Credit analyst: Avoid Reliant Energy as Reliant Resources' troubles may have impact

By Ronda Fears

Nashville, Tenn., May 20 - Reliant Energy may be insulated from the troubles at its 80% owned Reliant Resources unit but it is not entirely immune, so Carol Levenson, director of research at Gimme Credit, recommends avoiding both credits.

Reliant Energy has an exchangeable outstanding that converts into AOL common shares, but the debt is rated and serviced by Reliant Energy.

Over the past week, several energy names have been revealed as conducting "round trip" and "wash" trades that boosted revenues.

"When we last wrote about Reliant Resources (May 13), the company had discovered some 'wash trades' on its books and pulled its bond deal, but it hadn't yet quantified or explained anything," Levenson said in a report Monday.

"Since then the preliminary results of a review of its 'round trip' trades have been released, top management in the company's wholesale and trading group have 'resigned to pursue other interests,' the company's ratings have been placed under review for downgrade and its stock price has continued to fall.

"This has only intensified our concerns about both Reliant Resources and its parent, Reliant Energy (Baa1/BBB+)."

The "round trip" trades discovered so far increased Reliant Resources' revenues over the last three years by 10 percent.

"This amounts to $6.5 billion, not exactly chump change," Levenson said.

"And yet, management assured investors these activities had no impact on cash flow or net income."

But in the past management has often cited trading and marketing volumes in explaining decreases and increases in operating income, the analyst noted.

Furthermore, management claims Reliant Resources' decision to take a "time out" from its mark-to-market trading activities to cut back on its trading risk and concentrate on asset-based trading won't affect this year's earnings.

"Even if it did, we're not sure how we'd know," Levenson said.

"With nothing more to go on, we must take on faith management's assertion that the 'wash trades' had no impact on cash flow or earnings. This does not alleviate the company's liquidity situation nor relieve its urgent need to execute some major refinancing and soon."

Levenson said she is skeptical of management's belief that the company can still tap the debt markets between Labor Day and the end of the year, looking to term out $2.5-$3 billion in debt, once they've cleared things up with their banks in June and the markets have settled down.

"There seems to be no Plan B should these miracles not occur on schedule," Levenson said, and noted that Reliant Resources canceled a $500 million bond deal when the news broke.

The company's delay in filing its 10-Q could make matters even worse with regard to its bankers, she added, as could an expanded SEC investigation and/or a downgrade to junk.

Also, Levenson noted that subsidiary Orion Power violated one of its bank covenants in the March quarter and could be in default this quarter without a waiver or a refinancing.

"We previously expressed concern about how this whole mess might impact parent Reliant Energy, which hopes to spin off the rest of Reliant Resources this summer," Levenson said.

Should the SEC expand its investigation to include Reliant Resources' questionable trades, this spinoff could be delayed even further. While this might help Reliant Resources by keeping it within the fold of its somewhat stronger parent, it would certainly not be beneficial to the risk profile of Reliant Energy.

"Despite the fact there was a regulatory impetus for separating the company's unregulated businesses, we wonder whether Reliant Energy can simply cut Reliant Resources adrift amid its current troubles."

Levenson said Xcel Energy may be a good example of the repercussions still ahead for Reliant Energy. Xcel Energy decided to reabsorb its struggling energy trader, NRG Energy, by tendering for the public minority interest. Although Xcel is using stock for the tender, its promise of a substantial equity infusion into NRG and the inevitable increase in its business risk has prompted rating reviews, the analyst noted.

"So far there have been no rating actions on Reliant Energy, but it too has delayed the release of its 10-Q and it is already the subject of shareholder lawsuits," Levenson said.

"While the utility subsidiaries might be insulated to a degree, we don't believe they are immune to Reliant Resources contamination, and we would avoid both parent and subsidiary bonds."

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