THE MERRILL LYNCH RESEARCH OPINION ON NUCLEAR POWER Merrill Lynch and the investment community in general are neither for nor against nuclear power. We in the investment community are charged daily with finding the means to meet the objectives of the American investment public. Those objectives never change. In short, each investor seeks the maximum return commensurate with the risk involved on the dollars that he or she has to invest. The capital-formation process represents the aggregate actions of all kinds of investors doing just that, some with more success than others. The nuclear power controversy must be considered by security analysts, such as we, only from an investment point of view. To do otherwise would be to render a service that has not been requested. SURVEY OF INVESTORS' ATTITUDES The Merrill Lynch White Weld Capital Markets Group commissioned a survey of investors' attitudes toward electric utilities. Although the survey was conducted in 1980, we believe that the results represent current attitudes. The poll showed that individual investors viewed a company's nuclear involvement as a risk, but that attitude did not seem to extend to their investment decisions. The survey showed that institutional investors usually mentioned nuclear power as a cause for concern. Among the 13 to 16 items usually cited as relevant to an investment decision, however, nuclear power usually appeared in the middle of the list. In other words, institutional investors thought that many other elements were far more important than a company's nuclear involvement in choosing to buy or to sell a utility stock. Nevertheless, 56 percent of these investors said they would react unfavorably to a company that is highly dependent on nuclear power source, but only 2 percent said that they could not recommend investments in companies with nuclear facilities. The survey also showed that the Three Mile Island accident caused only about 25 percent of the participants to reduce the utility stock holdings in their portfolios. After the Three Mile Island accident, prices for shares of utilities generating nuclear power fell by about 5 percent in relation to prices for other utility stocks, and that relative loss has not yet been regained. Therefore, the cost of capital for nuclear utilities rose in relation to that for nonnuclear utilities. On an overall basis, we conclude that investors are mildly concerned about nuclear power and that the cost of capital for nuclear-involved utilities has risen. This conclusion, however, masks serious differences among companies. The real question is: What are investors' attitudes about: (A) completed nuclear plants; (B) nuclear plants under construction; and (C) starting a nuclear project at the present time. WHAT IS THE ATTITUDE OF THE STOCK MARKET ABOUT UTILITIES Ten utilities are in this category. Their financial ratios are as strong as or stronger than the financial ratios for our sample of 29 utilities that have no nuclear plants and no plans to build nuclear facilities. These 10 utilities are, in the main, respected companies, and their shares sell as such in the marketplace. That is, their market-price to book-value ratios are higher than the average for the industry-a reflection, we believe, of their higher interest coverage ratios and earnings quality, among other financial measures. Few investors have indicated to us that they object to purchasing or holding these stocks. As far as we can tell, the market does not differentiate appreciably between utilities with no nuclear involvement and utilities with nuclear plants in operation, but with no plans to build additional nuclear facilities. WHAT IS THE ATTITUDE OF THE STOCK MARKET ABOUT UTILITIES WITH NUCLEAR PLANTS UNDER CONSTRUCTION Ms. KELLEY. Most of the 58 utilities in this category are in weakened financial condition because construction projects have been delayed or prolonged by chaotic financial conditions, significant changes in demand for power, Federal and State conflicts, and the unwillingness of regulatory agencies to adjust rates. We should emphasize that the investment community, as we will discuss later, differentiates between utilities that seem to be able to manage their nuclear and regulatory efforts with a fair degree of success and those that seem to have difficulties. We believe that investors are concerned primarily about the timing of completions, cost overruns that could compound the problem of earnings dilution from financing, and the recovery of costs if a plant is not completed. We will discuss investors' attitudes about initiation of nuclear power projects later in this testimony. MERRILL LYNCH'S INVESTMENT ASSESSMENT Merrill Lynch's investment assessment is favorable for most utility companies with nuclear powerplants that are up and running. Our analysis has shown that utilities with operating nuclear plants and with no other nuclear plants planned have substantially higher fundamental quality than others and that their shares are favorably evaluated by investors. Such utilities are noteworthy and must be pointed out to investors seeking a company of high quality and with favorable prospects for earnings and dividend growth. For the common stocks of utilities in this group, nuclear power has contributed to, but is not the only element that accounts for, the relatively good value that they offer. What of the 58 utilities currently constructing nuclear powerplants? That group has clearly borne the brunt of the difficulties related to nuclear power. We do not, however, automatically dismiss them from an investment standpoint. In addition to the powerful influence that a State's regulatory climate exercises on utilities that are constructing nuclear plants, Federal regulatory attitudes can hurt or help companies in the group. We consider the stated policies of the current administration to be helpful to the industry, but not a panacea. We do point out to investors where they can place funds to possible advantage and where they may want to avoid placing funds in line with their various investment objectives. EXPECTED CHANGES IN INVESTMENT PROSPECTS RESULTING FROM ADMINISTRATION'S POSITION Current uncertainties confronting the nuclear power industry make it more attractive for investors to place funds in utilities that are winding down rather than starting up nuclear projects. In our opinion, policies that are being initiated at the Federal level, and that could possibly remove some uncertainties that investors have, hold promise for a particular group of utilities. We have defined that group as utilities having nuclear projects that are approximately 80 percent or more complete. We have assumed that those plants could be completed and in service to rate payers within the term of the current administration. We believe that investors can feel with more confidence than ever that funds invested in those utilities will be used to form an asset with eventual completion and start-up closely matching management's plans. Most of the utilities owning such units have been severely battered financially, but light has appeared at the end of the tunnels. For that and other reasons, we have been recommending shares of several such companies to our clients. CANCELLATIONS Another significantly smaller group of utility companies could actually benefit from cancelling construction of nuclear plants, if construction is less than 20-percent complete and if the company can identify alternative means of meeting projected demand for power. In anticipation of such cancellations, we point out the shares of those companies to those investors. We are aware of yet another group of companies that may opt to cancel nuclear projects, but that have no long-term alternative source of power. The long-term outlook for those companies remains unclear, because many would-be alternatives may be costly and may render no net gain from canceling nuclear plants. Such utilities owe much of their plight to regulatory policies of years gone by. Fulfilling their needs for power, whatever the method, will still mean sizable capital expenditures, and that promises to be burdensome. OTHER CATEGORIES Finally, there are utilities that fit none of our categories. Many are in the middle of plant-construction phases and are receiving little in regulatory guidance or support and even less in monetary rate relief. We apply a case-by-case appraisal to each. It is important to realize that State regulation has the potential to resolve these situations for better or for worse long before a Federal position can be translated into concrete help. WOULD INVESTORS SUPPORT THE INITIATION OF A NUCLEAR POWER PROJECT AT THIS TIME? Mr. HYMAN. When market conditions are difficult, a utility is occasionally unable to sell its securities. Such utilities have low credit ratings. In general, however, the market will make funds available at a price that is in accord with investors' perceptions of the risk. Investors do not decide whether to build or not to build a nuclear powerplant. They simply indicate at what price the money is available and let the managements and regulators decide whether the investment is worth making at that cost of money. SUMMARY In our opinion, the market requires and is getting a moderately higher return from investments in utilities that are constructing nuclear powerplants because of the additional risk being incurred. Utilities that are operating nuclear plants probably suffer little from their nuclear involvement. As for utilities starting nuclear projects, we suspect that the cost of capital would rise to a point at which the project would become questionable, at least under present circumstances. In other words, we doubt that large power stations of any kind would be greeted enthusiastically by investors unless the investors are offered exceptionally high returns in face of the uncertainties about governmental action, regulatory response, and levels of demand. Could investors change their attitudes and accept lower returns? Indeed they could, if the risks were reduced by substantially shortened leadtimes, prompt regulatory response to current financial conditions, and consistent Federal policies. We want to thank the committee for this opportunity to share our views on the investment climate. We will be happy to answer any questions that you may have. Mr. MARKEY. Thank you very much. I appreciate the patience you have shown in sitting through this earlier testimony. Ultimately it will be Wall Street which decides what happens with nuclear power. All the demonstrators in the world won't have one millionth of the impact as a few people sitting in a room on Wall Street deciding whether or not it is a good investment. I think one of the interesting statements in your testimony is that some utility companies could actually benefit from canceling construction of nuclear plants, if construction is less than 20-percent complete, and if the company can identify alternative means of meeting projected demands for power. In anticipation of such cancellation you point out the shares of these companies to investors. Now that is quite a bombshell-that a company could actually make out better in canceling a nuclear plant despite all the hundreds of millions of dollars that it might have had invested up to that 20-percent construction point. Could you comment on that? Ms. KELLEY. Most of what investors are doing as they evaluate a stock is futuristic. Those hundreds or so of million dollars that have been sunk in a project up to some point have been taken into consideration in the market. So now what the market has to do is appropriately value those stocks for future prospects. If it turns out that they have found out early that perhaps they may not need that particular unit and have found out at a stage in which the plant is only 20 percent or less complete, they could indeed cancel, assuming appropriate cost recovery, and actually realize a benefit in terms of what the future prospects are for a utility stock's outlook. Mr. HYMAN. That may be a benefit to the consumer, too, but that obviously depends on the circumstance. Ms. KELLEY. You have to have an alternative means of power production or determine that the demand is no longer there. Mr. MARKEY. You also say for utilities starting nuclear projects that you suspect that the cost of capital would rise to a point at which the project would become questionable, at least under present circumstances. I would like for you to expand on that in light of the statement that you make on page 29 of your full testimony regarding nuclear powerplants currently under construction, Securities associated with a newly announced nuclear project would most likely be valued at the lower priced, but high-yielding end of the market's valuation ranking. Before that yield could gain investor attention, however, it would have to be high enough so that no other investment vehicle could match it. Such a high yield level would suggest that the securities' prices have been lowered substantially. Once the yield reaches such heights the market produces investors who can no longer ignore it and are therefore willing to commit funds and purchase the securities. If this happens, the market has said yes to the original question; and funds have been supplied. But the high cost of those funds is an indirect no. What the investment community gives us is a tie vote and the tie breaker must come from another arena. The capital formation markets have made the funds available, but at higher than planned cost levels which may alter the attractiveness of the original plans for use. Rarely are there instances in which no funds are available to the utility other than during times of sustained market turmoil. The investors set the cost of the capital invested in the project, after taking into account the risks involved. The managements and regulators then must decide if the project is economical based on those costs of capital as well as other considerations. Now, I would just like you to answer that question bearing in mind the following statement by Louis Pearl, from the National Economic Research Associates, who has testified extensively in public hearings that while he is not yet convinced that coal is more economic than nuclear from the point of view of northeastern ratepayers, "If I were a utility executive today, either with a nuclear plant or a short distance underway with one that I hadn't yet started building, I would get out of it and I would never build another because I think the risks to the stockholders are just intolerable." Comment. Mr. HYMAN. I think what we have attempted to do in the longer section is to try to give you an idea of the process by which a decision would be made. Basically, what we were saying is, when the company is looking at the question of whether to go forward or not to go forward, at that point all of these various decisions have to be made. The company has to find out what the cost of capital is and put together all costs. When the utility finally looks at what the cost of capital is, it may very well decide that it is simply not worth going forward. That may very well be the case. Mr. MARKEY. If you were advising someone and they had a coalfired plant that was going to cost relatively the same amount as a nuclear-fired plant, but the coal-fired plant could be constructed in 88-213 0-82-6 |