National Association of Regulatory Utility Commissioners

1
National Association of Regulatory Utility
Commissioners

• Investment Risks and Returns in the Water Sector
• An Investors View of the U.S. Water Utility
  Industry
• Lester H. Krone
• A.G. Edwards Sons, Inc.
• September 21, 2005

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Disclaimer

• The information in this presentation, compiled
  from sources presumed to be reliable, should be
  used solely to better understand industry
  developments and trends. The information in this
  presentation is not intended to express or convey
  any opinion or viewpoint of A.G. Edwards
  concerning the investment merits or suitability
  of the industry, and investors should not rely on
  this information as the basis of any investment
  decision.

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An Investors View of the U.S. Water Utility
Industry

• Lester H. Krone A.G. Edwards Sons, Inc.
• Managing Director Investment Banking
• Head of the Utility Group
• AGE is a securities brokerage firm serving
  individual and retail investors in the U.S. (as
  well as institutional investors in Europe)
• Provide financial services to U.S. investor-owned
  utilities (electric, gas and water)
• Active banker and advisor to investor-owned water
  utilities
• 500 million common stock
• 200 million debt
• 10 MA assignments

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Who Invests in the Utility Industry?

• Individual (or Retail) Investors
• Securities of utilities (debt and equity) are
  part of a conservative portfolio of an individual
  investor saving for retirement and/or college
• Institutional Investors
• Mutual funds, pension funds, hedge funds, etc.
  that manage large pools of capital with specific
  investment objectives
• A.G. Edwards serves both retail and institutional
  investors

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How Large is the U.S. Utility Industry?

• Investor-owned utilities (IOUs)
• Electric/gas/water
• Publicly-traded, regulated by the states
• Not government-owned
• Doesnt include foreign-owned entities (e.g.,
  American Water is owned by RWE, a utility based
  in Germany)
• 6/30/05
• Equity Market
• Capitalization
• U.S. Electric Utilities (49 companies)
• (e.g., Duke, Exelon) 382.7 billion
• U.S. Gas Utilities (28 companies)
• (e.g., Laclede Gas, Atmos Energy) 68.8
• U.S. Water Utilities (11 companies)
• (e.g., Aqua America, California Water)
  5.5
• Total Equity Market Value 457.0 billion

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Publicly-traded US. Investor-owned Water Utilities

• 9/9/05
• Equity Market
• Operations Cap. ( mil.)
• Largest
• Aqua America 13 states 3,605
• California
• American States Water 2 states
  546
• California Water 4 states
  752
• San Jose Water CA 479
• Southwest Water 3 states 273
• Regional
• Connecticut Water CT 209
• Middlesex Water NJ 260
• Microcap
• Artesian Water DE 123
• BIW CT 33
• Pennichuck NH 91
• York Water PA 167
• 6,538

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Who Owns the Common Stock of U.S. Utilities?
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Value of Equity Holdings
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Value of Equity Holdings
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Why Do Investors Invest in the Water Utility
Industry?

• Local business, no substitute
• No competing water suppliers
• Old-style regulated rate-of-return business
• Very small non-regulated component
• Capital intensive business
• Growth and maintenance
• Government-mandated improvements additional
  capital expenditures
• Consolidation acquire troubled
  utilities
• Relatively lower risk
• Investment grade debt
• Dividend-paying stocks

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Value Differentiation in the Utility Industry

• Regulation distinguishing element of the
  industry
• How supportive?
• Growth Strategy
• Service territory (internal growth)
• Acquisitions
• Non-regulated ventures
• Operating Margins
• Capital Requirements
• Balance sheet strength
• Financial flexibility
• Cash Flows
• Internal cash generation
• External financing required

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How Have Equity Investors Fared Lately?
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How Have Equity Investors Fared Lately?
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How Have Equity Investors Fared Lately?
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Total Return and Valuation Statistics 9/9/05

• Total Return Valuation
• 9/1-9/8 YTD 2006E P/E Px/Book Yld
• AGE Gas Index -0.6 16.9 16.2X
  202 3.3
• AGE Electric Index 0.0 17.2 15.4X
  189 3.7
• AGE Merchant Index 0.8 13.1 18.7X
  165 1.3
• AGE Water Index 1.2 33.7 26.7X
  242 2.9
• SP Composite 0.9 2.9 15.8X
  285 1.7
• Source A.G. Edwards Securities Research

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How Have Fixed Income Investors Fared?
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How Have Fixed Income Investors Fared?
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Recent Waves in the Water Industry (1)

• Water Utility Challenges (As Seen by SP)
• - SDWA
• - Aging infrastructure
• - Consolidation
• - Nonregulated OM contracts
• (1) SP Report, November 2004

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Utility Industry Capitalization

• Gas Electric Water
• Common Equity 48.0 41.1 50.6
• Preferred Equity 0.7 0.4 0.2
• Long-term Debt 49.3 57.9 49.1
• Minority Interest 1.9 0.6 0.0
• Average Rating A- BBB A

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Water Industry Most Capital-Intensive Utility
2004 Capital Employed per Dollar of Revenue
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Additional Capital Required

• 2004 2005P
• Water Utility
• Capital Expenditures 481 mil. 542 mil.
• Projected 12.7 increase for 2005

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Water Industry Relies on Additional Investment
Cap Expenditures/Cash From Operations
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External Financing Required

• Projected 2005 Capital Expenditures 542 mil.
• Approx. 60 Cash From Operations 325
• Additional Financing Required 216 mil.
• - 50 Debt
• - 50 Equity

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Water Industry Relies on Additional Investment
Depreciation/Cap Expenditures
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Water Utilities Thirst for Capital

• Water utility industry is very capital intensive
• Capital needs will be high in years to come
• Maintenance
• Growth
• Meet stricter water quality standards
• Consolidation
• External financing required to fund capital
  expenditures
• Debt and equity investors are key stakeholders in
  the future of the water industry

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Investors Care About Regulation

• Capital structures that continue to attract
  capital
• Equity component that supports A rating
• Dividends are important to investors
• Predictability, growth
• Responsive regulatory policies
• Allowable ROEs
• Timely rate relief
• Depreciation policies
• Higher depreciation rates
• Depreciation of CIAC
• Incentives for infrastructure improvement
• Incentives to acquire smaller utilities