ML19347D271

Prepared Testimony & Exhibits of Rj Cadenasso,On Behalf of CA Association of Util Shareholders,Re General Rate Case

ML19347D271
Person / Time
Site:	San Onofre
Issue date:	04/16/1980
From:	Cadenasso R AFFILIATION NOT ASSIGNED
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References
59351, NUDOCS 8103110704
Download: ML19347D271 (49)

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CALIFORNIA ASSOCIATION OF UTILITY SIIAREllOLDERS Prepared Testimony F Nh Vi and Exhibits

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CALIFORNIA AS".OCIATf0N OF UTILITY SHAPEHOLDERS PREPARF.D TESTIMONY OF ROSS J. CADENASSO 1 0. Please state your name and business address.

2 A. My name is Ross J. Cadenasso and my business address is 44 3 Montgomery Street, San Francisco, California.

4 Q. Please state your educational and prof <ssional qualifications 5 as they relate to the testimony you are cbout to cive.

6 A. I received a nachelor of Science degree fra, the University of 7 California at Borkeley, majoring in Business Anciristration and 8 a Master of Business Administration degree, also from the 9 University of California at Berkeley, majoring in Corporate 10 Finance and Accounting. After graduation I practiced as a Certified Public Accountant for four years. I then joined the 11 12 investment banking firm of Blyth & Co., Inc. initially as a 13 security analyst. After one year I transferred to the Corporate 14 Finance Department of Blyth and for the next sixteen years I 15 was engaged in various corporate finance activities for that firm.

' What did you do in the Corporate Finance Department?

16 0 17 A. The last eight years I was a vice president and a first vice 18 president in the Corporate Finance Department in San Francisco.

19 My investment banking experience included working with the firm's 20 corporate clients in the raising of capital through public a

21 of f erings of stocks and bonds, private sales of securities to N

22 institutional investors, mergers and acquisitions, and appraisals ~'

23 of corporations. Blyth & Co., Inc. was heavily engaged in the 24 underwriting and financing of public utilities in the United J 25 States and had a number of important utility clients on the ,,

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27 Q. Did you ever work on offerings of public utilities?

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1 A. I have worked on financings for the Pacific Gas and Cloc+ric 2 Company on many m:risions over a fifteen year periel. I worked on the initial financing of the Pacif ic Gas Transmission 3

4 Company, the pipeline co nany which brings natural :as to California frcm ranada. I have also bean involved in financings 5

6 for Portland General I:l oc t r ic , San Dingo Gas and E lectric 7

Company, Telephone Utilities Company and Alaska El'ctric Light 8

and power Ccmpany.

9 Q. What have you done since leaving Blyth?

10 A. Since May of 107 , I ha/e practiced as a Corporate 1,'inancial 11 Consultant. My activities have involved advising corporato 12 clients on matters pertaining to long term financing and 13 appraising corporate securities for various purpones.

14 Q. Are you a member of any professional organizations?

A. Yes. I am a member of The Security Analysts of San Francisco 15 and the Financial Analysts Federation. I am also a member of 16 the California Society of Certified Public Accountants. I 17 18 served as an officer and a member of the Board of Directors of The Security Analysts of San Francisco.

19 0 Ilave you had any articles published in the field of public 20 utility regulation?

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.A. Yes. I presented a paper before the Pacific Coast Gas Associ-22 ation entitled "The Return Allowance" which was published in 23 the proceedings of the Association.

24 1 O. 11 ave you appeared as a witness in court or in administrative 25 Proceedings?

26 A. Yes. On a number of occasions I have appeared before courts 27 "

and administrative egencies. I have been a witness on rate of 28 29 return matters before the California Public Utilities Commission ,

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1 on behalf of The California Association of Utility Shareholders i

2 in the racific Gas and Electric Company general rate case 3 (Application nos. 57284, 57285), San Diego Gas and Electric 4 Company general rate case (Application no. 58067) and racific 5 Telephone general rate case (Application no. 58223) and before 0 the Alaska public Service Commission on behalf of the Alaska 7 Electric Light and Power Company. I havn appeared as an expert 8 witness on valuation beforc the California Corporations Commissione 9 and in the United States District Courts, the Northern District of California, the the State of Oreqon and 10 State o[ Nevada and 11 in the Oregon Tax Court and the United States Tax Court.

12 Q. For whom are you appearing in this matter?

13 A. I am appearing for the California Association of Utility 14 Shareholders in these proceedings. Many of the Association's 15 members are shareholders of Southern California Edison Company 16 (SCE) and the Association is also a shareholder of SCE.

17 0 Could you describe the Association for us? -

18 A. The Association is a nonprofit corporation whose members are shareholders of California public utility companies. The 19 20 Association was organized in June of 1976 and now has a member-ship in excess of 9,000. The purpose of the Association is to 21 22 give voice to utility shareholders before regulatory agencies, 23 the State Legislature and Congress and in the news media. Our qe 24 aim is to see that shareholders are treated fairly by government 25 and regulatory authorities and that the interests of the share-26 holders are protected.

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1 Q. Do you hold any office in the Association?

2 A. Yes. I am president of the Association, a member of thn 3 board of directors.

4 Q. What is the interest of the Association in this prosent 5 proceeding?

6 A. The Association is vitally interested in this Southern 7 California Edison Company general rate case. We bolieve that 8 SCE sharnholders have nuffered greatly during the past seven

~9 years from unjust and inequitable treatment in pre ious rate 10 cases. We intend to bring before the Commission in these 11 proceedings a stockholder perspective which we hopa will help 12 the Commission to arrive at a ;ast and fair decision in this 13 case.

14 O. Can you tell us how many shareholders own SCE shares?

15 A. The Company had about 180,000 shareholder accounts at December 5, 16 1979 including 33,000 preferred shareholders and 147,000 17 common shareholders. Of these accounts 46,000 were joint 18 accounts representing at least two shareholders. Small L9 shareholders, those owning less than 500 shares accounted for 2 ~. 91% of shareholders. (500 shares of SCE common has a current 21 market value of only $11,000).

22 O. Mr. Cadenasso, as a potential investor, what do you expect 23 when you make an investment in an electric utility company 24 common stock?

25 A. I would expect the company to be abic to earn a fair return ,

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27 to the return earned on stockholders' investments in other L ,P 3- .

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1 enterprises of corresponding risk. I would also expect the 2 company to be able to maintain a sound capitel structure and 3 a sound credit rating. If the company had to raiso additional 4 equity capital to finance necessary expansion, I would 5 expect it to be able to raise capital through the sale cf 6 additional shares of common stock at prices that would not dilute 7 my interest in the ccmpany.

8 Q. What gives rise to those expectations?

9 A. An electric utility company is granted a franchiso by gevornmental 10 bodies to provide an esnential public service. An'a natural 11 monopoly its rates are regulated by the State. A utility is 12 permitted the opportur.ity to earn a fair and resonable return 13 on its investment in utility properties under stato and 14 federal statutes and under the provisions of the United States 15 Constitution. Over the years the Supreme Court of the 16 United States has laid down certain definitions of a 17 fair and resonable return. I micht quote here some of the 18 key portions of the landmark Supreme Court cases dealing with fair and reasonable return: In the Southwestern Bell Telephone Ig 20 case of 1923 the Supreme Court stated "The compensation which the 21 Constitution guarantees an opportunity to earn is the reasonable cost of conducting the business. Cost includes not only 22 J. 23 operating expenses, but also capital charges. Capital charges 24 cover the allowance, by way of interest, for the use of capital, whatever the nature of the security issues therefor; the 25 i.

26 allowance for risk incurred; and enough more to attract s

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1 capital.' in the Bluefield Water Works -sso, 11sc n l'23, 2 the Court added several more reasurements of r a i s c : a t l e r.c a n .

3 it staead that 'he ra*e should permit a return ' r .a 1 to

• hat 4 #>nore.11y bein ; ade at the nine tiro and in tha c -' wroral 5 part of the coun+ y on inve s tme nt s in oth :r P v :ner - m dor-6 takings which i e attended by corresponding rimks '-d un-7 certaintins...~ho r turn should be reasonal;1y suff <: l e n t to 3 assure coafidence in the financial soundness of tho util:~v and 9 should to adequate under officient and economica1 inago-ant, 9

10 to maintain and support its credit and onable it to raiso *he 11 money necessary for the proper discharge of its public iutten."

12 Q. Those cace* wore decided in 1927 Has the Supreme court censid-13 ered the iesue since then?

14 A. Yes. In 1943 in the Hope Natural Gas case the Court reiterated 15 that "the return to *.he equity ownor shculd be cer ensu-ite 16 with the returns on investments in other enterpri.nes having 17 corre ?onding risks", and that "the return should ce nu"ficiert 18 to assure confidence in the financial integrity o: the enter-19 prise,sc as to maintain its credit and to attract capit't..."

20 These decisions centinue to be recognired today ar laying down 21 the three important guidelines to be used in the deternination 22 of a f air and reasonable return to the cwners of public utility

23 property. These are (1) the owners should be allewed an oppor-24 tunity to earn a return which is ccm.mensurate to returns on 25 investments in other enterprises having corresponding risks, 26 (2) the return should be sufficient to maintain the financial 27 integrity and credit of the utility and (3) the return sht;uld 28 be sufficient to allow the company to attract capital.

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i 1 O. How much reliance do you put on the Southwestern Bell 2 Telephone, Bluefield and Hope Natural Gas cases?

3 A. I place a great deal of reliance on these landmark Supremo 4 Court decisions. The stockholders of southern California 5 Edison Company and any other utility look to public utilities 6 commissions to fairly balance the interests of consumers and 7 investors. If a fair balance is not maintained, consumers 8 may be injured by being forced to pay higher than necessary 9 rates for public services, or shareholders of the titility 10 company can be harmed by not allowing them to earn a fair 11 return on their investment and by creating a situation that 12 results in a loss of their investment through the forced .

13 dilution or confiscation of a portion of their investment.

14 Q. Why is it important to you as a shareholder that a utility 15 company be able to maintain its financial integrity and 16 credit rating?

17 A. If a utility cannot maintain its financial integrity and its 18 credit rating, the shareholders can be severely injured. In 19 the even of a default on a senior security of the company, the stockholders' investment could be wiped out. Even a less 20 21 severe situation such as a downgrading of the quality of 22 the company's bonds and preferred stock can have an adverse 23 impact on the market price of the company's common stock to Obviously, any deter- w 24 the detriment of common shareholders.

25 ioration in a company's financall position and financial  ;

26 integrity increases risks to the common shareholder who is the

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1 low man on the totem pole. It is the common shareholder 2 who has the value of his investment eroded first in a 3 deteriorating situation.

4 O. Why is it important to a shareholder that a utility be able to 5 attract capital?

6 A. A utility company has an obligation to satisfy its customers' <

demands for service. This means that the company nust expand 7

8 its facilities to provide additional capacity to satisfy 9

consumer needs at all times irrespective of what conditions may 10 currently exist in the securities market. If returns are in-11 adequate to maintain a market price at least equal to the 12 investment of existing shareholders, then new capital can only 13 be attracted by selling shares at a price below the value of the 14 existing shareholders' investment in the company. The effect 15 is that existing shareholders are compelled to give up a portion 16 of their investment to entice new shareholders to contribute their money to the enterprise. This is a dilution of existing ,

17 18 shareholders interests and is brought about when the return to 19 common shareholders is inadequate in relation to risks borne 20 by shareholders.

21 Q. Is the balancing of rewards and risks an important part of 22- the regulatory process?

23 A. Yes, it is the heart of the process. If risks increase and 24 returns (another word for rewards) do not also increase 3 25 commensurately, the price of the stock will fall in the market- ,

26 place. When the price falls below the book value at existing n

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1 1 shareholders' investment per share, the utility is no longer 2 capable of attracting equity capital except on a basis which 3 is confincatory to existing shareholders.

4 Q.  !!ow has the high rate of inflation in recent years a f f ect ed 5 the risk / reward balance you speak of?

6 A. Inflation is the root cause of many critical problems facing 7 utilities in recent years. Inflation has had a major _ , pact 8 on investors and on security values. Investors react to 9 increasing rates of inflation by demanding higher , returns 10 to help compensate for the loss of real purchasing power of 11 their capital and income. This evidences itself in the decline 12 of security prices in anticipation of rising inflation. Inflation 13 also affects the earnings of companies. A regulated utility 14 is at a great disadvantage during an inflationary period 15 because it is not free to raise its prices to compensate for 16 higher costs. Its earnings fall until new higher rates are 17 authorized and put into effect. Where regulation is slow and 18 unresponsive, utility investors can be greatly harmed, not 19 only by lower rates of earnings on investment but also from 20 the dilution of their investments when new shares are sold 21 ,

below book value. This becomes a vicious circle. +

22 Q. Can you explain how this vicious circle works?

J' 23 A. It works like this:

24 1. Inflation causes costs to rise. With fixed rates this 25 means that the rate of earnings on' common stock falls. '

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1 2. Inflation also causes investors to demand hiaher returns 2 from stocks and bonds.

3 3. As a result of lower earnings and the demands of investors i for higher returns, utility stock prices drop sharply to 5 prices well belcw book value.

6 4. Inflation encalates the costs of new plants which a 7 utility is required to build to satisfy customers' 8 demands for service.

9 5. Internal generation of funds -- retained earnings and 10 depreciation -- provide a smaller portion of funds for 11 new plants thus requiring the sale of greater amounts of 12 stocks and bonds.

13 6. The sale of large amounts of bonds and preferred stocks .

14 at the higher interest and dividend rates demanded by 15 investors in the marketplace causes imbedded costs of 16 senior capital to rise and correspondingly reduces the 17 return flowing to the common stock.

18 7. To maintain its financial integrity and credit rating, ,

19 the utility must cell large amounts of common stock.

20 Since common stock prices are well below book value, many ,

21 more shares must be sold to raise a given amount of 22 equity calatal. This reduces book value and earnings $;

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25 Q. How do investors react in these circumstances? ,

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1 A. First, investors tena to favor industrial stocks or other

~2 forms of investment ever utility stocks since in an inflationary 4 3 environment they perceive much greater risks associated with 4 utilities, particularly regulatory risks.

5 O. What do you mean by regulatory risks?

r 6 .A. This is the risk that regulatory authorities may be slow or 7 un: 'sponsive to the changes brought about by inflation,

'8 anu as a result, returns to shareholders will drop to un-

-9 satisfactory levels. .

-10 0 How do the dif ferent types of investors react in an inflationary

- 11 -environment?

12 A. Sophisticated investors tend to move out of utility stocks

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13 and prices decline relative to industrial stocks. When 14: utility prices drop enough to compensate for the higher risks

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associated with inflation and regulation and the lower rate 16 of earnigns, the dividend yield becomes attractive to buyers, ,

17 particularly small investors who need higher yields to cope 1

' with inflationary pressures. 'Thus utilitier. have been able to 18 r"

- 19 sell large amounts of common stock primarily to unsophisticated .

20 investors who are seeking high current yields even though the 21 . . rate of-earnings on equity has been at depressed, low levels t

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tremendous cost to-existing shareholders as I will discuss in'  ;(( .

23 24 detail later_in my testimony.

What you are saying is' that the high rate of inflation since :p 25 Q.- _

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1 utilities. Is that correct?

2 A. Yes, a massive impact as risks have skyrocke' el whi le roturns 3 for many utilities have not increased sicnificantly and, in 4 fact, at times have fallen precipitously <here roqulation 5 has not been responsive to these chanced conditions. Such 6 situations have been a disaster for utility sharebelders.

7 O. How can this ricious circle which you doscribed be broken 8 and a fair balance betwean investors and ratepayers be 9 restored?

10 A. The only way it can be broken is for roturns to increaso 11 significantly and for risks to diminish so that investors 12 again will be willing to buy utility stocks at prices at 13 least equal to existing shareholders' investment in the 14 enterprise, that is book value. The most important thing 15 that regulatory commissions can do is to recognize the true 16 cost of equity capital today and increase the allowed 17 rate of return on common equity by 200 to 400 basis points --

18 (2% to 4%). Commissions can also reduce risks by (1) pro-19 viding for rate adjustments to effectively offset both financial 20 and operational attrition so that the a llowec' return can 21 actua'lly be earned and (2) improving the quality of earnings 22 and cash flow by permitting the normalization of income 23 taxes and incorporating CWIP in rate base.

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1 O. You have describr-d in goneral terms what has taken 2 place in recent fears. Can we now get more specif i c wi t.h 3 respect to SCE's situation; have you made a study of 4 Southern California Edison company's operatina results 5 and the impact of these results on common stockholders?

6 A. Yes, I have preparod a number of tables and charts, all 7 of which are included with and which support the testimony 8 I am presenting. Table 1, page 39, is a ten year summary 9 of financial data of the Company and other factors 10 impacting determination of allowed return.

11 Q. Can you describe this summary and discuss the importance 12 of the data shown therein?

13 A. The tabulation first shows on lines 1 through 5 the 14 important per share financial data on the company's 15 common stock -- average price, earninos, dividends 16 and book value. The second set of data on lines 17 6 though 8 shows the return on average common equity.

18 Line 6 shows the return found reasonable by the 19 Cal lNornia Public Utilities Commission in rate cases 20 since 1970. On line 7 is the actual rate of return 21 earned before adjustment for dilution. Line 8 b

3 22 shows the return adjust for dilution.

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1 O. Would you explain how the return adjusted for dilution 2 has been determined?

3 A. Yes. In computing the return adjusted for dilution, I 4 have taken into account the change in book value per share 5 caused by the sale of additional shares. When additional 6 shares are sold below book value as they have been in 1980 7 and each of the previous four years, there is a loss of 8 existing shareholders' investment in the Company. 'This 9 is a very real loss which will result in lower earnings 10 and dividends in the future. This loss should be reflected 11 in his return in the year in which it occurs. You will note 12 that the difference between the adjusted and unadjusted 'igures 13 was insignificant up until 1974 and since then v.he shareholders dilution 14 have suf fered / every year except in 1975. I will discuss the magnitude of dilution later in my testimony. This adj us tment 15 16 has had the following impact on the return on average common .

17 equity:

18 As Reported Adjusted for Dilution 19 1974 9.8% 6.0% >

20 1975 9.8% 9.7% .

21 1976 12.6% 9.0%

22 1977 12.1% 11.7% ,(

1978 10.9% 7.9% T 23 g

24 1979* 13.6% 1.4%* '

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• Includes dilution from sale of 7 million shares in g 26 February, 1980.

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Mr. Cadenasso, would you continue tr doncrit the material 1 O.

2 shown on Table 1?

3 A. Yes. On lines 9 through 15 I qhow some k.*y me a su ren.o n t s o f 4 risks. First, shown on I ine 9 1s the a~orano 3CE c rmon 5 stock prica as a percent of average book value. This percent 6 has dropped from 116% tr 1970 to 619 in 1974, incrcisod t(

7 771 in 1977 and 1979 and as of April 1990 had fallen sharply 8 to 68%. The important fact is that SCE stock has continuous 2 9 sold below book value since the beginning of 1973 -- over seven 10 y_ ears. When a stock mells below book val'ie, the risk of 11 dilution when new , hares are sold is great and alront certain 12 to occur. Line 10 shows the number of times interest has 13 been earned before income taxes. This ratio declined 14 from 3.1 times in 1970 to 2.7 timos in 1975 and has 15 nince recovered to 1.0 times in 1979. The combined after 16 tax coverage of interest and preferiod dividend requirements 1 showed a drop from 2.2 times in 1970 to 1.8 times in 1974 and 18 1975 and rose to 2.1 times in 1979. Line 13 shows that the 19 Company's effective income tax rate has risen from 24% in 1970 to 30% in 1974 and then declined to 181 in 1979. Lines 20 21 le and 15 chow a significant drop in the quality of earnings 22 and the internal generation of funds to pay for construction.

23 AFDC, a noncash credit to earnings, as a percent of common 24 earnings has risen sharply from a l ow o f 6 S. in 197 2 to 41%

25 in 1979. Internal cash generation as a percent of con::truction 26 has fallen from a high of 55% in 1972 to 27% in 1979.

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1 Lines 16 through 19 show other faccors which impac* the 2 determination of allowed return, such as, rate of tnflation, 3 long term interest rates and return on equity and price' hook 4 value ratios for industrial common stocks. These factors 5 will be discussed later in my testimony.

6 0 How have SCE shareholders fared in recent years?

7 A. Very poorly. In Table 2I have shown the total return, that 8 is dividends received and change in price of the stock, for 9 SCE shareholders who have held their shares for the past 10' 2, 5, 10 and 15 years. The investor who invested his 12 retirement funds in SCE stock in 1964 has received a total 13 return of only 2.1% annually over the past 15 years.

14 After the average inflation of 6.2S. annually over the 15 year 15 period is taken into account, the shareholder has had a 16 negative real return of 4.1%. The same poor results were 17 achieved iy the person owning SCC stock for the past 10 years.

18 His total return was 1.4%, with an inflation rate of 7 . 2 S.

19 he ended up with a negative return of 5.8% annually. A buyer 20 of the stock in the dark days of 1974 when SCE was selling 21 at an average discount of 39% from its book value received a 22 17.5% return over the past five years when inflation averaged 23 9.2% or a positive real return of 8.3% annually. A buyer 24 of the stock in 1977 has received a total return of 7.2%, .

25 but af ter deducting the inflation rate of 8.2', he again had 25 a negative return of 1.0% annually.

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26 When appraising these returns, keep in mind that SCE was 27 not a dying, obsolete company but an expanding company with

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1 a hugh appetite for money to finance its cus*omers' demands 2 for service -- a company that must continue to attract 3 capital to survive.

4 Q. In view of the poor returns earned by SCE shareholders, how 5 has the Company been able to attract the equity capital it 6 has required?

7 A. The Company has been able to attract equity capital by 8 selling its stock substantially below the book value of its existing shareholders' investment in the Company. Over the 9

10 past five years new investors have received $1.40 of book 11 value in the Company's equity for each one dollar of new <

12 equity money invested. Thus by the simpic expedient of 13 selling new shares at whatever price the market dictates, 14 _the Company's inadequate returns have been transfermed into

- 15 returns high enough to attract new equity capital.

16 Q. Does not selling stock below book value hurt existing 17 shareholders? w. . .

18. A. 'Of course it does. Table 3 shows the dilution of existing j li 19 shareholders' investment from the sale of new stock below book X:

20 value over the past five years. The Company has sold a total

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.These shares were sold for $542 million or 28.5% below their

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24 book value. The total dilution suffered by existing shareholders was 4216- million which equalled 14.5% of 'the total common jk N 2 5 .a 7

26 stockholders' equity-in the Company at the beginning of this v.

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five year period. In other words, the old shareholders had 1

2 $216 million taken away from them and given to new shareholders 3

to entice them to buy stock in the Company which was earning 4 inadequate profits.

5 O. '.iow has SCE met the Supreme Court's attraction of capital 6 test over the past five years?

7 A. It has not. The Company could not sell one single share of 8 its stock for a price equal to the investment in the Company 9 of its existing shareholders at any time over the past seven 10 years. It could only sell its shares at discounts ranging 11 from 22% to 35% below book value, and it is these discounted 12 prices which attracted the equity capital, not the socalled 13 " fair" return it was earning.

sell its 14 O. Some people say that as long as a company can 15 shares, regardless of price, it is meeting the attraction 16 of capital test. Do you agree?

17 A. No, but I have heard even public utility commissioners make 18 such statements. That reasoning in my opinion, is a complete s 19 perversion of the Supreme Court's attraction of capital test --

20 it makes the test meaningless,

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f e 21 ,O. llave not the regulators justified their allowed returns on-(R 4 22 equity by claiming they are balancing the interests of 7..

23 customers and shareholders? .W4 l[;

• 6 24 A. Yes, when the hard evidence is ignorsd and allowed returns ^

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1 general rate case decision, the Commission, giving weight to l

2 the Staft's and GSA's expert testimony, allowed a 12.25' return on equity. Within seven months after the decision,

-3 4 the company sold its serior bonds at a 15.71 cost,to the 5 company -- nearly 350 basis points higher than the allowed 6 return on its common equityl 7 Q. Do you have any hard evidence which has a bearing on the 8 balancing of customer and shareholder interests?

9 A '. Yes. Chart 1 shows six pertinent factors which illustrates 10 how SCE customers' and shareholders' interests have been

~ balanced since 1970. The cost of living, which affects 11 12 both customers and shareholders, has risen 841 since 1970.

11 3 Californians have been able to more than keep up with this 14 inflation. Their per capita disposable personal income has

-15 -risen by 125% since 1970 and'after adjusting for inflation, 16 it has. risen 21% in real terms. SCE chareholders have not J17- been.so lucky. 'Their dividends have risen 81% since 1970, 16 or only 3% below the increat in'the cost of living. This e

19 'is a good performance when considered alone. Increased 20:1 dividends, however, were due, in part, because'of a higher

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21 dividend payout policy in'recent years. This is evidenced E

22 Eby' earnings increasing;only 19% or a decline of 8% in real t 123 -terms and book value increasing-only 34% or a decline of ,,

24L c27%.in real terms. While higher dividend-payments caused a #.

25 lesser increase in book value than in earnings, the major cause -

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C 26 I was! dilution from the sale of a huge number of shares belou ,

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1 book value.

2 The price of SCF ntock hts declined about $5.50 per sharo or 3 19% since 1970 in absolute terms but when adjitsted for inflation the decline is a staggering 56?! This large doeline 4

5 in market value is due in large measure to the sharp rise in 6 returns demanded by invostors in the markat place because of accelerating inflation. When returns earned by a company 7

8 on its equity do not increase in line with the hicher cost 9 of equity capital, stoc:- prices decline. The market is the 10 mechanisn by which a purchaser of SCE stock today is able to 12 achieve the going market rate on his investment because he 13 acquires about $1.50 of book value in the Company for each 14 dollar he invests. Thus his return is 1.5 times the return 15 the Company is carning on its shareholders' investment.

6 It is this trenendous gap between the returns demanded by 17 the market and the returns actually earned by the Company

]8 that must be closed before we can end the present seven year 19 era of dilution and confiscation.

20 I think these figures clearly show that there has been a 21 great imbalance b3 tween customers' and shareholders' interests 22 in recent years and as a consequence, shareholders of SCE have 23 suffered tremendcus losses that can never be recouped.

24 O. How can this imbalance be corrected and a fair balance

+

25 established between customers' and shareholders' interests?

26 A. The imbalance can be corrected if we acknowledge the 27 realities of the high inflation environment we are in now, 28 have been in since 1973 and undoubtedly will be in durin.J the

" - igy vf** ;;

1 period in which rates established in these proceedings will 2 be in effect. That means that we must look at the hard 3 evidence of the past seven years -- not the soft evidence of 4 some Staff member's opinion supported only by an allegation 5 that customer and shareholder interests are balanced; not by 6 wishful thinking that inflation will some how disappear; not 7 by looking at a mass of comparative data on other utilities 8 whose shareholders have suffered fates similar to those 9 suffered by SCE shareholders.

10 Q. What sort of hard evidence should we be looking at?

11 A. First, we must consider the historical inflation rate and 12 its impact on the returns investors demand in the marketplace 13 ani bow the CPUC has responded to these changes in the past.

14 Charts 2 and 3 show that since 1970 the rate of inflation 15 has risen 120%, long term bond yields have risen 69%, and 16 investors have demanded 101% to 128% more earnings on their _

17 common stock investments as measured by earnings /orice 18 ratios. The earnings / price ratios of SCE common stock has 19 increased 110%, Moody's Electric Stocks 1014 and S & P 400 20 Industrial Stocks 128. 1.nce 1970. Contrast this to the 21 14% increase in the CPUC allowed return on equity to SCE 22 from 11.79% in 1970 to 13.49% in 1980. This tremendous 23 disparity is the prime reason why SCE common stock is currently 24 worth only 68% of shareholders' investment in the Company and 25 why the stock has sold continuously below book value since 1972.

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26 It should be obvious that tha allowed return must be increased 27 substantially to make up for the past inadecuacies.

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l 1 Nevertheless, the staff has recommended a 11.6t allowed 2 return in this case which is slightly above the 13.494 rate 3 of return allowed in the last general rate case -- a return 4 which has proven so inadequate in the 1979 test year of that 5 case.

6 Q. It has been said that the CPUC does not control the market 7 price of the stocks of companies it regulates; their concern 8 is with the return earned on investment in utility properties.

9 Do you agree?

10 A. No, the CPUC has a tremendous influence on the market price of the stocks of companies it regulates. Market price is 11 12 primarily determined by the return earned on investment and 13 this is under the control of the CPUC. In addition, the 14 CPUC has a responsibility to see that the utility is able 15 to attract capital on a reasonable basis (nonconfiscatory 16 basis) to enable it to discharge its franchise obligations.

17 Thus the market price of a utility's stock should be of central concern to public utility commissioners. When a utility's 18 19 stock starts to sell below book value, a regulator should 20 recognize this as a serious problem and respond by taking actions to correct such a situation. Unfortunately for 21 22 California utility shareholders, the CPUC response has been 4

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23 consistently too little, too late and as a consequence all ,

24 of California's major utility stocks have sold below their 25 book values continuously since early 1973.

26 Q. How have utilities fared in other jurisdictions?

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F 1 A. While some other states have had records similar to California, 2 in many states utility stocks have sold above book value at 3

various times since 1973 and some equity financing has boen done on a nonconfiscatery basis. At the present time, h wever, 4

5 there is practically no ability in the entiro natton tha-6 con raise equity capital on a nonconfiscatory basis.

7 The only exceptions are where the utility has nonreculatod 8 earnings from oil and gas production or some other source.

9 This is why using returns of comparable utilities to establish 10 allowed returns is meaningless at this time except to explain We must 11 why utility stocks are selling below book value.

study the returns earned by nonregulated companies and 12 13 companies whose stocks are selling above book value in order 14 to arrive at a fair return for utility shareholders.

15 O. How have allowed returns and returns earned by SCE compared 16 with those of nonregulated companies during the inflationary 17 period since 19707

18 A. Chart 4 shows the return on average common equity earned by 9 19 SCE and S & P Industrial Companies and compares these to the return allowed SCE by the CPUC. In 1979 industrial companies 20 t

21 , increased their average return to 16.8%, a 62% increase over p"

22 1970. SCE's return increased 21% since 1970 to 13.6% last ,

7" from the sale of 7 million shares in ,

i 23 year. When dilution j 24 early 1980 is recognized, the true return in 1979 to SCE C -

25 shareholders was 9.4% or 44% below the average return earned kw N

(, 26 by the S & P 400 Industrial Companies and 30% below the CPUC's allowed return. The allowed return increased only C ':

27

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gs 28 14% since 1970 and was 20% below the return on industrial kh. 29- stocks in 1979.

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1 Q. You have just reviewed the returns earned on "quity and the 2

returns demanded by investors in the marketplace sinco 1970.

3 How do you tie these two factors te, ether?

4 A. They are tied toonther by the price /Look vaiue ratit where we 5 relate the price of a stock with its book valun. This is a key ratio since it is influenced by the rate of earnings 6

7 on equity and by the returns demanded by investors in the a marketplace. Chart 5 shows price / book value ration since 9 1970 for SCE, Moody's Electrics and the S & P 400 , Industrial 10 Companies. The average price of SCE stock in 1970 was 11 116% of book value, it declined to 103% in 1972 and then 12 plunged steeply below book value beginning in 1973 and has 13 remained there ever since. Between 1974 and 1980 the ateck 14 has fluctuated between 61% and 77% of book value and currently 15 is at 68t of book. The price / book ratio of Moody's Electrics 16 showed a similar pattern; however, it was slightly higher than 17 SCE from 1970 through 1978 and has been slightly lower in 1979 18 and 1980. While the price / book value ratio of industrial 19 companies has also declined, it has remained over book value 20 and is currently at 116% of book value. This indicates that 21 investors are willing to pay more than b;ok value for the 22 average industrial company stock beca.so earnings have risen 23 along with inflation. So even though investors have demanded 24 a higher return (as witnessed by rising earnings / price ratios) -

25 because of inflation, the average industrial company has been 26 able to increase its earnings sufficiently to give the investor 27 this higher return at stock prices above boox value. On the 4 28 other hand, SCE and almost all other utilities have not been

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1 able to increase returns sufficiently to satisfy investors' r

2 demands for a higher return, and, therefore, investorn vill only 3 pay an average of less than 70 cents on the dollar for SCE and .

4 electric utility common stocks generally today.

t 5 Q. Would a return equal to the return earned by S & P 400 6 Industrial Companies in 1979 be enough to make investors pay 7 at least book value for SCE common stock at this time?

8 A. No, at the present time, I do not think a return of 16.8% would 9 be enough to make SCE stock sell above book value. If we 10 look at Chart 3, you will notice that investors have consistently 11 demanded higher returns from utility stocks since 1970 12 because they perceive greater risks associated with ownership 13 of utility stocks than with the ownership of the average 14 industrial stock.

15 Q. Have investors always considered utility stocks more risky 16 than the averace industrial stock?

17 A. No, back in the late 1950's and early 1960's when inflation 18 was at- a-low level, investors at times paid higher prices L

-19 for utility stocks than for' industrial stocks, but this 20 changed when inflation accelerated in the last half of the e

6 21., 1960's and during the 1970's. Investors have rightly l22. appraised the relatively greater risks of utility stocks  %

23 in recent years. .During inflationary periods, utilities i ,

124 are highly risky businesses. Consider.some of the risks 3

4

25. unique'to electric utilities which their.-shareholders must '"

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1 26 bear at this time: c 5;

, -27 1. - Regulatory lag and attrition which have prevented m, "e

428s utilities from earning their allowed' returns during the -

f29 past five'to seven years.

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1 2. Inability of utility managements to increase rates of 2 return to compensate for inflation except to the extent 3 relief may be granted by governmental bodies subject 4 to all sorts of political pressures from hard pressed

-5 consumer groups.

6 3. The risk of being forced to raise capital to finance 7 franchise abligations when the utility's stock is selling 8 below book value thereby conffscating a portion of 9 existing shareholders' investment in the company.

10 '4. The financial risks associated with nuclear plants.

3:

11 These huge projects which involve a substantial portion 12 of stockholders invec.anent, may be subject to long 13 delays before being placed into service and once in

.14 service may be removed from service at any time for 15 modifications because of changing technical, political,

'16 environmental and economic considerations. When such <

17 changes take place there is great political pressure '

6 18 to make shareholders absorb losses even though they have a L19 never been compensated with highor returns to assume the 20 unusual risks associated with these huge projects.

1 21 ,-Q. How can the CPUC reduce the unusual risks now being borne j 22 by utility shareholders? 1(W ?

k (23' A. These unusual risks can be reduced by: Q,

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1 ratepayers the legitimate costs of providing service 2 including the return allowed on sharei.olders ' investment.

3 2. Allow returns to rise to the level necessary to make 4 utility stocks again worth as much as shareholders' investment in them. In other words, increase returns 5

6 on equity so that the shares will be selling above book 7 value and thereby put an end 'o the seven year poriod 8 of dilution and confiscation which has plagued the 9 industry, especially in California.

10 0 Are you advocating reducing risks to utility shareholders to 11 below the level of risks borne by the shareholders of 12 the average industrial company?

13 A. No, I am suggesting that the unusual riskr unique to utilities, which are related to inflation, be lowered. Such risks as 14 15 regulatory lag, attrition and forced dilution are not borne 16 by industrial company shareholders.

V 17 Q. Assuming your suggestions to reduce risks are implemented, ,

18 what rate of return on common equity must SCE have to meet the Supreme Court's criteria of a fair return?

19 20 A. A return on common equity of between 17% and 18% would be i 21 required to meet the Supreme Court's comparative earnings standard if we make the assumption that common shareholders h

22 W 23 of the average industrial company and SCE shareholders are j:#

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f bearing corresponding risks. I believe it is safe to say 24 f

I that SCE shareholders bear at least as much risk as the /

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y' average industrial company shareholder. Chart 3 indicates 1 26 i' h that investors have consistently demanded higher earnings j, 27

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1 returns from SCE and eltctric utility stocks generally than 2 from industrial company stocks since 1970. These tnvastors 3 have, in fact, perceiven greater risks to electric ut ili ty 4 shareholders in recent years. But to be conservative, iet 5 us assume the risks are equal. SCE shareholders, tr cefere, 6 should have an opportunity to earn as much an their .nvestment 7 as the average industrial company shareholder in order to 8 meet the comparative earnings standard set forth in the 9 Hope case.

10 The average return on ccmmon equity of nonutility corporations 11 was 17.4% in 1979. The March 17, 1980 edition of Business 12 Week (page 116) reported average returns on common eouity of 13 16.6% for 1,200 corporations in 1979. This tabulation 14 included 83 utilities with average returns of 12.81 If 15 the utilities are removed from the total, the average return 16 for the remaining 1,117 nonutility corporations was 17.41 17 on common equity in 1979.

t

'8 It should also be noted that this Business Week tabulation 19 clearly shows the grave national problem facing utili ties.

20 Average returns of utilities were 263 below those of n.n- .

21 utility companies in 1979. Nevertheless, utilities must 22 compete in the capital markets for huge amounts of equity 23 capital. The only way this capital is being obtained today_ ['

24 is by massive confiscation of utility shareholders' investment. [

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25 We cannot expect this situation to continue indefinitely.

26 We are asking the CPUC to take leadership in solving this b,v i

27 national problem, and they can by their decision in this case W 4

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I axi in the pending Southern California Gas company general 2 rate case.

3 O. What return is required to meet the Supreme Court's 4 attraction of capital test? ,

5 .A. In general terms it is a return which would make SCE common 4 6 stock attractive enough to investors to make them want to pay 7 at least book value for the shares during the period in 8 which the rates set in this case are to be in effect. If 9 the price of the Company's stock does not increase to book 10 value, then dilution will continue through 1982, and we will 11 have witnessed a full decade of dilution and confiscation.

12 The Company will, no doubt, continue to attract equity capital c 13 but only by the discounted price at which it will sell its 14 shares, not because of a " fair return." earned on its equity.

15 O. How do we get the price of its shares up to book value?

16 A. By increasing the return on equity substantially above the _

'17 present allowed level which has proven to be woefully j.

4 18' inadequate this past year as inflation has accelerated and

'19 returns on stocks and bonds in the marketplace have risan

~20- sharply. f 21', O. gWhat rate of return on equity is necessary today for SCE stock .g v

22 to sell for book value? . tyf 1

. :23 A .. I would estimate that a return of around 20% would be required. yE r

Y 24 The earning / price ratio for the Company's stock is presently  : ,

i. Lt (G 25 20%. Thel Company just sold its first mortgage bonds at a .if

'26 cost'of 15.36.% and if we add the 5%.to'6% risk premium for b

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1 20% and 21% is indicated. With SCE stock now selling at 3 68% of book value, investors are acquiring $1.47 of book equity 3 for each $1 invested. Their return based on the 13.6%

4 actually earned on equity in 1979 is 20% (1.47 x 13.6%).

5. Q. Does not the current market represont an extreme high point 6 in interest rates and stock returns historically?

7- A. We have witnessed a dramite acceleration in the inflation 8' rate in recent months and it is now apprcaching 20% annually.

9 Investors have raised their long term inflationary expectations 10 sharply as witnessed by the steep rise in long term bond 11- _

yields to the 14% to 16% area. Bank prime len ling rates are now 20%. All of these rates are at all time highs. Who 12 13 can say what rates will be in 1981 and 1982 when the rates set 14 .in this case will be in effect. We are in uncharted waters.

'15 As'one-student of the money market recently remarked: "We 16 have never played this ballgame before." In the past the .

c 17: Commission and Staff have' tended to assume rates will retreat 18 to-lower historical levels. Such wishful thinking has proven f

.190 incorrect as the trend of each cycle has been higher than 4:

.'20 the previous one. .I don't believe we can again deprive 21' , ~ shareholders of a fair return by wishfully thinking that rates  %[

7 :23 .are going to go_back to/the levels of several years ago. {

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.231 .There.is,;of course,-the possibility of a decline from current 9 There is also the possibility of further increases. P; 24 ' levels.

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25. :Q. Are you suggesting tha't current market conditions ~be used.

"26 'to determine: the ~ fair rate .of return in this case . for' : test - . .

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J 1 A. While I have no basis for predicting a substantial drop in ,

2 long term interest rates and return on equity expected by 3' investors, I am, nevertheless, basing my recommended allowed 4 return in this case assuming a substantial reduction in the S rate of inflation and long term interest rates from present E

6 levels, and not on the higher returns that have prevailed so 7 far in 1980. This may prove to be an entirely too optimistic 8 assumption as far as shareholders are concerned, but I 9 believe this assumption v' .1 definitely not be unr,ealistically 10 high at the time a de- .sion must be made in this case 11 Q. How did you deterwAne that a 17% return is necessary for SCE 12 to meet the attraction of capital test?

13 'A. The 17% return figure is supportable on the basis of the 14 ' current earning level of nonutility companies referred to 15 previously. With industrial stocks earning this rate of

_ return, investors-are currently paying on average more than k 16 17 book value for their shares. Unfortunately all electric 7

18 utilities are now selling below book value and earning less 19_ than.17% on equity. .Therefore, we cannot test the adequacy r>

20 ~of.a 17% return for utilities _in today's market. Investors s

21 have consistently demanded higher returns from utility stocks L.9 M

. 2 21 than from industrial stocks over the last decade and this g f.x" 231  ; indicates that a return higher than 17% would be required. he.b

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124 I am anticipating, however, some improvement in'the capital 4 L, ,

,c 23 markets from present levels and believe such improvement would j ,;2p

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to sell above book next year _if it -h g 126] permit a utility stock P.

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1 earned a 17% return.

2 With respect to SCE we must recognize that investors 3 perceive more risk in this stock than in the average electric 4 utility stock because of SCE's current and future heavy 5 dependence on nuclear power generation. Since the Three 6 Mile Island problem, which commenced March 38, 1979, 7 investors are demanding greater returns from nuclear utilities 8 to compensate for greater risks. This shift in investors' 4 attitudes shows up clearly when we compare SCE's orice/ earning in ratios to those of the average electric utility since the end 11 of 1978. This is shown below:

a 12 Prica' Earnings Ratios Median SCE as %

3? 100 Electrics (a) SCE of Median 14 12/29/78 7.4x 8.1x 109%

15 3/30/79 7.4x 7.5x 101%

16 6/29/79 7.3x 6.3x 86%

17 9/28/79 6.9x 6.3x 91%

18 12/31/79 6.5x 5.4x 83%

19 2/29/80 5.9x 4.7x 80%

20 (a) Source: Electric Utility Common Stock Market Data, 21 '

Salomon Brothers. .

22 So when I recommend a 17% return on equity for SCE, I am se' clearly anticipating a very significant improvement in capital 23 markets from current levels. Of course, inherent in the h 24 r 23 assumption that interest rates are going to fall is also the i ' s

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1 assumption that a recession will hit our economy. This 2 could hurt SCE earnings since revenues are likely to fall

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3 faster _than expenses during a recession.

4 Q. Suppose long term interest rates drop 300 to 400 basis 5- points and suppose SCE were granted an allowable return of -

t 6 17%'on common equity. Would the price of its stock sell 7- way above book value?

8 A.- If rates in fact decline 300 to 400 basis points and SCE were 9 to actually earn 17% on equity, I doubt that during the time

10. new rates are in ef fect in 1981 and 1982 the price of SCE 11 stock would be significantly above book value. Investors 12 will first want to be shown that the Company can actually  !

13 earn an allowed rate of 17%. If this is achi.eved in 1981, 4

14 investors then will want te see if the Company will get rate 15' ' adjustments at the start of 1982 to offset attrition so that 16 17% can acutally be earned in the year following the test /

~ 17L year. At that time, if investors feel fairly confident that  ;

18 17% will be earned in 1982, the stock may well sell above 19 book value assuming the 300 to 400 basis points decline in 1

'20-- long term: bond yields. i, ^

21 .Q. If.that were the case, would it not be unfair to ratepayers?- .kA O

22! -A. If such a situation. materialized,-Iodo not think any(fair hl

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! 23 minded' person could reach that conclusion. Aft @* SCE's l'.

L-12 4 common: stock has sold continuously at-discounts of'20% ~ y

, . . Ili lto.40%'below book for the past seven long years, when. share .

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I holders have suf fered massive dilutions of their investment.

2 a brief period when the stock sells above book could hardly 3 be considered an undeserved windfall to shareholders.

4 Q. What is your recommended return on average common equity 5 for SCE in this case?

6 A. I recommend that the allowed return on average equity be 7 not less than 17%, provided that provision is made to 8 adjust rates at the beginning of the year following the 9 test year for financial and operational attrition so that 10 the Company will have a fair opportunity to actually earn 11 this allowed return in 1982.

12 Q. Your 17% recommendation represents a big j ump from the present 13 allowed rate of 13.49%, the Staff's recommended rate of 14 13.6% in this case and even from the Company's requested 15 rate of 15% in this case. Why are you recommending a rate 16 so much higher?

17 A. Anything less would not meet the standards set by the 18 Supreme Court in my opinion and would assure that the con-19 fiscation of existing shareholders' equity would continue 20 for another three years. The present 13.5% allowed rate 21 has been proven entirely inadequate. The Company actually p

22 earned slightly more than 13.5% in 1979, the test year for p their last rate case, however, the price of its stock has /jp, 1

23 24 never sold above 83% of its book value since the last F:

25 general rate case decision was handed down in December 197f. [

26 Experience and hard evidence in the marketplace have proven -

I 27 that the 13.5% allowed return in the last rate case should ,

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I have been at least 15A and probably higher. My 17%

2 recommendation reflects the worsening inflation rate since 3 the previous rate cane decision.

4- The Company's requested return of 15% was developed in 5 the fall of 1979 before the recent charp acceleration in 6 inflation and the big jump in long term interest rates and 7 long term inflationary expectations. The Company's 15%

~8 request was based on an analysis of conditions prevailing 9 from-1974 through 1978. At this time, in my opinion, it is 10' not realistic to expect that during test year 1981, inflation

'll.-

rates and the money and financial markets will return to 12 the average of levels prevaiting in the 1974-78 period. -

~

7t3 Q. What would the composite cost of capital be to SCE in 1981 ,

14 using your 17% recommended return on common equity?

15l .A. .The composite cost of capital would be 12.02%. -Table 4 16 shows the computation.of this figure. It is based on-the y 17 capital ratios contained in the Company's and Staff's cost 5

18' of capital studies and the estimated cost of senior. capital 5 19 -for 1981' contained the testimony of H.-Fred Christie on

. ' 20 April '2, 1980.-

2{ ,0 _ What is the total : interest coverage under your acommended

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. composite cost of capital?  %^

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[f23 .A. ;2.90 times'for test year 1981. h.,

w f24 Q. : Is.2.90 times an. adequate.coverag'e ratio?

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,[ 25_ :A. I beliess'it'.isiif the Commission makes an a .quate provisions

.i lfor attrition in its decision so that the Companyjwill have s} ; .

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1 an opportunity to actually earn its authorized return in 2 1982. In other words, I believe my recommended rate of 3

return will meet the Supreme Court's third test of a fair 4 return, that is, a return which will be sufficient to maintain 5 the iinancial integrity and credit of the Company.

6 Q. What would be the cost to ratepayers of providing a 17% ,

7 return on equity eampared with the 13.6% recommended by the 8 Staff?

Approximately $135 million which would represent a 3.6% increase 9 A.

10 in CPUC jurisdiction revenues. This would increaEe the 11 average customer's bill by approximately $1.80 per month.

12 A small price to pay for reestablishing a fair balance 13 between ratepayers and shareholders -- a balance which has ,

14 not existed for eight years.

15 O. How do you suggest attrition be handled?

In the three previous general rate cases we have participated 16 A.-

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17 in, we have called attention in our prepared testimony ,

18 to the need to provide.for attrition in the year following (

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19 the test year. The two year cycle for general rate cases ,

20 under the Commission's Regulatory Lag Plan makes this necessary Particularly in our inflationary environment. In the PG&E 21 22 Decision No. 89316,~ dated September 6, 1978, the Commission -x 23 did not discuss. our suggestion for handling attrition. In .

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.25- attrition and_in the most recent PG&E decision we were p@; '

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'Pleased to read Mr. Bryson's opinion urging the Commission

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1 to focus on the problem of both financial and operation 2 attrition. We are also pleased to see that Staff has recommended 3 an attrition adjustment to curve both financial and operational 4 attrition to be effective at the beginning of 1982.

5 In a period such as the present when we are witnessing .-

6 accelerating inflation and swiftly rising cost of senior l

-7 capital, it is imperative that any general rate decision 8 be based on the most current data and fair and reasonable ,

9 estimates of test year expenses and must provide for ad- .

10 justments to rates to cover attrition at the beginning of ,

11 the year following the test year. I believe it is preferable 12 to have an interim adjustment based on conditions prevailing 1/

13. at the end of the test year than to try to guess the impact L" 14 of attrition in 1982 at the time a decision is rendered on

-15 this case in the latter part of 1980.

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16 In this regard, I do not agree with the Staff's proposal to y k

17 place a ceiling on the attrition-allowance. To do so is b ,,

M 18 dangerous in these fast changing times and may tend to defeat y.

dr 19 the. purpose of the adjustment, that is, to give the Ccmpany a f6 t- 20I fair opportunity to earn its allowed return. Who can .k ;

21;- , accurately estimate attrition two years ahead when inflation y{n-p

' .22 is currently raging at nearly a 20% annual rate? ' ( tf

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23, .If we-can agree that fair treatment of shareholders requires W

. '24: .that rates be adjusted at the beginning of the year following tem r ,. Lp 25 the test year so that the Company wi]' have a reasonable ik

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. W2,71 that.is sufficient.

The Commi'ssion should clearly state '.pn Q. .

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1 in its decision that it intends to adjust rates at the 2 beginning of 1982 so that the Company will have a fair 3 opportunity to earn its allowed return in 1982. This would 4 have a beneficial impact on the Company's stock.

5 Q. Does this conclude your testimony?

6 A. Yes.

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.. .TA6LE 1-SOUTHERN CALIFORMIA EDISON COMPANY TEN YEAR PECCRD OF COP 90h STOCK DATA i AND FACTORS' IMPACTING DETEPMIMTION OF AttaiED RETURN {

.1970-1960

. LINE April  !

.1970

..30. , 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 d<.

.i PfR C(900N SHARE'OATA ,

l' Average of high and. low price. 28.00 30.43 27.45 22.90 17.25 19.15 21.00 24.20 24.95 - 25.44 22.62  :

'2 Earnings __

2.70 2.46 2.51 2.67. 2.80 2.86 3.30 3.80 3.52 4.56 3' Dividends declared 1.50 1.515 1.56. 1.56 1.63 1.68 . 1.58 2.06 2.30 2.60 4 Bock Value, year end - 24.72 26.20 27.14 28.a6 28.50 29.64 20.67 32.30 32.57 34.22 33.07b ,

.5 Book Value, average begin & end of year . 24.13 25.46 26.67 27.S:1 28.48 29.07 30.16 31.49 32.44 33.40

' FIT' J RN ON AVERAGE CCMPCM EQUITY - .

Li . 6 L- Found fair & reasonable by CPUC (weighted average) 11.791 11.791- 11.9% 12.251 12.251 12.25 12.t5: 12.65: 12.65I 13.49 f Actually earned, per share: t

'7- Before adjustment for dilution 11.2%. 9.7% 3.4% 9.6% 3.8% 9.8% 12.6% . 12.it 10.91 13.6% 1 8 After adjustment for dilution (a) 11.2% 11.5: 9.4% 9.6% 6.0; 9.71 9.0* 11.71 7.9% 9.41b de . MEASUREMENTS OF RISK  ;

' 9 Av+ra9e consnon price as % average book ' value 116 119 103% 82% 61% 66 70% 77: 77 761 68 I Coverage ratios:

10. Times interest earned before taxes .3.1X 3.0x 1.01 3.0x 3.01 2.7x 2.9x 2.91 2.7x 3.0x ,

11 - Times ' interest earned after taxes 2.6X 2.5X 2.5X 2.LX 2.4X 2.41 2.6X 2.6X 2.4X 2.71 t

. 12 Times interest and pref. div. earned after taxes ' 2.2X 2.0X 2.01 1.9x 1.8X 1.Sx 2.01 2.04 1.9X 2.1x 1 13 Effective income tax rate 24% 24 251 251 30% 2u% W IS: 17: 18 l 14 . AFOC as percent of consnon earnings 15% 154- 6% 9% 13; 201 26% 29: 39% 41:

15 . Internal cash generation as % construction (c) 43 45% 55% 47% 46: 39% 36 : 351 26% 271 OTHER FACTORS IMPACTING DETEPMINATION OF ALLOWED PETURN l

16 Inflation rate 5.9% 4.3% 3.3% 6.2% 11.0 9.1 5.M 6.8% 7.7% 8.7t 13.0; i 17 'Long Term interest rates (Moody's Util.AA) 8.52% 8.00% 7.60% 7.72% 9.04% 9.411 8.92 8.43; i.101 10.77. 14.44:  !

18 5&P 400 Industrials - return on av9. cocinon equity 10.4% 11.2% 12.0% 14.6% 14.8% 12.31 14.5% 14.7; 15.3: 15.e:  ;

.19 SLP 400 Industrials- Avg. stock ;. rice as % avg. book value 171% 1991 216 196% 139: 133: 15G1 138: 12' ' 123: 116 '

(a) ' Dividends paid plus net change in bnok value per share as percent of average cocenon equity.

t (b). Peflects sale of 7 millinn st. ares on r/5/80 at 34.5% discount from book value. .

{

-(c) Net income to conson plus. depreciation minus AFDC minus common divider!s divided by construction expenditures. i i

t I

L i

i b c

. mms F. . - ..=t**- - y g .u: 79.s _,_,, , -

y..

. gfh 4 , .

q ; . y{.; m'_i k . - . 3.;p'Pm.:

y g.

.: X

[> y. <

5

_ ., , . ,- ~ _.__ _

TA8LE 2 TOTAL RETUPN TO SOUTHERN CALIFORNI A EDIS0N SHAREH OVER 1 AST 15 YEAR, 10 YEAR, 5 YEAR AND TWO YEAR PERIOOS Period Holding _1974 19// '

LINE 1964 1969 NO. to 4/80 to 4/80 to 4/80

~ ~ ~ to 4/80 (c) (d)

(a) (b) 5 2 15 10 1

Nunber of years 2

Market price beginning $34.40 $17.25 $24.20 of period (a) $34.50 3 Market price end of period 22.62 22.62 22.62 22.62 4/3/80 (11.78) 5.37 ( 1.58)

Change in market price (11.88) 4 5 Total dividends received 18.82 11.00 5.58 during period 25.44 i

1.84 2.10 2.48 Average annual dividend 1.67 .

6 7

Total average annual return ,

to shareholders:

(4.0%) 5.3% (3.0%) ;c'~

a. From price change (2.7%)

8 12.2% 10.2%

4.8% 5.4%

a 9 b. From dividends ( ;;

i y<

10 Total average annual return j,4% 17.5% 7.2% ,5

.)- >

(8+9)  !>

11 Less average rate of 7.2% 9.2% 8.2% g 6.2% u w inflation '

t ';. a.

Real average annual total R 12 (5.8%) 8.3% (1.0%) '

return (4.1%)

t h,l

f-q (a) Average of high and low price for year. ,

l'

'. t.

TABLE 3 SOUTHERN CALIFORNIA EDIS0N p OILUTION INCURRED BY SALE OF COMMON STOCK BELOW 800K YALUE 1976-1980(a)

TOTAL LINE 1976-NO. 1976 1977 1978 1979 1980 1980 (a)

Number of shares sold 5,644 966 7,472 1,951 7,000 23,033 1

(000) 2 Net proceeds (000) $123,951 $23,742 $188,842 $48,174 $156,975 $541,683 3 Book Value per share before offering $31.25 $31.49 $32.87 $33.40 $34.22 p

4 Net proceeds per' share $21.96 $24.58 $25.27 $24.69 $22.39 5 Dilution per share (3) --(4) $9.29 $6.91 $7.60 $8.71 $11.83 6 Total dilution (000) $52,432 $6,677 $56,787 $16,993 $82,800 $215,6P9 r -

7' Net proceeds percent  ?

below Sook Value '29.7% 21.9%- 23.1% 26.1% 34.6% 28.5%

8 Additional shares sold - "

because of.. dilution':

-9 Percent 42.3% 28.1%- 30.1% 35.3% 52.6% 39.9%  ?'

t

.10 - Number '(000) 1,678 212 1,727 509 2,413 6,539 [,s b

$1 y ,.

!(a): Through February 1980. 7.p J,

h a

i.. h HU ia ~ h.

? ? l >.

-Ih .$ a y-

. .> = .,

_41- ,,

o, <c

e ,

TABLE 4 COMPOSITE COST OF CAPITAL BASED ON RECOMMENDED RETURN ON COMMON EQUITY TEST YEAR 1981 t

i Capital Cost Return Ratio Rate Component (a) (b) (c) (d) 47.0%. 8.82%* 4.15%

1. Lon9-term debt

2. Preferred stock 13.0 8.21* 1.07

3. Common equity 40.0 17.0% 6.80

4. Total capital 100.0%_ 12.02%

5. Times interest earned 2.90X

(

cPer testimoney of H. Fred Christie, April 2, 1980. Imbedded cost of long term debt includes actual cost of 15.36% for debt  ;

sold April 1980, and estimates of 14%,12% and 11% for issues to be sold in 1980, 1981 and 1982, respectively, and estimated costs of preferred stock to be sold of 13%, 11% and 10% in 1980, pf 4. ,

1981 and 1982, respectively. p-c.

He

}.

A S)~

T:s V'

b t.

t-f.

CHART 1 SOUTHERt1 CALIFORNIA EDiSotJ I1EASUREMEf1TS OF THE EALAf1CE OF CUSTOMER Af1D SHAREHOLDER ItJ TE RE STS PERCEt4T CHANGE 140%

i J20 ta t175% (n l,, . '.. . . '

100 g ..' -

5 9 + 84%

80 ge, b ,h -

,..- / +81%, (c)

@jI

,..- g /g(GC0 +69% (d) 9C:. L \0 40 p$.. t. *'

f9}h 'gChL0

- 34% M, 20 .... ' sotALED CO M g

PRICE OF SOCALED Comon ,

-20 -19% m .

-40 -

t' -

t.

V fv

,j; .

h h

g.j

h. ,

1970 3/80 p'N -

fi i!'

(a)

(b)

After Federal and State inecxnr2 taxes; 1979 estifrated.

22% increase in real terms after adjusting for ir _lation.

Q (c) 2% decline in real tenns af ter adjusting for inflation. [N; 3 (d) 8% decline in real terms af ter adjusting for inflation. x?

(e) 27% decline in real terms af ter adjusting for inflation. (f. '

,, , .(f) 56% & cline in real terrs af ter adjusting Zer inflation. -

/;;;

1 l

u

,--zm - n----

CHART 2 SOUTHERf1 CALIFORNIA I ALLOWED RETURN ON EQUITY, IfJFLA . loN RATE Af1D LONG IERM INTEREST RATES 20%  % CHANGE i

1970 - 80 18 16 -

+ 697.

14 .

',, . . . . . .. . +1tg

. . .f .f .

/ +120%

12. ,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,...

- - - - - . .. - /

p

/

10

/

/ ,

s' /

/ ~~~~ ** . d , /

8 *_,e' '

+; f.;

t 6

~

r r.

$C

- ~~~~

RETURN ALLOWED BY CPUC Y

.---- ic e - .

0 LONG TERM BOND YIELDS (a) Di RATE OF INFLATION (b)

. :fy -

.n e.

1970 71. 72 73 74 75 76 77 78 79 3/80 W, p:

'(a) Moody's" A A rated _ utility bonds 37

e. '

(b) Change in cost of living index by f'*

t;- o u,

P l i

Cll!\RT 3 SOUTHERfJ LALIFORfJ f A EDISCf1 EARNif1Gs/ PRICE PATIOS 22% 2 HAtlG 190-ki

+1107' '

0 18

/ +1017.

/ y 16 '

f

/

s /

e'.....

/

lI4 / \ i

, s, ,s +128z e

, s /

                                                       /                                 ... *,,...
                                                    /                                  '

s e 10

                            /

p / j

                                                                  .c.....**.........**...-                                                a
                   -                                     ,./                                                                             M' 8-
                                                      ./                                                                                  f~

6 ' EARtilt1GS/ PRICE RATIOS: l-14 , SOUTHERf1 CALIFORfilA EDIFJN p Rs

                   ---. M00Dh'S ELECTRIC STOCKS I
                  . . . . . . . . . .. . . S & 400 P' It1DUSTRIAL STOCKS                                                                   gN p ,:

gE

• 1970 71 -72 73 74 75 76 77 78 79 3/80 C f'.*
• fi-5,
• O

f. _. '

.y- .- . g Y ::t-j7 ' 99; k T ,, i med

CHART 4 SOUTHERtJ CALIFORfi!A EDIS0ra PETUPN ON AVERAGE COMMON STOCK EOUlTY 18% 16

                                                                                           /'-
                                                                             ',s'
                                                                                      '/
                                        ,   - . ~ ,

yN / \ /,,, .

                                   /                 'N      -
                                                               /,/                       .

g

                                                         \
                              '/'/, "....................'%d.,.""'"""""""*""".....-

12 ................,.s." ,

               ~ 7g                                                       /\
            .-           N                                              /    \

10 s' '

                                                                      /        \
                                                            /N y/                \           /
                                                          /                        \       /
                                          \                                             /

8 \

                                                        /                            \/                      .
                                              \

f

                                                \\,l 6

4 i: 2 RETURN ON AVERAGE COMMON EQUITY

• SOUTHERN CAL IFORNI A EDI SON ACTUAL! C. ARi4ED -

p. 0 .

                                                                                                          +#
               ---- SOCALED ACTUALLY EARNED ADJUSTED FOR DILUTION                              (a)

S&P 400 INDUSTRIAL STOCK 3 c

               '"""*"" RETURN ALLOWED BY CPUC 5

1970 71 72 73 74 75 76 77 78 79 80 w

                                                                                                            .4 (a) Equals dividends paid plus net change in book value per share as a percent of                  k average coimion stock equity per snare.

2

             ..                                                                  CHART 5 SOUTHERN CALIFORNIA EoisOn PRICE /800K VALUE RATIOS 220 A
                                   /
                                       / \
                                            \

200

                              /
                                 /            N g
                                                  \
                            /

7 \ - 180 f \

                      /                                 \
                                                           \

160 \

                                                                \
                                                                  \                     /'s '
         '140                                                       \
                                                                              ~ ~, /e'             s%
                                                                                                         '~~'s N

120 - 100 -y.,# 3 , _,s

                                                .p/;u? A s 4.py 4 .: j-{ -;;                             d.: _a
                                                                          -a +-  w                     - f 80                                                     ++                     n            ""U       ~
                                                                                                                    -" - - ~i 60                                                                                                                  e PRICE / BOOK VALUE RATIOS SOUTHERN CALIFORNIA EDISON                                                                    -

40 C8P 400 INDUSTRI AL STOCKS

    +
                                                                                                                               )     .

4 1970 71 72 73 74 75 76 77 78 79 3/80 ff k i., (a) Shaded area represents period when company has been unable to raise new comon i S y ,, equity except on basis confiscatory to existing shareholders. g. 9_

     .a
    - ~.                          gg ,

• Mu ._
• 11E19 "r_8__.'*-  :'L____}}