Business Context and Reporting Period
Company: Hawaiian Electric Industries, Inc. (HEI) and principal subsidiary Hawaiian Electric Company, Inc. (HECO).
Reporting Period: Quarter and nine months ended September 30, 2007.
Operations: HEI operates as a holding company for electric utilities serving approximately 95% of Hawaii's population (HECO, HELCO, MECO) and a banking subsidiary, American Savings Bank, F.S.B. (ASB). The company is heavily influenced by Hawaii's tourism, construction, and federal government sectors.
Key Financial Metrics (Nine Months Ended Sept 30, 2007)
| Metric | 2007 (in millions) | 2006 (in millions) |
|---|---|---|
| Total Revenues | $1,828.2 | $1,853.8 |
| Operating Income | $121.9 | $196.2 |
| Net Income | $44.2 | $91.9 |
| Diluted EPS | $0.54 | $1.13 |
| Operating Cash Flow | $170.0 | $203.4 |
| Total Assets | $10,030.6 | $9,891.2 |
| Long-term Debt (excl. bank) | $1,229.9 | $1,133.2 |
| Stockholders' Equity | $1,130.4 | $1,095.2 |
Segment Performance
- Electric Utilities: Net income was $24.0 million (down 61% from $61.9 million). Revenues declined due to lower fuel costs passed to customers and a $15 million accrual for potential rate refunds. Expenses rose due to higher O&M, depreciation, and a $12 million write-off of HELCO plant costs.
- Bank (ASB): Net income was $35.9 million (down 23% from $46.5 million). Earnings were pressured by a flat/inverted yield curve, higher funding costs, and a $3.9 million provision for loan losses.
- Other: Net loss of $15.7 million.
Material Changes vs. Prior Period
- Significant Earnings Decline: Consolidated net income dropped 52% year-over-year. The primary drivers were a $15 million reserve accrued for a potential refund of HECO's 2005 interim rate increase and a $12 million write-off of HELCO's CT-4 and CT-5 generating unit costs.
- Utility Expenses: Other operation and maintenance expenses increased significantly due to higher retirement benefit costs, demand-side management (DSM) expenses, and maintenance of aging generating units.
- Bank Margin Compression: ASB's net interest margin decreased to 3.09% (from 3.23%) due to higher funding costs and a shift in deposit mix to higher-cost certificates.
- Dividend Payout: The dividend payout ratio for the first nine months of 2007 was 172%, significantly higher than the 93% ratio in 2006, due to the depressed net income.
Guidance, Outlook, and Risks
Management Commentary and Outlook
- Rate Relief: Future utility earnings depend heavily on the timing and amount of rate relief to cover rising O&M and capital costs. HECO received an interim rate increase of ~$70 million in October 2007, subject to refund pending final PUC approval.
- Capital Expenditures: Continued investment is required for reliability, including the 2009 Campbell Industrial Park (CIP) generating unit (110 MW) and transmission upgrades.
- Banking Environment: ASB faces a challenging interest rate environment. Management expects higher legal and compliance costs to continue as they strengthen risk management infrastructure.
- Dividend Policy: Management aims for a sustainable payout ratio of 65% or lower. The current high payout ratio is viewed as temporary due to the specific non-recurring charges.
Risks and Contingencies
- Regulatory Risk: Significant uncertainty remains regarding the final outcome of HECO's 2005 and 2007 rate cases. The PUC's amended proposed final D&O for the 2005 case excluded HECO's pension asset from rate base, triggering the $15 million refund accrual.
- Generation Reliability: Oahu faces strained generation reserve margins, increasing the risk of outages until the new CIP unit is installed in 2009.
- Environmental Compliance: Potential costs associated with the Regional Haze Rule, Clean Water Act cooling water intake requirements, and the Honolulu Harbor investigation remain uncertain.
- Banking Compliance: ASB is addressing compliance deficiencies identified by the Office of Thrift Supervision (OTS) regarding Bank Secrecy Act requirements, which may result in enforcement actions.
Investor Verification Checklist
- Rate Case Finalization: Monitor the final Public Utilities Commission (PUC) decisions on HECO's 2005 and 2007 rate cases to confirm if the $15 million refund accrual will be reversed or if additional refunds are required.
- HELCO Plant Costs: Verify if the PUC disallows additional costs for the CT-4 and CT-5 units, which could trigger further write-offs beyond the initial $12 million.
- Bank Asset Quality: Review ASB's allowance for loan losses and nonperforming assets, particularly regarding the specific commercial borrower that drove the $3.9 million provision.
- Regulatory Compliance: Track the outcome of OTS examinations of ASB and any resulting consent orders or penalties.
- Capital Project Timeline: Confirm the schedule for the 2009 CIP generating unit and the East Oahu Transmission Project to assess future capital expenditure requirements.