Reliant Energy narrows loss, shoots for reduced debt/EBITDA ratio; Orion refinancing top priority

By Paul Deckelman

New York, May 5 - Reliant Energy on Wednesday reported a narrowed first-quarter loss from a year ago, and said it was continuing its efforts to cut costs in hopes of bringing the ratio of its net debt-to-adjusted EBITDA down substantially.

The Houston-based energy provider's chief financial officer also told a conference call that refinancing or otherwise eliminating the debt it incurred with its early 2002 purchase of Orion Power Holdings Inc. remains its "Number One objective from a corporate finance standpoint this year."

The company - which recently changed its name to Reliant Energy from Reliant Resources Inc. - said that in the first quarter ended March 31 it had a loss from continuing operations of $46 million, or 15 cents per share, somewhat narrower than the loss from continuing operations of $52 million, or 18 cents per share, for the same period of 2003.

Reliant's chairman and chief executive officer Joel V. Staff told analysts and investors on the company's conference call following the release of the earnings data that the latest quarter's results "are consistent with previously communicated expectations for both the quarter and the year."

Reliant has been looking to sell assets and has been tightening its corporate belt by trimming operations and headcount - in fact, it announced on Tuesday that it was mothballing a Mississippi power plant due to weak electric wholesale market conditions in the Southeast. Staff said the company had "made some real progress toward the strategic goals we outlined on our last conference call - positioning this company to be a winner in what we believe is fundamentally a cyclical business in an industry that's very likely to face restructuring."

The CEO said that Reliant expects to achieve an additional $200 million in cost reductions by the end of 2006, in addition to the $140 million the company announced last year.

Aiming for 3x

He also said that Reliant was trying to reduce the ratio of net debt-to-adjusted EBITDA to 3x or less from the 5.3x ratio in place as of the end of 2003.

CFO Mark Jacobs estimated that given what he called "the modest debt paydown we had in the first quarter, we've improved that by 0.1 or 0.2, so [net debt] would be about 5.1x or 5.2x [adjusted EBITDA as of the end of the first quarter] on an apples-to-apples basis."

In response to an analyst's question, Jacobs said that Reliant had done "a significant paydown in debt, about $2.2 billion, in 2003, and that's really starting to work in our favor."

Reliant reported that interest expense, net for the first quarter of 2004 was $105 million, up from $83 million for the same period of 2003, due to higher interest rates resulting from the company's bank refinancing in March 2003 and subsequent capital markets transactions last summer; however, underlining what Jacobs said, these were offset somewhat by the reduced debt levels.

Jacobs said that in the latest quarter, the company had capitalized interest of $17 million, and said that Reliant expects that to be "in the $40-$50 million range for this year."

Seward to raise interest expense

He said that when the huge new Seward Generating Station the company is constructing in New Florence, Pa. comes on line later this year, "that interest expense will start hitting the income statement. But I feel we've very close here to rounding the top, where we should start seeing some declines in interest expense."

He also echoed Staff's prediction of lower debt-to-EBITDA levels, declaring that "I do think that where we're going with debt-to-EBITDA, target, you're going to see our debt levels come down."

Jacobs said that when that would occur would depend, in large measure, on the progress of asset sales. "Those are obviously big drivers on paying down debt levels. If those happen in the near term, it could happen in the next quarter or two where we'd see that."

However, he acknowledged the possibility that "absent any big asset sales, we'll probably hit the peak again [in terms of interest expense] in the third or fourth quarter of this year, when we have no more of the interest expense being capitalized and all of that comes onto the income statement."

Fate of New York assets

Reliant has in the past indicated that it might entertain offers for some of its generating facilities in New York, among other assets, but in response to several conference-call questions that seemed to treat New York asset sales as practically a fait accompli, Staff admonished the investors and analysts on the call that "we've been talking publicly of our desire to make dispositions of assets, but we really haven't made any decisions to sell them. We're continuing to actively look for opportunities and look for places where the valuation would be right for us."

Sales, cash flow, equity issuance

Asset sales, the CEO said, were one lever of a three-part strategy "dedicated to building and maintaining a very conservative capital structure."

Besides "selective asset sales - to identify selected assets where we can realize reasonable values", the other levers Reliant has for tweaking its capital structure include working toward strong operating cash flow of the organization, which Staff said "is going to be enhanced by the cost reductions." The other tool, he said, is "to consider equity issuance at an appropriate valuation" - although he took pains to reassure Reliant shareholders that issuing new equity would not be a "final option" to which the company would "automatically default" to take up the slack if it weren't able to achieve its cost-reduction and asset-sale proceeds goals.

"Each of [our triggers] have to be executed in a responsible manner," Staff said. Any equity issuance to strengthen the capital structure, he said, "is going to be a relatively small amount and it's going to have intrinsic value, and we want to capitalize on that."

Jacobs said while it is "hard to speculate on a hypothetical transaction . . . if we sell assets, broadly across the company, the proceeds would go to debt repayment. In general, if we sold any assets in our Orion entities, the cash would go to repaying bank debt - first the bank debt associated with that entity, and then, if it was [an Orion asset in] New York, it would go to [pay debt associated with the company's operations in the] Midwest or vice versa."

Refinancing Orion debt

Jacobs said that refinancing the bank debt incurred in the Orion purchase "is our Number One objective from a corporate finance standpoint this year," and said that there were "a number of ways in which that could happen," including using the proceeds from asset sales, or even possibly "additional fixed-income issuances we might do as a holding company in downstream money. We really haven't figured out a specific strategy yet how we're going to do that. So there's nothing new to report, other than to reiterate that this continues to be a very high priority for us this year."

Floaters hedged

With interest rates expected to be heading back upward before too long, several of the callers on the conference call expressed concern about what would happen in that case to the sizable volume of floating-rate debt Reliant currently has outstanding, which Jacobs estimated at between $3.8 billion and $3.9 billion.

He said that the company had already hedged against that possibility by having purchased interest rate caps for "substantially all of that." The CFO added that "some of those capped rates have declined since we put those caps in place, so we would have some exposure - in general, for the first 1% uptick in rates, we may bear that on an annual basis, but essentially, all of that floating-rate debt is capped."

Staff meantime reconfirmed the company's previously announced adjusted earnings guidance for the year of 25 cents per share in earnings, and free cash flow target of $250 million.

Addressing the continued softness in the wholesale electricity market, which led to the decision to mothball the Mississippi plant, the CEO sought to reassure company stakeholders that "this management team is not counting on a recovery in the wholesale markets. To the contrary, our model is to exploit the cyclicality of this business, to position the company for value creation during the trough. That being said, we really see this as a race to be positioned to capture greater upside before a significant recovery occurs."

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