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[Enterprising Investor]

Oncor the shining light during dark times at EFH (3/24/14)

Remember when utilities were so safe and steady that the investments were recommended for widows and orphans?

Oncor Electric Delivery Co. is a throwback to that time, despite being part of a doomed leveraged buyout.

While its largest owner, Energy Future Holdings, veers toward bankruptcy, Oncor keeps growing revenue and profit, and investing heavily in infrastructure.

Last year, as EFH struggled to hold off creditors, Oncor paid $310 million in dividends and still invested more than $1 billion in capital improvements.

EFH may be running out of cash after its 2007 buyout of TXU Corp., but Dallas-based Oncor might as well be operating in another world.

Credit Texas-style regulation, which includes a legal “ring-fence” that protects Oncor and ensures its independence.

The rules set limits on dividends, debt-equity ratios and the composition of the board. Independent directors hold a majority of board seats.

The best example of Oncor going its own way: In recent years, it spent almost $2 billion on new transmission lines to West Texas.

The investment resulted in smaller dividends for several years, when EFH could have used the extra cash. The new transmission lines also strengthened wind power in the state, putting downward pressure on electricity rates.

While lower rates benefit consumers, they hurt power generators like EFH’s Luminant, the largest in the state.

How to balance the trade-off? Oncor didn’t have to worry about it because it’s truly independent. Officials even refer to EFH as an investor, not a parent company, because EFH doesn’t have control.

In a 10-K filing, EFH said it depended on Oncor for a significant amount of cash flow from dividends. But EFH said it has “a very limited ability to control” Oncor’s activities.

Oncor provides the poles and wires that deliver electricity to almost 3.3 million Texas customers, the most in the state. It earns a guaranteed return on investments approved by regulators, and it’s been building and collecting.

In addition to the transmission lines, Oncor spent $660 million on smart meters. Oncor expects to get $1 billion in surcharges on the meters over an 11-year period.

In 2013, Oncor’s operating revenue increased almost 7 percent, the fourth straight year at that pace. Operating income grew at a similar rate. And Oncor said it will continue capital spending at more than $1 billion annually for the next five years.

EFH’s bankruptcy may put Oncor into play, as investors try to recover more of their losses by selling pieces. With a growth market and favorable regulatory environment, Oncor is a premium asset, according to Moody’s Investors Service.

“So the list of interested buyers would probably be as long as a West Texas country mile,” analyst Jim Hempstead wrote in a report in October.

Investors would range from energy companies to pension funds. They’ll be drawn by the potential of locking up $300 million in annual dividends for years to come. Some have compared buying Oncor to buying a huge annuity because the business is so reliable.

Besides steady growth, Oncor offers a safe play in the energy industry. Luminant and EFH’s electricity retailer, TXU Energy, have been buffeted by broader trends in the competitive market.

Power prices have plunged, largely from the abundance of natural gas with shale drilling. And TXU Energy has lost 400,000 residential customers since 2008, as many switched from the incumbent retailer to new entries with lower-price plans.

Oncor has taken other steps to separate itself further from EFH. In 2008, almost 20 percent of Oncor was sold to a group that includes a Canadian pension fund and the Singapore government. A small stake was also sold to Oncor management, and dividends are shared among the owners.

Hempstead estimated that Oncor is worth about $8 billion and said the figure could go higher if a strategic buyer could acquire all of the company. But he believes the minority investors would be unwilling to sell their stake, even at a high price.

Last year, about half the increase in Oncor revenue came from pass-through expenses that it collects for third-party transmission services and others. The other half came from growth in customers and consumption, and higher revenue from transmission improvements.

In 2009 and 2010, Oncor’s customer base grew less than 1 percent, but revenue kept cranking. Since the buyout, Oncor’s annual revenue has grown 42 percent. In roughly the same time, EFH revenue has fallen by half.

Strong results at the regulated utility have become almost routine.

“2013 was another very good year for Oncor,” CEO Robert Shapard told analysts a month ago.

In the energy business, nothing’s closer to a sure thing.

http://www.dallasnews.com/business/columnists/mitchell-schnurman/20140324-oncor-the-shining-light-during-dark-times-at-efh.ece