Michael Gorman’s Responses to Mr. Aaron Engen
1. Références : (i) ACIG-7, Document 1, Written evidence of Michael Gorman for IGUA, page
2, lignes 26-31 (ii) ACIG-7, Document 1, Written evidence of Michael Gorman for IGUA, de la
page 5, ligne 25 à la page 6, ligne 3 (iii) ACIG-7, Document 1, Written evidence of Michael
Gorman for IGUA, de la page 7, ligne 25 à la page 6, ligne 3
Préambule : Mr. Gorman refers to security analyst reports assessing utility financial risks
primarily by its book value.
Demandes : 1.1 Please provide copies of all referenced analyst research reports which assess
utility company financial risks.
Response 1.1
Please see Carpenter Attachment 2.1c, which includes the Value Line reports for the U.S.
LDCs. Also, please see the following reports that include book value financial ratio data:
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DBRS Report, Gaz Métro, Enbridge, 2009.04.05, Gaz Métro-7, Document 9.
Credit Analysis – Scotia Capital, 2009.05.04, Gaz Métro-7, Document 11.
S&P RatingsDirect, Gaz Métro, April 6, 2009, Gaz Métro-7, Document 10.
Scotia Capital Equity Research, Gaz Métro-7, Document 7.
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1.2 Please indicate where in such research reports the equity research reports analyze utility
company financial risks rather than merely providing debt to total capitalization ratios.
Response 1.2
The research reports are providing relevant information to investors to make informed
investment decisions. The existence of data included on these reports is evidence of
information used by investors to assess investment risk and investment outlooks. Because the
book value capital structure information is included on the reports, and market value capital
structure weights are not, it is evident that equity analysts and investors primarily rely on book
value capital structure weights to assess the investment risk and investment outlooks of an
investment.
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1.3 Please confirm that equity research analysts use financial metrics such as P/E, dividend
yield, EV/EBITDA and DCF to determine utility target share prices.
Response 1.3
Mr. Gorman confirms that the price-to-earnings (P/E) ratio, dividend yield, and equity value per
earnings before interest tax depreciation and amortization (EV/EBITDA), and discounted cash
flow (DCF) studies are used to assess utility share price valuation. The primary reliance on this
information includes data taken directly from the audited financial statements and books and
records of the utility including book debt obligations, book debt interest obligations, and earnings
and cash flow that support equity investments after all debt obligations have been satisfied.
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1.4 Please confirm that all such financial metrics include some market-based element, namely,
P/E (share price); dividend yield (share price), EV/EBIDTA (equity market capitalization and
debt capitalization); and DCF (cost of capital).
Response 1.4
The referenced financial ratios include both data from audited financial statements and book
value balance sheet data, as well as share market value data. For example, the earnings
component and dividend paying ability of the utility are based on the earnings strength of the
utility after all book debt obligations have been satisfied. The earnings before interest
depreciation taxes and amortization is also a book value factor that reflects the actual pre-tax
cash flow as recorded on the enterprise’s financial statements. DCF numbers are typically
based on market value yields, and expected growth in earnings/dividends. The enterprise’s
ability to produce earnings/dividends and growth to earnings/dividends is based on the actual
book financial results of the enterprise.
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2. Référence : ACIG-7, Document 1, Written evidence of Michael Gorman for IGUA, de la page
7, ligne 25 à la page 6, ligne 3
Préambule : Mr. Gorman refers to a CIBC equity research analyst report referred to by Mr.
Engen. Because Mr. Gorman does not identify which CIBC research report Mr. Engen included
in his “work papers” (presumably a reference to Mr. Engen‟s written evidence) it is assumed
that the reference is to the August 19, 1995 CIBC research report published by Matthew Akman
entitled “Kinder Just „Trusted‟ Terasen: Who‟s Next?” a copy of which Mr. Engen provided as
Schedule E in his response to Dr. Booth‟s question 9.8.
Demandes : 2.1 Please confirm that the referenced report does not specify whether the debt to
cap ratios described on page 13 of the report are based on the market or book value of the
subject companies‟ debt and equity.
Response 2.1
The CIBC reports referenced by Mr. Gorman were attached to Mr. Engen’s testimony.
Specifically, the company reports include: Enbridge, Inc. from January 19, 2004 (page 194) and
December 17, 2008 (page 123). In CIBC’s review of Enbridge, it clearly identifies the book
value long-term debt amount, preferred stock amount, and common equity amount. The CIBC
report in individual company reports does specifically reference book value capital structure
data. In the referenced CIBC World Market report referenced in the question, Mr. Gorman
agrees that that “industry” assessment did not provide book value capital structure data for
individual companies. However, Macquarie Research Equities does include book value debt
ratio data for Canadian utilities at 172. Further, the Equity Research report on Gaz Métro by
“Daily Edge,” lists the debt to total capital ratios in the data table, Gaz Métro-7, Document 11,
Annexe 2 (8 pages) at 1.
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2.2 Please confirm that in the report Mr. Akman does not provide any analysis (other than a
calculation of each company‟ s debt to cap ratio) of the financial risk of those companies listed
on page 13 of the report.
Response 2.2
Confirm, but the data is provided to investors to make such an assessment based on book
value capital structure data.
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3. Référence : ACIG-7, Document 1, Written evidence of Michael Gorman for IGUA, de la page
10, ligne1 à la page 11, ligne 3
Préambule : Mr. Gorman refers to S&P‟ s use of utility company book values.
Demande : 3.1 Please confirm that S&P does not use capital structure calculations to
determine the referenced companies‟ capital structures.
Response 3.1
Mr. Gorman does not concur with the assertion. Indeed, S&P does rely on development of
capital structure weights, adjusted for off-balance sheet obligations, to determine financial ratios
in developing its criteria for evaluating utilities’ credit standings. S&P publishes guidelines for
total debt to total capital structure adjusted for off-balance sheet obligations as part of this credit
rating review. The primary source of information for the components of the total debt ratio, or
total capital structure, is derived from the audited financial statements of the utility. Please see
Mr. Gorman’s evidence at 11, for more detail.
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4. Référence : ACIG-7, Document 1, Written evidence of Michael Gorman for IGUA, page 43,
lignes19-13
Préambule : Mr. Gorman discusses Canadian and U.S. utility stock price valuations, earnings
and dividends. Specifically, he states: « The combination of strong stock price valuation and strong
earnings support of dividends indicates that investors in Canadian equity securities have been fairly
compensated and the compensation is comparable to those of U.S. Gas LDCs. These stock valuation
factors are largely impacted by the authorized rates of return approved in regulatory proceedings. »
Demandes : 4.1 Please provide the data and analysis Mr. Gorman undertook to support his
assertion that Canadian utilities enjoy “strong stock price valuation.”
Response 4.1
The assessment of the utility stock price performance is provided in Mr. Gorman’s evidence at
28-30.
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4.2 Please provide the data and analysis Mr. Gorman undertook to support his assertion that
Canadian utilities have “strong earnings support of dividends.”
Response 4.2
Supporting documentation for this conclusion is provided in Mr. Gorman’s evidence at 29 and
on Exhibit MPG-4.
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4.3 Please confirm that falling formula-determined ROEs reduce utility company regulated asset
earnings and, hence, would provide less dividend support.
Response 4.3
When the return on equity is adjusted to reduce capital market cost, utilities can and likely will
adjust their dividend payment policy to reflect that long-term earnings outlook. Typically,
management attempts to pay out a certain percentage of its earnings as dividends. As the
capital market declines, the dividend cost in relationship to book value will, over time, decline in
accordance with sustainable earnings outlooks. As such, it is not correct to conclude that
dividend payments will not adjust to changed authorized returns on equity which follow changes
to market capital costs. On a shorter term basis, as authorized returns on equity decline, there
is a higher percentage of earnings paid out to support current dividend payments. However,
this higher payout would normally be corrected over time if earning levels and capital market
cost will be lower over time.
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4.4 Please provide the data and analysis Mr. Gorman undertook regarding stock price
valuations for U.S. gas LDCs.
Response 4.4
Please see response 2.1. Specifically, see Carpenter Attachment 2.1a, which includes the
electronic format of Exhibit MPG-3 with all formulas intact. Also, please refer to Carpenter
Attachment 2.1c, which includes the supporting workpapers from Value Line and Thomson
Financial.
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4.5 Please provide the data and analysis Mr. Gorman undertook regarding U.S. utility earnings
support of dividends.
Response 4.5
Please see response 2.1. Specifically, see Carpenter Attachment 2.1a, which includes the
electronic format of Exhibit MPG-4, and Carpenter Attachment 2.1b, which includes the
electronic format of Exhibit MPG-6. Also, please refer to Carpenter Attachment 2.1c, which
includes the supporting workpapers from Value Line and Thomson Financial, and Carpenter
Attachment 2.1d, which includes the Blue Chip Economic Indicators as of March 10, 2009.
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4.6 Please provide the comparative analysis Mr. Gorman relied upon when concluded that
Canadian utility shareholder compensation arising from “strong price” valuations and “strong
earnings support of dividends” is comparable to those of U.S. gas local distribution companies.
Response 4.6
Mr. Gorman’s assessment and supporting data are described at pages 26-31 of his direct
evidence, and described on his Exhibit MPG-3 and Exhibit MPG-4.
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4.7 Please indicate what proportion of the referenced utility company earnings are based on
“authorized rates of return.”
Response 4.7
The referenced information is derived from actual earnings, and earning outlooks. Authorized
rates of return are used to set utility prices, which are highly influential in determining the level of
the company’s actual earnings, and earnings outlooks. Hence, authorized rates of return in the
overall development of rates impact actual earnings, which are reflected in the financial metrics
discussed by Mr. Gorman.
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4.8 Please indicate on what market evidence Dr. Gorman relies upon in concluding that stock
valuation factors are largely impacted by “authorized rates of return.”
Response 4.8
Please see response to 4.7.
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