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Sunday, February 17, 2002 - Page updated at 12:00 AM

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Dividend power: Puget Energy rewards its shareholders as earnings sag and debt mounts

Seattle Times business reporter

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For nine years, Puget Energy and its predecessor have pumped out dividends with piston-like precision. In good times and bad, through flood and drought, the Bellevue-based company has given grateful stockholders $1.84 a year for each share of common stock they own.

The company pays out more of its profits as dividends than nearly every other major utility, Seattle Times research shows. Last year, in fact, it paid out more cash dividends than it made in profits.

But those fat dividends have attracted the skeptical notice of state regulators, who've said the money could be better used to pay down debt and strengthen the utility's balance sheet.

Puget Sound Energy (PSE), Puget Energy's regulated subsidiary, has asked the Washington Utilities and Transportation Commission (UTC) for $170.7 million in interim rate increases. PSE says it needs the money to fill the gap between what it costs to provide power and what it can charge.

The increase would cost the average residential customer $10 to $14 a month. With more than 940,000 electricity customers and nearly 606,000 gas customers, PSE is the state's largest utility.

But commission staff have recommended, at most, $42 million in temporary rate increases, and have pointedly suggested that Puget Energy could save money by cutting its dividend, or at least paying more of it in stock rather than cash.

It's a classic utility squeeze play: investors' expectations of consistently high dividends clashing with regulators' mandate to keep rates as low as possible without irreparably damaging the company.

Cutting the dividend would bite into one of the main reasons people buy Puget Energy's stock, company treasurer Don Gaines said.

"We're not growing at 15 to 20 percent a year like Microsoft," he said. "If there's not much prospect for (stock-)price appreciation, no one would look at your stock if you didn't pay out a dividend."

James Bellessa, a veteran utilities analyst with D.A. Davidson in Great Falls, Mont., said Puget Energy shares could fall to $15 on a dividend cut, from the $21 range they're in now. They've already fallen 13.4 percent over the past year — in part, Bellessa said, due to concerns about the dividend.

And a lower dividend would make Puget Energy stock a harder sell, Gaines said. The company plans to sell "a couple hundred million dollars' " worth of new stock this year, to reduce its dependence on debt.

"It would be very, very difficult, if not impossible, because you wouldn't have anything to offer investors," he said. "They'd take their money and go elsewhere."

But regulators and outside experts say the real issue is what Puget Energy is doing with the cash it already has.

"Retaining a reasonable amount of the company's earnings (by cutting the dividend) would begin to move Puget's financial risks in the right direction — downward," said utility analyst Stephen Hill, who testified on behalf of the state Attorney General's office.

With a lower dividend, Hill testified, "Puget would be able to retain some of its earnings and use (them) to avoid continued reliance on debt financing and shore up its financial position. That would be viewed positively by the market, in my opinion."

Tradition of high dividends

Utilities long have paid among the highest dividends in American industry. That comes from necessity, said James Simmons, president of ICM Asset Management in Spokane.

Once the country was fully electrified, Simmons said, utilities couldn't tap into a rapidly growing market. And as regulated entities, they were limited in how much profit they could earn and how they could spend it.

"Utilities, if they wanted to keep their stock in any way attractive to any investors out there, became almost entirely dependent on dividends," he said.

That situation began to change in the past decade, as deregulation has reshaped the utility world and companies have chosen to free up cash to invest in new businesses. Still, of 80 major electric and gas companies studied by The Seattle Times, only 16 have cut their dividends or stopped paying them entirely since 1992.

Even among utilities, though, Puget Energy stands out.

Among the 67 dividend-paying companies in the sample that have reported 2001 financial results, Puget Energy's dividend yield — the annual payment as a percentage of the stock price — topped the list at 8.59 percent; the average was 4.65 percent.

The company ranked fifth in how much of its 2001 profit it paid out to shareholders: 161.4 percent. Puget Energy paid $133.4 million in cash to owners of its common stock, even though it made just $98.4 million in profit (after paying preferred dividends). An additional $25.6 million in dividends was paid in stock, through an optional dividend-reinvestment plan.

The payout average — excluding three utilities that paid dividends despite losing money last year and one that essentially broke even — was 82.85 percent of profit.

Gaines, Puget Energy's treasurer, said the payout ratio rose not because the company paid more in dividends, but because its profit fell nearly 45 percent; in 2000, the ratio was 81 percent. The company wants to lower the ratio, he said, but by growing profit instead of cutting dividends.

Worries about debt

Regulators are also concerned about Puget Energy's debt. They note that while the company has paid out nearly $800 million in common-stock dividends over the past five years, its long-term debt load has almost doubled: from $1.3 billion shortly after the company's 1997 formation to $2.25 billion as of Dec. 31.

Puget Energy's equity ratio — a measure of how much stake stockholders have in the business as opposed to creditors — has fallen over the same period, from 43.2 percent of total capitalization to 31.7 percent, Times analysis of the company's financial statements shows.

That's important because the lower a company's equity ratio, the more exposed it is to volatile business conditions, said Lisa Steel, the UTC's assistant director for energy.

She has recommended limiting PSE's cash payments to Puget Energy unless the latter can raise its equity ratio to at least 36 percent. That likely would force Puget Energy to cut its dividend, since the subsidiary provides most if not all of the cash portion of the parent company's dividend.

Bellessa, the D.A. Davidson analyst, warned that such a move could backfire. Credit-rating agencies already have warned they'll cut Puget Energy's ratings without the interim increase. If the stock market also cools to Puget Energy, he said, that leaves just one source of money: ratepayers.

"This company has presented itself ... as a yield investment," he said. "The cost of capital will soar if the dividend is cut and the bond rating goes down. Puget's customers will have to pay much higher rates over the next 10 or 15 years than if (Puget Energy is) treated fairly now."

If that's so, UTC energy coordinator Merton Lott said, Puget Energy has only itself to blame for using its cash to pay dividends instead of reducing debt when it had the chance.

"The capital structure no longer supports the dividend," he said. "I don't think they should be allowed to have it both ways."

Drew DeSilver can be reached at 206-464-3145, ddesilver@seattletimes.com.

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