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Tarnished Reputations, Shining Stars

Summary / Outlook

RRC’s ongoing statistical and fundamental analysis of a sampling of the major electric power companies in the United States, coupled with in-depth studies of the perceptions of senior industry executives and analysts in 2002 and 2004, shows a moderate decline in reputation strength over the two-year period.

In the wake of adverse events including high-profile restatements and the Blackout of 2003, the industry’s average Reputation Strength Rating declined to mid-BBB, down from a high-BBB level in early 2002. The industry’s overall reputation strength remains below that of both the US pharmaceutical and the US banking industry. In that environment, RRC lowered Reputation Strength Ratings of seven companies in June 2004, while ratings on four “shining stars” were upgraded, thanks mainly to their better positioning in three increasingly important dimensions of marketing effectiveness, corporate culture and ethics, and financial stability.

As in 2002, RRC’s Reputation Strength Model shows that those three dimensions continue to be the strongest predictors of reputation strength. New for 2004 is the finding that a perception of management leadership has become an important driver of reputation.

Based on an assessment of both reputation strength and familiarity among key constituencies, six electric power producers stand out as having the best outlook for building or maintaining a position of leadership in the industry: The Southern Company, FPL Group, Inc., Calpine Corp., American Electric Power, Inc., Duke Energy Corporation, and TXU Corporation.

Methodology – Brief Overview

Reputation strength can roughly be defined as the collective perceptions and opinions of key industry constituencies that can be a powerful weapon in achieving competitive goals in good times and that can make or break a company in times of controversy.

To measure those perceptions, RRC conducts in-depth surveys of industry insiders, including senior executives and analysts who follow the industry. RRC has found that these key constituencies are among the most likely to be current on industry trends and events, while having good insight into the impact of those developments on individual companies. Among these key groups, company reputations are hard-earned and their perceptions of the companies’ standings are not likely to be influenced by public relations campaigns or discrete events.

Earlier this year, RRC polled a total of 350 such executives and analysts to determine how the 18 companies surveyed stack up against each other and to see how their reputations have changed over the last two years. In analyzing survey results, the responses of executives and analysts are considered both separately and as composite scores. Where there is consistency between the views of both groups, we have greater confidence that the overall scoring provides a clear measure of a company’s reputation; where there is inconsistency, it is necessary to dig deeper into the reasons for that difference of opinion and incorporate those risks into the final rating.

For a more detailed discussion of RRC’s Reputation Strength Rating methodology, please contact Dory Gasorek, Rating Committee Chair (908-432-0800).

Electric Power Industry Reputation Strength Takes a Hit

Overall, reputation strength in the US public power industry has remained at the medium-quality BBB level; but it has shown clear signs of deterioration, as RRC’s average rating for the industry fell to the mid-BBB range, down from high-BBB in 2002.

This is not surprising, given the many adverse events and challenges that have beset the industry over the last two years, including the blackout of 2003 that affected 50 million people and media headlines of investigations into manipulative energy trading practices, as well as the general skepticism that has beset corporate America broadly following the collapse of Enron and subsequent corporate scandals. Though many industry commentators have maintained that the industry’s overall reputation has remained stable even in these turbulent times, RRC polls of key industry executives and financial analysts show otherwise.

A key element in RRC’s methodology centers on questioning designed to measure the degree to which respondents in both groups would be willing to put money into each company studied and support it in times of controversy, and the degree to which they believe that the firm is an “excellent company.” As shown in the chart below, our research shows significant declines in each of RRC’s measures of reputation strength, looking at composite results including the opinions of both executives and analysts. The percentages in that chart refer to the percentage of respondents that would be strongly willing to invest in or support a particular company or that strongly believe that it is an excellent company. On average, the industry’s scoring in these areas fell by eight-to-11 percentage points between 2002 and early 2004.

Electric Power Industry Reputation Strength in Context

Another key element in RRC’s methodology is to ask and assess the answers to questions designed to get at the key drivers of reputation strength. These remain generally standard over time to facilitate time-series comparisons, but they also change marginally to tap important new elements of reputation strength as the industry evolves and faces new challenges.

This year’s survey asked about 40 questions designed to assess areas such as whether respondents believe the company offers innovative products and services, adheres to ethical business practices, is well positioned for the future, is led by highly talented management, and so on. The answers to these questions are then analyzed statistically using RRC’s proprietary Reputation Strength Model to determine which clusters of reputation components are the strongest drivers of reputation strength.

The resulting component scores are then employed to create a composite score that can be used to rank each company within the industry and for comparisons between industries. This score is one key statistic evaluated in the rating process. The chart below shows the average Reputation Strength Score (RSS) for three US industries studied in recent years, providing a strong indication that the public power industry has a significantly lower reputation strength than that of major firms in the pharmaceutical industry and the banking sector. The Reputation Strength Scores of Electric Power companies in both 2002 and 2004 are for the 17 companies that held RRC ratings during each survey.

Reputation strength in each of the three industries as been challenged by the increased public scrutiny of corporate behavior in the post-Enron environment. The utility industry continues to face the added challenge of having grown up in a regulated environment where financial stability was the main driver of reputation. In the new deregulated and more challenging environment, key industry constituencies place greater emphasis on drivers including competitive marketing, corporate culture and ethical behavior, and CEO leadership.

All Eyes on the CEO: Corporate Leadership Takes on New Importance

In analyzing the key drivers for 2004, a new picture of reputation strength appeared. As shown in the table, marketing effectiveness, corporate culture and ethics, and the old standard, financial stability, continued to show up as the top three drivers of public power companies’ reputations. But as the perceptions of reputation have changed among key constituencies, there has been a remarkable shift in the importance of leadership and all of the other drivers that rank below the top three.

The relative importance of the new reputation drivers for 2004 can best be understood in the context of all important dimensions resulting from this year’s study. These can be generally defined as follows:

• Marketing Effectiveness— A company that is strong in this driver is perceived as offering innovative products and services, having a positive impact on its community, and successfully differentiating itself from competitors. The increasing importance of perceptions relating to marketing helps to explain why companies like Southern and FPL group did well in this year’s study. Both are recognized as strong performers in this dimension, which has become increasingly important in a deregulating industry. This year, Southern Company, FPL Group, and Calpine top the list on this dimension; First Energy and CMS Energy ranked at the bottom of the list.

• Organizational Culture/Ethics— Companies that rank highly in this important dimension are recognized has having a culture that promotes both ethical behavior, trustworthiness, and openness and honesty. Those ranking highly in this dimension are also seen as customer-focused companies with loyal customer bases and support on environmental issues. Though seemingly unrelated, these two areas of reputation strength were highly correlated in the minds of both industry executives and analysts in both studies. This dimension is very important in dealing with external constituencies, such as regulators and customers. Progress Energy and Dominion Resources ranked highest in this dimension; again, CMS Energy and First Energy ranked at the bottom of the list.

• Financial Stability— Companies that rank highly here are perceived as leaders in the industry, well positioned for the future and to weather industry downturns. Not surprisingly, Southern Company, FPL Group, and American Electric Power ranked in the top three positions in this important dimension.

• Leadership— Companies in this new dimension of reputation strength for 2004 are recognized as being led by talented management that can lead the company to adapt quickly to changing market conditions, an obvious feature of today’s turbulent industry environment. They are also seen as companies that are able to deliver on the key dimension of marketing effectiveness and companies that communicate effectively with their markets (including financial markets). Southern Company, FPL Group, and Calpine score highly in this dimension. CMS Energy, First Energy, and PG&E hold the lowest three rankings in this increasingly important dimension of reputation.

• Social Responsibility— This dimension measures a company’s commitment to charitable causes and solid employee relations.

• Regulation — This dimension focuses on measuring the degree to which companies have a positive relationship with regulatory bodies.

• Partnerships— This dimension assesses a company’s dedication to developing strong relationships with third parties, be they business alliances or vendor relations.

• Competitive Pricing— Among other things, companies scoring well on this dimension offer their customers energy at competitive prices.

Data on company performance in each of these dimensions is available to RRC clients in spreadsheet form accompanied by written analysis. It is designed to provide users with an in-depth assessment of the factors underpinning trends in each rated company’s reputation strength.

At the same time, the data provide benchmark assessments that managements can utilize to assess where their firm stands now and which are the most actionable drivers that they can emphasize to improve their standing in the future. In the context of an in-depth fundamental analysis of each company, the scoring also provides a basis for our ongoing Reputation Strength Ratings on each company, as well as changes to those ratings over time.

Weakening Reputations and Shining Stars

Looking specifically at each rated company, there was a dramatic shift in both Reputation Strength Scores and in Reputation Ratings in 2004 compared with those in 2002. This year’s Reputation Strength Scores stretched Southern Company at the top of the list, with an overall score of 59, to CMS Energy ranked at the bottom of the group, with a score of 21.

Given the challenging industry environment over the last two years, it is not surprising that a number of companies—notably Duke Energy, TXU, and Exelon—saw significant declines over the period. What is surprising, however, is that four firms—FPL Group, Dominion Resources, PPL, and PG&E—were able to buck turbulent industry conditions to receive much higher overall reputation scoring.

RRC ratings are by no means based solely on companies’ overall Reputation Strength Scores. Rating committees are convened for each company, and analytic judgment and fundamental analysis always play a critical role in each ongoing rating assessment. The result of that process has led to seven rating downgrades, four upgrades, and six rating confirmations to date in 2004, as shown below. Calpine Corp. received its initial RRC Reputation Strength Rating this year.

RRC Reputation Strength Ratings on US Electric Power Companies
June 9, 2004

Company-by-Company Analysis

Southern Company -- Confirmed at AA
Southern again achieved a strong vote of confidence from executives. Its consistent results across each reputation dimension earned Southern the top spot in RRC’s Reputation Strength Scores for electric utilities this year. The company showed solid improvement on certain component scores that were weak in the prior study, especially in the areas of ethics and environmental support. The views of the financial analyst community are slightly less favorable than those of executives and lower than the previous results. Interestingly, this constituency holds views contrary to executives on the topics of ethics and the environment, suggesting an area of weakness.

Calpine – New rating of BBB
Calpine scored well across answers to most component questions by industry executives; and it has earned a solid reputation strength score in 2004, the first time Calpine has been included in an RRC study. The company shows much weaker results on the financial stability dimension, however. This finding is consistent with the company’s aggressive expansion program and high debt levels. Over the near term, Calpine risks a major change in reputation strength from a potential shock resulting from disappointing financial results. Financial analysts score the company in the middle-of-the-pack in most areas, but much more negatively than do executives on ethical and regulatory issues, suggesting another hurdle.

Progress Energy – Confirmed at A
Progress Energy again earned solid results from industry executives and achieved the top position on ethical behavior out of the 18 companies in this year’s study. Additionally, executives said they would be much more willing to invest in and support the company than they were in the prior study. Financial analysts view Progress Energy as about average overall, with little change from earlier results. Analysts did, however, register a sharp drop in their perception of the company’s commitment to environmental issues, lowering it to below average from second-place.

Duke Energy – Downgraded to A from AA
Duke Energy’s reputation strength has deteriorated as viewed by both the executive and analyst groups in our 2004 survey, mainly as a result of the negative impact of investigations into its merchant trading operation and weaker financial results over the past two years. Both constituencies regard Duke as significantly weaker now in the areas of ethics and leadership. However, executives are more positive than analysts on their willingness to invest in and support the company in times of controversy. The company’s Reputation Strength Score remains high, at a respectable sixth-place among the companies surveyed this year; but that is down from Duke’s first-place ranking in 2002.

Edison International – Downgraded to BB from BBB
The reputation strength of Edison International declined in the eyes of executives this year, but improved in the eyes of financial analysts. The “halo” that seemed to exist in 2002 following Edison’s decision not to declare bankruptcy—as did its fellow California power company PG&E Corporation—seems now to have evaporated. That has had an especially negative effect on executives’ perceptions of the company, particularly in the areas of ethics and social responsibility. The financial community, on the other hand, recognizes Edison’s improved operating and financial performance since the depths of the California energy crisis, and scores the company higher on almost all components.

FPL Group – Upgraded to AA from A
FPL Group showed strong results from both executives and analysts across most areas, including leadership positions in four of the key reputation dimensions. Both groups are strong supporters of the company in times of controversy and are willing to invest in it. In particular, the quality of its management team and CEO leadership show exceptional strength as viewed by both stakeholder groups, up significantly from their assessments in the prior study. These results are consistent with FPL Group’s steady financial and operating performance in the high-growth state of Florida.

Dominion Resources – Upgraded to A from BBB
Dominion Resources earned strong results from both constituencies, but especially from industry executives. Many component scores moved from the bottom half of companies studied in 2002 to near the top this year. The company achieved superior results in two areas – ethics and investment. Financial analysts remain solidly in support of the company and rank it among the top two on many attributes. Dominion Resources received one note of weakness in its environmental support. Both groups surveyed rank it average or below average in that area of reputation strength.

American Electric Power – Confirmed at A
American Electric Power (AEP) showed generally consistent reputation strength among both survey groups between the two studies. The company scored well in the areas of financial strength and competitive pricing, but below average with regard to the integration of its system with other providers. The latter finding is consistent with the controversy surrounding AEP’s admission to PJM Interconnection, a regional transmission organization. Although the company recently took steps to be more environmentally friendly—notably by adopting a proposed shareholder resolution for environmental impact reporting ahead of its annual meeting—financial analysts moderated their views of AEP’s support for the environment to below average among the companies studied.

TXU – Downgraded to BBB from A
TXU’s reputation has suffered over the past two years as a result of financial and operational stress in its international subsidiaries and subsequent bankruptcy of its European business. Almost all component scores are lower from both survey groups. TXU’s scores in 2002 on treatment of employees and customer loyalty have now fallen below the industry average. The financial community viewed the company as mediocre in the prior study, then gave it even weaker scores this year. Ranking eighth in this year’s survey, TXU’s overall Reputation Strength Score remains high; but that ranking is down from a position as fourth-highest in 2002. The BBB rating reflects RRC’s assessment that new senior management is beginning to undertake changes that may salvage some of TXU’s historical strength.

Exelon – Downgraded to BBB from A
Exelon’s overall Reputation Strength Score for 2004 is comparable to its position in 2002, but the volatility of individual component results is troubling. Some improved dramatically, whereas many others decreased. The analyst community views Exelon moderately more favorably than do executives, giving it a particularly strong vote of confidence in the areas of management quality, leadership, and employee relations. Analysts lowered their views significantly, however, in the important areas of ethical behavior, trustworthiness, and regulatory relationships. This volatility, combined with poor results on three reputation dimensions, resulted in a decline in the rating from its weak A level in 2002.

Entergy – Confirmed at BBB
Entergy’s overall reputation strength is stable, although both groups surveyed applauded the company’s significant progress in two areas – ethics and financial stability. Entergy showed lower results on employee diversity and customer loyalty. Financial analysts view the company more favorably than do executives on most components, giving Entergy stellar rankings in the areas of corporate governance, financial transparency, and adaptability.

PPL – Upgrade to BBB from BB
PPL showed good improvement in reputation strength and consistency across most reputation dimensions. It scored solid results from executives in ethics and financial stability, moving to the middle-of-the-pack from the bottom-tier of companies in the 2002 study. Analysts viewed the company even more favorably on several components related to ethical behavior, as well as in its regulatory relations.

Public Service Enterprise Group – Downgrade to BB from BBB
The industry executives viewed the reputation strength of Public Service Enterprise Group (PSEG) as declining. Financial analysts viewed its reputation as generally stable; but the company scored significantly lower scores this year on several key components relating to ethical behavior, treatment of employees, and environmental consciousness. PSEG did score highly with executives in a few areas, such as safety, management quality, and regulation. This improvement may reflect, in part, organizational changes at the company’s Hope Creek and Salem nuclear facilities to address safety issues.

PG&E Corporation – Upgrade to BB from CCC
PG&E’s reputation has improved significantly from a low level following the company’s bankruptcy declaration in the wake of the California energy crisis. Both executives and financial analysts view the company more favorably this year across many component questions, although it is still below average among the companies studied. PG&E scores quite well on treatment of employees and offering high quality products and services. Analysts have somewhat stronger views of the company than do executives.

Xcel Energy – Downgraded to BB from A
Xcel Energy’s overall Reputation Strength Score suffered in this year’s study, with a dramatic double-digit point decline. Both industry executives and the financial analyst community score it weaker in almost all areas. The company’s wholly-owned subsidiary, NRG Energy, Inc., filed for bankruptcy last year, following a year of financial stress resulting from the California energy crisis. Xcel Energy is in process of repositioning its business and selling assets, but the impact of these actions on its corporate reputation is untested.

Consolidated Edison – Downgraded to BB from BBB
Consolidated Edison generated a significant decline in reputation strength as perceived by industry executives, but garnered somewhat better results from financial analysts. Any industry support that may have existed following September 11, 2001 seems to have eroded. The company scores weakly with executives on several questions that focused on its marketing and product pricing, as well as its charitable support and safety record. Con Ed does better on employee diversity, generating solid results consistent with the prior study. The financial community views the company as much improved in the areas of ethics and adaptability, giving it leading rankings in financial disclosure, ethical behavior and trustworthiness.

FirstEnergy – Confirmed at B
FirstEnergy’s reputation continues to suffer this year following its role at the center of the major blackout in August 2003. Industry executives continue to score the company at or near the bottom of the companies studied on most component questions. Financial analysts, too, have joined the executives in viewing the company as weak among its peers, a dramatic decline from the above-average scores FirstEnergy received from analysts in 2002.

CMS Energy – Confirmed at B
There is little good news in the reputation research for CMS Energy this year. This is likely a reflection of the ongoing restructuring of its business, which has yet to result in markedly improved financial performance. The company’s overall Reputation Strength Score dropped almost by half, to a weak 21. The company falls at or near the bottom out of the 18 companies studied on most component questions from both executives and financial analysts. It receives little backing from either group regarding the willingness of either to invest in it or support it in times of controversy. A couple of glimmers of hope can be found in the company’s very strong showing on its support for charitable causes and solid improvement in employee diversity.

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For more information on RRC’s Corporate Reputation Ratings contact Ashley Burleson.