The corporate parent of United Illuminating wants to perform a $2.1-billion upgrade of the New Haven electric utility's aging infrastructure, but raising capital will be a difficult venture.
When the Department of Public Utility Control last year gave United Illuminating an 8.75 percent return on equity in its electric rates, the stock of parent company UIL Holdings Corp. fell and its costs of borrowing rose.
The 8.75 percent ROE is one of the lowest in the country — the national average ROE for utilities is more than 10 percent — and potential investors no longer saw UIL as the best option.
"Investors can always vote with their feet, and they can always go to better returns," said David Parker, senior utility analyst for equity firm Robert W. Baird & Co.
In May, Bank of America Merrill Lynch and Argus Research Co. each downgraded its rating of UIL shares, warning investors to watch what happens with the company and state regulators. Merrill Lynch dropped the stock price target to $30, which would be an 8-percent decrease from its current price.
"The perception from investors around the country is that Connecticut is anti-business," UIL CEO James Torgerson said.
Connecticut has the second highest utility rates in the nation behind Hawaii, and the political pressure is increasing to lower the state's rate standing. The Connecticut state government is developing a new agency and energy strategy to bring electric costs down, among other things.
To pay for the proposed 10-year, $2.1 billion upgrade of its 45-year-old infrastructure, United Illuminating will need higher electric rates, Torgerson said.
The infrastructure project is mostly maintenance on an aging system to ensure reliability for customers and prevent problems such as blackouts, said UIL spokesman Michael West. One-third of the $2.1 billion will go toward the distribution system, replacing old substations, poles and other vital infrastructure.
Small parts of the project started in 2010, and the plan calls for completion by 2019.
"It is time to make some of those improvements," West said. "It is making sure our infrastructure is as robust as it can be."
Having $2.1 billion worth of work would provide a huge boost to the struggling construction industry, particularly in the area of utility construction, said Matthew Hallisey, executive director of the Connecticut Environmental and Utilities Contractors Association.
The Metropolitan District Commission in Hartford is doing $1 billion worth of sewer work, which has helped construction firms last in trying times, Hallisey said. But other than MDC work, Connecticut doesn't have much utility work. Northeast Utilities' $2-billion transmission project is largely in the planning stages, except for work around Springfield.
"We very much support (UIL's project) and appreciate the opportunity to get the work," Hallisey said. "We're excited about this. Among others, we are looking forward to working on that."
With the project still in the planning stages, West said contractors still have the opportunity to get various segments of the $2.1 billion proposal.
"We have a fairly good idea of what we need to do and when we need to do it," West said.
To raise capital for its $2.1 billion project, UIL is still weighing its options, West said. Asking for increased rates is still an option, and the company will need to raise its distribution rate base by $200 million.
Despite the ratings drop by Argus and Merrill Lynch, not all investors are down on UIL. Robert W. Baird gave the company its 'outperform' rating and pushed its 12-month stock price target to $35.
The main upside is that UIL is no longer strictly an electric utility holding company, Parker said.
In November, UIL completed its $1.3 billion acquisition of two Connecticut and one Massachusetts natural gas utilities. The acquisitions gave UIL a total of 690,000 utility customers in 66 communities across two states with combined 2009 annual revenues of $1.63 billion. The company now employs 1,858.
UIL acquired the three companies to capitalize on the competitive advantages of natural gas, Torgerson said. For home heating, natural gas is 30 percent cleaner and 50 percent cheaper, and half of Connecticut residents have yet to make the switch from fuel oil.
The company has launched an aggressive advertising campaign to encourage people to make the switch to natural gas, and management has targeted adding 35,000 gas customers over the next three years, generating $315 million in net income.
Long-term, this makes UIL a smart investment, Parker said.
"We are a little more optimistic than others for what that can do from an earnings perspective," Parker said.
In addition to its new natural gas business, UIL will continue to yield above average dividends from its electric infrastructure, Parker said. Connecticut still has transmission and congestion issues, and UIL can profit from upgrading the system.
Despite its ROE of 8.75 percent, UIL has managed to increase its profits by keeping its expenses in check.
"UIL is not a huge utility company in the United States, and doesn't get the attention like the top 10 largest utilities, but what this management team has done … is put together a good strategy," Parker said. "The last several years have been positive for UIL."