electric Company j
AVMBV R0E BKYLD PAYOUT.
EQRAT PSCOV DPSCOV 1973 1.032
.1051
.0828
.788
.297 1.747 2.218 1974
.848
.0808
.0868
.928
.287 1.531 2.012 1975
.780
.1088
.0854
.714
.305 1.706 2.156 1976
.919
.1191
.0865
.722
.303 1.779 2.843 1977 1.004
.1023
.0867
.816
.324 1.727 2.918 1978
.895
.1156
.0868
.698
.344 1.858 2.826 1979
.812
.0978
.0909
.829
.338 1.683 2.303 Average
.899
.1042
.0866
.785
'.314 1.719 2.468 1980
.716
.1196
.0936
.705
.342 1.773 2.093 Average
.876
.1061
.0874
.775
.318 1.726 2.421 w
m-ws
=
~
m e
m-w.s
+ - + =
o Sch:dule 21 UNIO'N'EL'CTRIC COMPANY ~
~ ' ~ ~
E Case Naber ER 81 - 180 r
Average Market-to-Book Values and Returns on Common Ecuity Non-regulated Firms i
i Cgnpustat Industrials All Companies Excl. Oil Componert Oil Component p
Year No. AVMBV ROE No. AVMBV_
POE No. AVMBV R0E 1970 (761)1.95
.095 (723)1.97
.094 (38)1.62
.107 L
1971 (776) 2.17
.093 (738)2.18
.093 (38)1.90
.100 1972 (786) 2.36
.110 (745)2.38
.110 (41) 2.1 3
.104 1973 (794) 1.85
.114 (751)1.83
.113 (43) 2.14
.133 1974 (797)1.20
.114 (753)1.18
.110 (44)1.55
.174 j
1975 (798)1.13
.103 (753)1.12
.100 (45)1.33
.148 1976
-(803) 1.26
.104 (758)1.2?
.101 (45)1.35
.149 I
1977 (800)1.18
.ls6 (755)1.18
.125 (45)1.34
.1 41 1978 (804)1.15
.129 (759)1.15
.128 (45) 1.20
.1 41 1979 (806)1.17
.143 (761)1.15
.139 (45) 1.45
.209 t'.
Mean 70-79 1.54
.113 1.54
.111 1.60
.141 75-79 1.18
.121 1.17
.119 1.33
.158 t.
S&P 400 1970 (384) 2.22
.111 (359i 2.27
.111 (25)1.44
.106 1971 (389) 2.44
.106 (364) 2.49
.107 (25)1.70
.096 1972 (393) 2.62
.114 (365) 2.67
.115 (28)1.88
.103 1973 (393) 2.20
.135 (365) 2.21
.135 (28) 2.04
.125 1974 (393) 1.44
.136 (365)1.44
.133 (28)1.48
.172 1975 (397)1.35
.123 (369)-1.36
.122 (28) 1.31
.143 1976 (398)1.47
.135 (370)1.48
.134 (28) 1.37
.148 1977 (396)1.32
.135 (368) 1.31
.134 (28)1.38
.139 1978 (397) 1.26
.139 (369)1.27
.139 (28)1.18-
.135 1979 (397)1.24
.150 (369)1.23
.146 (28)1.37
.192 Mean 70-79 1.76
.128 1.77
.128 1.52
.136 75-79 1.33
.136 1.33
.135 1.32
.151
g Schedule 22 i-UNION ELECTRIC COMPANY Case Number ER 81-180 I
Rates of Return Using Returns on Common Equity b-of 14.4%,14.6% and 14.8%
i' l.
l 1.
Weighted Cost Using Returns on Equity of:
Capital Embedded Ratios Cost 14.4%
14.6%
14.8%
long-term debt 50.72%
.08825 4.48%
4.48%
4.48%
Preferred Stock 13.94
.0783 1.09 1.09 1.09 Common equity 35.34 5.09 5.16 5.23 Totals 100.00%
10.66%
10.73%
10.80%
1
?
~
4 f
a t
l' 2
I
Schedule 23 UNION ELECTRIC COMPANY Case Number ER 81-180 Overall Cost of Capital i.
t Weighted Overall Cost of Capital Using Pre-Tax Returns on Equity of:
Capital Embedded Weighted Tax
~
Ratio Cost Cost Factor 14.4%
14.6%
14.8%
Long-term debt 50.72%
8.825%
4.48%
.51537 2.31%
2.31%
2.31%
Preferred stock 13.94 7.83 1.09 1.00000 1.09 1.09 1.09 Common equity 35.34 1.00000 5.09 5.16 5.23 100.00%
8.49%
8.56%
8.63%
l
~
1 i
i I
I l
l I
e I
i e
l
--