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Indiana-American Water Company, Inc. Iurc Cause No

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Indiana-American Water Company, Inc. Iurc Cause No INDIANA-AMERICAN WATER COMPANY, INC. IURC CAUSE NO. 45142 DIRECT TESTIMONY OF ANN E. BULKLEY SPONSORING ATTACHMENTS AEB-1 THROUGH AEB-13 DIRECT TESTIMONY OF ANN E. BULKLEY CAUSE NO. 45142 1 I. BACKGROUND 2 Q. Please state your name, affiliation, and business address. 3 A. My name is Ann E. Bulkley. I am employed by Concentric Energy Advisors, Inc. 4 (“Concentric”) as a Senior Vice President. My business address is 293 Boston Post Road 5 West, Suite 500, Marlborough, Massachusetts 01752. 6 Q. On whose behalf are you submitting this testimony? 7 A. I am submitting this testimony on behalf of Indiana-American Water Company (“IAWC” 8 or the “Company”), a wholly-owned subsidiary of American Water Works Company Inc. 9 (“AWK”). 10 Q. Please describe your background and professional experience in the energy and 11 utility industries. 12 A. I hold a Bachelor’s degree in Economics and Finance from Simmons College and a 13 Master’s degree in Economics from Boston University, with more than 20 years of 14 experience consulting to the energy industry. I have advised numerous energy and utility 15 clients on a wide range of financial and economic issues with primary concentrations in 16 valuation and utility rate matters. Many of these assignments have included the 17 determination of the cost of capital for valuation and ratemaking purposes. My 18 qualifications and testimony listing are presented in more detail in Appendix A. Bulkley - 1 1 Q. Please describe Concentric’s activities in energy and utility engagements. 2 A. Concentric provides financial and economic advisory services to many and various 3 energy and utility clients across North America. Our regulatory, economic, and market 4 analysis services include utility ratemaking and regulatory advisory services; energy 5 market assessments; market entry and exit analysis; corporate and business unit strategy 6 development; demand forecasting; resource planning; and energy contract negotiations. 7 Our financial advisory activities include buy- and sell-side merger, acquisition, and 8 divestiture assignments; due diligence and valuation assignments; project and corporate 9 finance services; and transaction support services. In addition, we provide litigation 10 support services on a wide range of financial and economic issues on behalf of clients 11 throughout North America. 12 13 II. PURPOSE AND OVERVIEW OF TESTIMONY 14 Q. What is the purpose of your Direct Testimony? 15 A. The purpose of my Direct Testimony is to present evidence and provide a 16 recommendation regarding IAWC’s authorized return on equity (“ROE” or “cost of 17 equity”) and to assess the reasonableness of its proposed capital structure for ratemaking 18 purposes. I will also support IAWC’s fair value rate base. 19 Q. Please identify the attachments you will be sponsoring and for which you will be 20 providing testimony. 21 A. I am sponsoring the following attachments: Bulkley - 2 1 - Attachment AEB-1 (Constant Growth DCF Analysis) 2 - Attachment AEB-2 (Projected DCF Analysis) 3 - Attachment AEB-3 (Value Line ROE Projections) 4 - Attachment AEB-4 (Betas) 5 - Attachment AEB-5 (S&P 500 DCF) 6 - Attachment AEB-6 (CAPM Analysis including AWK) 7 - Attachment AEB-7 (CAPM Analysis excluding AWK) 8 - Attachment AEB-8 (CAPM Analysis excluding CTWS and SJW) 9 - Attachment AEB-9 (Capital Expenditure Analysis) 10 - Attachment AEB-10 (Regulatory Risk Analysis) 11 - Attachment AEB-11 (Capital Structure Analysis) 12 - Attachment AEB-12 (Fair Value Rate Base) 13 - Attachment AEB-13 (Rate of Return Summary) 14 15 Q. Were each of Attachments AEB-1 through AEB-13 prepared by you or under your 16 direction and supervision? 17 A. Yes. 18 Q. Please provide a brief overview of the analyses that led to your ROE 19 recommendation. 20 A. In developing my ROE recommendation, I applied the Constant Growth Discounted Cash 21 Flow (“DCF”) model and the Capital Asset Pricing Model (“CAPM”). In addition to Bulkley - 3 1 these analyses, I also considered the Value Line projected ROEs for the proxy group 2 companies, and a Constant Growth DCF analysis based on projected dividend yields and 3 share prices. My ROE recommendation also considers the following factors: (1) the risk 4 associated with IAWC’s capital expenditure program relative to the proxy group 5 companies; (2) the risk associated with variations in volume/demand and the resulting 6 effect on IAWC’s revenues and cash flows; and (3) the test year convention used to set 7 rates for IAWC. Although I did not make any specific adjustments to my ROE estimates 8 for the foregoing factors, I considered each of them when determining where the 9 Company’s ROE should fall within the range of analytical results. Finally, I compared 10 IAWC’s proposed capital structure to the actual capital structures of the proxy group 11 companies. 12 Q. Please summarize your analytical results. 13 A. My analytical results are summarized in Table 1. Bulkley - 4 1 Table 1: Summary of Cost of Equity Results Forward-Looking CAPM Results 2018-2019 2020-2024 Current Risk- Projected Risk- Projected Risk- Mean Free Rate Free Rate Free Rate Result (3.14%) (3.54%) (4.20%) Including AWK1 Bloomberg Beta 12.55% 12.65% 12.81% 12.67% Value Line Beta 12.20% 12.31% 12.50% 12.34% Excluding AWK2 Bloomberg Beta 12.61% 12.71% 12.87% 12.73% Value Line Beta 12.34% 12.44% 12.62% 12.47% Excluding CTWS and SJW3,4 Bloomberg Beta 13.43% 13.50% 13.62% 13.51% Value Line Beta 12.41% 12.52% 12.69% 12.54% 2 1 See Attachment AEB-6. 2 See Attachment AEB-7. 3 See Attachment AEB-8. 4 As discussed later in my testimony, SJW Group (SJW) and Connecticut Water Service, Inc. (CTWS) announced their merger in March 2018. I have conducted my analysis with and without them as a part of the proxy group. Bulkley - 5 1 Table 1: Summary of Cost of Equity Results (cont’d) Mean Low Mean Mean High Constant Growth DCF – 30 Day Average5 Including AWK 8.54% 9.38% 11.54% Excluding AWK 8.26% 9.15% 11.00% Excluding SJW and CTWS 8.97% 9.24% 11.39% Constant Growth DCF – Projected DCF Model 2021-20236 Mean Low Mean Mean High Including AWK 8.32% 9.95% 12.11% Excluding AWK 8.00% 9.72% 11.57% Excluding SJW and CTWS 8.37% 9.83% 12.00% Value Line Projected Equity Returns 2021-20237 Low Mean High Including AWK 10.50% 12.50% 14.00% Excluding AWK 11.00% 12.79% 14.00% Excluding SJW and CTWS 10.50% 12.50% 14.00% 2 3 As shown in Attachment AEB-1, the DCF model is producing individual company results 4 as low as 4.87 percent, or 30 basis points lower than IAWC’s embedded cost of long- 5 term debt of 5.17 percent for the test year ending April 30, 2020.8 This result is 6 inconsistent with the relative risk of owning common equity or debt instruments. 7 Because shareholders are the residual claimants on the firm’s earnings and assets, the 8 return to equity holders must be higher than the return to bond holders. As discussed in 9 more detail in Section IV of my Direct Testimony, I applied a minimum threshold to the 10 DCF results of 7.00 percent, which results in an equity risk premium of 183 basis points 5 See Attachment AEB-1. 6 See Attachment AEB-2. 7 Source: Value Line Investment Survey, Water Utilities, April 13, 2018. 8 Source: Company provided data. Bulkley - 6 1 above IAWC’s current cost of long-term debt.9 The results summarized in Table 1 reflect 2 this lower bound. 3 As discussed in more detail in Section IV of my Direct Testimony, there are concerns 4 among investors and regulators that the DCF model is not producing reasonable results at 5 this time due to anomalous conditions in capital markets. My ROE recommendation also 6 considers the results of a forward-looking CAPM analysis and the projected ROEs for the 7 water utilities in the proxy group, as published by Value Line. In addition, I consider 8 company-specific risk factors and current and prospective capital market conditions. 9 Q. What is your conclusion regarding the appropriate authorized ROE for IAWC in 10 this proceeding? 11 A. A reasonable range of ROE estimates for IAWC is from 10.00 percent to 10.80 percent. 12 Considering the business and financial risk factors facing IAWC, I believe that an ROE 13 of 10.80 percent is reasonable and appropriate. The required ROE should be a forward- 14 looking estimate; therefore, the analyses supporting my recommendation rely on forward- 15 looking inputs and assumptions (e.g., projected analyst growth rates in the DCF model, 16 forecasted risk-free rate and Market Risk Premium in the CAPM analysis, etc.). I also 17 take into consideration capital market conditions, including the effect of the current low 18 interest rate environment on utility stock valuations and dividend yields, and the market’s 19 expectation for higher interest rates. 9 The lower bound is based on a recent position established by the Minnesota Department of Commerce in Docket No. E017/GR-15-1033, In the Matter of the Application of Otter Tail Power Company for Authority to Increase Rates for Electric Service in the State of Minnesota (August 16, 2016), at 11. Bulkley - 7 1 Q. How is the remainder of your Direct Testimony organized? 2 A. The remainder of my Direct Testimony is organized in seven sections. Section III 3 reviews the regulatory guidelines pertinent to the development of the cost of capital.
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