Finance investment due 7 hrs from now

CFA Institute Research Challenge Hosted in

Spokane, Washington

Eastern Washington University Daniel Goodman, Danielle Good, Leah Robinson, and Sandra Jeffries

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Eastern Washington University Student Research

This report is published for educational purposes only by students competing in The CFA Institute Research Challenge

Electric & Gas Utilities, Utilities Industry

New York Stock Exchange (NYSE)

Avista Corp

Date: 1/9/2014 Ticker: AVA

Current Price: $35.48 Dividend Yield: 3.6%

Recommendation: SELL Target Price: $25.11

Investment Highlights We have a sell recommendation of the stock, based on target price of $25.11.

 Stock is not attractive with a low historical ROE.  Stock is inflated due to zero-interest rate environment and the temporary increase in demand from

investors seeking higher yielding securities.  Heightened operational risk due to recent acquisition of a company in new geographic area.  The current winter season has had low precipitation (low snowfall), which may impact 2015 hydro-

electricity generation.

Avista Stock Information Price (1/9/15 Closing Date) $35.48 52-Week Price Range $27.99 - $37.37 Beta (β) 0.83 Dividend 1.27 (3.70%) Dividend Payout Ratio 40% Book Value Per Share 23.75 ROE (ttm) 9.08 % P/E (ttm) 11.29 EPS (ttm) 3.13 Sustainable Growth Rate 3.99%*

Source: Yahoo! Finance, Team Calculation*

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Avista's Monthly Closing Stock Price for the Last 5 Years (2009-2014)

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Business Description Avista Corp (AVA) is a producer and distributor of electric and natural gas energy services to residential and commercial customers located in eastern Washington, northern Idaho, portions of Oregon, and portions of Alaska. Originally founded as The Washington Water Power Company, Avista established its roots in the Inland Northwest in 1889. The company’s innovative business practices led to the development of the first Spokane River hydroelectric generator and state-of-the-art wind turbines on the Palouse Hills of eastern Washington. Avista takes pride in its commitment to philanthropic practices that enrich the communities in which the company conducts business in. Avista consists of two business segments, Avista Utilities and the recently acquired Alaska Energy & Resources Company (AEL&P). Avista Utilities regulates the electric and natural gas operations of the business, including the generation, transmission, and distribution of electricity and natural gas, and also facilitates the wholesale purchases and sales of electricity and natural gas. The customers served by this segment include residents, businesses, and communities, consisting of approximately 1.5 million people in a 30,000-square-mile area of eastern Washington, northern Idaho, and Oregon. AEL&P was acquired on July 1, 2014, just shortly after the disposition of a former segment, ECOVA, and is the provider of retail electric service in the city and borough of Juneau, Alaska. The subsidiary of AEL&P, Alaska Electric Light & Power Company, was founded in 1893 and is the oldest regulated electric utility in the state of Alaska.

Industry Overview The diversified utilities industry focuses on the distribution and transmission of electricity, natural gas, and water to businesses and consumers. The industry has numerous participant companies with their own target markets. These regional markets are subject to a local approval process mandated by the state(s) in which they reside. Due to regulation and high start-up costs, most of these companies are monopolies or duopolies sanctioned by the government. As a result, the government often determines the prices that these utility companies can charge for their services. Federal, state, and local government agencies work to ensure that these utility monopolies are providing their customers with a rational service level at a sensible price. In order to raise prices, public utility companies must file a rate case, which is a lengthy process of appealing to the public utilities commission, usually filed per annum. There is a wholesale side to the diversified utilities industry that comes into play when a power company generates electricity that they do not deliver to the end- user. The energy generated by these companies is often bought and resold several times before it is delivered to the final consumer and the transactions that unfold through this process make-up the wholesale market. Many of the sales take place across multiple states and are regulated federally. The wholesale market is useful to companies, such as Avista, at times when the amount of electricity that they can generate does not keep up with the demand of their customers. Using the wholesale market to fill this demand negatively impacts revenue potential because the cost of generating their own electricity is cheaper than the cost of acquiring it from somewhere else; therefore, Avista must absorb

2.20%

3.33%

25.29%

Avista's Market Cap. Compared to Competition

Avista (AVA) IdaCorp (IDA) PG&E Corp. (PCG)

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that cost because they are not able to raise the prices of their customers without filing a rate case. The diversified utilities industry typically offers a high dividend yield and is stable with low risk due to the universal demand for its product.

Industry Analysis Porter’s Five-Force Analysis 1. Industry Competition (rivalry) The rivalry amongst utility companies is increasing as they fight to attain the market share that is necessary to create the economies of scale needed to bring down costs. Due to the nearly universal use of utilities, the main option for competitors is to lower their prices, which in turn dives the profitability of the industry down. Some competitors are trying to segment the market by offering bundled services to increase value to their customers; however, it is assumed that the electricity market will work against these attempts and eventually neutralize them. 2. Threat of Substitute Products Power is a necessity and there is no substitute for it. The modern world depends on it, therefore, even if the prices were to increase rapidly, the consumption rate would remain nearly the same, at least in the short-run. There is no substitute for power, but there are substitute methods for generating power, so in the long-run if prices were to remain high, consumers would look for other ways to fill their electrical needs. The use of small generators, micro-turbines, solar power, and fuel cells are a few examples of nontraditional options for the generation of electricity that could pave the way for users to bypass the current energy grids all together, or at least to greatly diminish their use. 3. Threat of New Entrants The threat of new companies emerging into the utilities market is almost nonexistent due to the high upfront costs required to establish power generation plants. Competitors would need a substantial amount of initial capital and must endure rigorous regulatory constraints. In addition, new companies would need to appeal to the public in a way that would convince customers that the new utility company is better equipped to serve them than their current utility company. Time is a necessity when trying to achieve a foothold in a service area, so upfront costs will not realize recompense for many years, if at all. New entrants will find it hard to have price wars to gain customer approval because the government regulates the prices. An exception exists in which a potential entrant were to buy an existing utility company. 4. Bargaining Power of Consumers In the commercial and industrial markets, power is shifting toward the consumer. Residential markets have very little to no bargaining power. Electricity is the same no matter who produces it; therefore, it is a commodity item and can be bargained for. Commercial and industrial consumers are beginning to seek out lower prices and better contract terms. Locking in long-term contracts at low prices places the risk of fluctuating prices of electricity onto the utility company and away from the end-user. As competition in the utility market becomes more competitive, consumers may see more and more bargaining power over utilities.

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5. Bargaining Power of Suppliers A limited number of companies monopolize the power systems supply chain and there is not a lot of intense competition between them. Suppliers do enjoy significant power over the generation companies because they can choose where to get the power that they supply to the end user. They can purchase power from the lowest priced generating company and bypass the others. The wholesale market is seeing the emergence of many new suppliers and over time profitability per supplier will decline. Summary According to Porter’s five forces model, the diversified utilities industry should enjoy high profitability when facing weak suppliers, weak buyers, few substitutes, little rivalry, and high barriers to entry, but it is not highly profitable. Although the industry scores favorably on all five of these points, it is hindered by regulatory pricing. Regulatory pricing has contributed to a low return on equity level for Avista utilities, resulting in no economic value added for its shareholders.

Company Analysis Competitive Strengths Low Cost Electric Power Source As the results of the prior financial year (2013) were announced, the performance of the company had surpassed the company’s expectations, contributing to a net income attributable to Avista Corp shareholders of $111.1 million for the y ear. The higher than expected performance was due to warmer than normal temperatures during summer, cooler than normal temperatures during fall, which led to lower than expected operating costs. The lowering of costs is what enables the company to keep both customers and shareholders satisfied. This was evident in 2013 when there was the implementation of new rates in Washington and Idaho for the next two years. This gives rate certainty and clarity to customers for the next two years, thus putting Avista ahead in terms of price. Diverse Mix of Power Generation Avista Corp uses a diverse mix of power generation to ensure that there is continuous flow of power. For this reason, it does not depend on one mode of generating power, but several, such as biomass, water, and other renewable sources. In addition, more than 50% of power generated comes from renewable sources that reduce the use of timber. Access to Capital The company has a strong financial base that can carry out its operations efficiently. In the year 2013, it had a capital budget of $335 million to cater for its operations. This included generation, transmission, generation, growth, environmental, technology and fleet. Avista had revenues of over $1.6 billion, thus putting it in a position that is able to finance and sustain itself. Over the years, it has been distributing dividends to its shareholders, indicating strong performance of the company in the utilities industry. Avista had $201.6 million in available liquidity, which is under the $400 million line of credit. It took a $90 million loan, which matures in 2016, and also issued $4.6 million in common stock for dividend reinvestment.

Location Residential Commercial Industrial

1,000 KWH 14,000 KWH 200,000 KWH

Birmingham, AL $119.91 $1,617 $17,834

Boston, MA $165.86 $2,224 $39,599

Chicago, IL $118.90 $1,368 NA

Colorado Springs, CO $95.24 $1,200 $22,099

Henderson, NV $127.12 $1,098 $21,265

Madison, WI $148.66 $1,645 $27,255

Portland, OR $108.33 $1,251 $17,299

Raleigh, NC $106.00 $1,092 $22,242

Salt Lake, UT $95.96 $1,138 $21,834

San Diego, CA $217.55 $2,071 $37,777

Seattle, WA $97.33 $1,296 $20,407

Spokane, WA $76.75 $1,325 $18,797

Tucson, AZ $94.07 $1,541 $21,441

National Average $125.91 $1,535 $23,711

Source: Greater Spokane

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Entrenched Market Position It is usually every company’s desire to have an edge above the rest. For this reason, organizations endeavor to position their product well to attract more customers. There are different aspects of positioning. These are brand positioning, product positioning, competitive pricing, competitive positioning and alternatives to marketing firms. Avista is known for its diversity of products in the energy sector, thus it uses its expertise in this area to position itself as a more superior brand. In the year 2013, Avista Corp acquired Alaska Energy and Resources Company (AERC), which serves its customers with clean renewable hydroelectric power in the Juneau, Alaska area. The transaction is set to put the company on another level of ensuring its operations cover a wide geographical area. Management Avista has had tremendous success through the years due to its strength in leadership. The company endeavors to pick the best leaders for the company and it has stayed true to this ideology. Through the leadership of Scott Morris, the president, chairman, and chief executive officer, the company has continued to show growth amidst some turbulence. This gives investors peace of mind as they are assured the security of their investment.

Competitive Strategies Generation Capacity Diversification Avista incorporates a diverse mix of electric generation capacity; to the left there is a chart that shows the five different forms of Avista’s generation capacities. Hydropower and natural gas are Avista’s two main sources of electricity generation. Washington requires a portfolio to be composed of at least 15% renewable generation capacity, such as hydropower; Avista has far more hydropower in their portfolio. Their diversification allows them to sustain their long-term demand. Avista is one of the greenest utility companies in the country and they were “green before it was cool to be green”. High Customer Appreciation Avista strives to provide quality service and low prices to its customers, enabling them to achieve a customer satisfaction rating of 90% or above since 1999. Avista also seeks customer satisfaction through philanthropic community orientation. They provide energy assistance programs and continually invest in the communities that they serve through charitable giving and volunteer hours. Due to Avista’s long history in their communities, 125 years to be exact, they have acquired an extreme amount of customer trust and reliability. Growth Through Acquisition Avista has several competitive strategies, the first of which is growth through acquisition. Avista acquired Alaska Electric Light and Power Company (AEL&P) on July 1, 2014, as management views this as a “gateway to new growth”. Avista feels this will allow them to seek new paths for future growth that may lead to branching out services into the greater Alaska area. Alaska also has the highest allowed rate of return on equity of 12.87% out of all the other states Avista operates in; Washington and Idaho both allow 9.8% ROE and Oregon allows 9.65% ROE.

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35%

9%

6% 2%

Electricity Generation Resource Mix

Hydro Natural Gas Coal Wind Biomass

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Commitment to Stable Dividend Finally, Avista has committed itself to providing a stable earnings base and a consistently growing dividend yield for its shareholders. Their current dividend yield is 3.7%, which is a very attractive level in the current low interest rate environment.

Financial Analysis Balance Sheet & Leverage Due to the high capital requirements of being a utility company, Avista is extremely asset heavy with property, plant and equipment, constituting approximately 75% of the firm’s assets. The leverage of the firm is high, but is state regulated. The debt-to-equity ratio must be maintained at approximately a 1:1 ratio in order to stay compliant. They currently stand with a debt of 49.7% and equity of 50.3%. The firm’s total debt is approximately 70% of its assets with the remaining 30% in equity. In regards to the firm’s equity multiplier (leverage), they place at 3.36 times. Due to the firm’s low cash and equivalents, the firm’s liquidity is relatively poor. The firm currently has a current ratio of .88, a quick ratio of .81, and a cash ratio of .13. Although the figures are low, they rank second to its competitors PG&E (current ratio = .8, quick ratio = .74, cash ratio = .08) and IdaCorp (current ratio = 1.90, quick ratio = 1.52, cash ratio = .31). (See Appendix 6)

Income Statement & Forecast Based on the fiscal year of 2013, Avista realized a profitability margin of 6.86% and an operating margin of 15.10%. Although the margins are low, they do not stray too far from its competitors’ (PG&E and IdaCorp) profitability margins, which are 5.31% and 14.64%, and Oms of 11.30% and 23.41%, respectively. Using both information from Avista’s SEC 2013 10K filing and team computation, the team built a pro forma statement looking up to the fiscal year of 2017. The growth rate used was the firm’s sustainable growth rate, discussed later in the paper. We determined that the firm’s margins appear to be stable based on the assumption that both revenues and expenses are perfectly correlated and that current conditions are constant. (See Appendix 3)

Sales Analysis Using a linear regression model, Avista’s sales since 2002 have fallen below the trend line of the forecast, with the exception of 2005, 2006, and 2008. The statistics yielded a mean absolute deviation (MAD), the absolute deviation in sales predicted by the model, of $77,891,938. This translated to a mean absolute percentage deviation of 5.45%. The correlation of the model, based on the variables ‘years’ (x) and ‘annual sales’ (y), shows a Pearson’s coefficient of .87. The correlation within the model is moderately strong, indicating that the model should be used but should be monitored and updated as new data becomes available in order to improve accuracy. The model’s high and low-end revenue predictions for the fiscal year of 2014 are $1,680,658,183 and $1,836,442,059, respectively. (See Appendix 4)

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39%

15%

1%

Avista's Electric Operating Revenues - 2013

Residential Commercial Industrial Public Street & Road Lighting

66%

32%

1% 1%

Avista Gas Operating Revenues -2013

Residential Commercial Industrial Interruptible

Debt 49.7%

Equity 50.3%

Avista's Consolidated Capital Structure

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Net Income Analysis Using a linear regression model, Avista’s net income has exceeded the forecast trend line 75% of the time. The statistics yielded a mean absolute deviation (MAD) of $9,902,394. This translated to a mean absolute percentage deviation of 14.67%. The correlation of the model, based on the variables ‘years’ (x) and ‘annual operating revenues’ (y), shows a Pearson’s coefficient of .89. The correlation within the model is moderately strong, indicating the model should be used carefully, due to the high MAD, and should be monitored and updated as new data becomes available in order to improve accuracy. The model’s high and low-end revenue predictions for the fiscal year of 2014 are $101,933,499 and $121,783,288, respectively. (See Appendix 5)

Profitability Margin As shown in the adjoining table, from 2010 to 2013, Avista’s profitability margin has been relatively stable at approximately 6%. Compared to its closest competitors, PG&E (approximately 5.5%) and IdaCorp (approximately 15%), Avista falls in second place. Concerning the fiscal year of 2014, investors should be aware that the profitability margin will be inflated due to the recent disposition of ECOVA, which skyrocketed their bottom line for 2014Q2, giving them a 37.61% PM.

ROE Analysis Avista is currently sitting at an ROE of 9.08%. As mentioned in the profitability margin section above, Avista’s 2014Q2 was inflated due to the recent disposition of ECOVA. As a result, the ROE of 9.08% is not an accurate measure and instead the historical ROE should be used. After compiling the data from the SEC filings from 2002 to 2013, we have determined that the most accurate measure of the company’s ROE is 6.64%, its historical ROE. Compared to the ROE caps based on the states in which Avista operates (Washington: 9.8%, Oregon: 9.65%, Idaho: 9.8%, Alaska: 12.87%), Avista falls short of its potential returns.

Stock Valuations Utility stocks, in general, become more attractive as interest rates decrease; the market is currently in a “zero-interest” environment. We feel that Avista’s stock is inflated due to the temporary increase in demand from investors seeking higher yielding securities.

Sustainable Growth Rate In determining an appropriate growth rate, we determined that the sustainable growth rate was most appropriate. A sustainable growth rate is defined as the rate of growth a firm can sustain without having to increase its financial leverage. Since Avista’s debt-to-equity ratio must be maintained at an approximate 1:1 ratio, the sustainable growth rate is a perfect match. In calculating the growth rate, we used the historical ROE of 6.64%, as we feel that the current ROE of 9.08% is inflated and, therefore, an inaccurate representation of what the firm should normally realize. With using the appropriate ROE and Avista’s plowback ratio of 60%, we have concluded that the growth rate of 3.99% is most appropriate when using the valuation models to determine the equity’s fair market price. (See Appendix 15)

Sustainable Growth Rate: 3.99%*

Historical ROE 6.64%*

Plowback Ratio 60%

Dividend: $1.27

Discount Rate: 8.98%*

Market Return 10%*

Risk Free Rate 4%*

Beta (β) 0.83

Book Value: $23.75

ROE (ttm): 9.08%

Valuation Assumptions

Source: Yahoo! Finance, Team Estimation* & Team Calculation*

Year PM

2010 5.93%

2011 6.19%

2012 5.06%

2013 6.86%

2014 Q1 9.88%

2014 Q2 37.61%

2014 Q3 3.47%

Profitability Margin

Source: Yahoo! Finance

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Discount Rate Using a risk-free rate of 4% and a market risk premium of 6%, along with Avista’s beta of .83, we calculated a discount rate of 8.98%. Due to the recent recession, interest rates and returns are not representative of the historical figures, which is why we took an average of the last 20 years. One could argue that we should use the current risk-free rate and the YTD market risk premium, but it would not be accurate from a historical standpoint. The risk-free rate is at a historical low and the S&P 500 has recently seen historical highs. (See Appendix 15)

Dividend Discount Model This first model used, the Dividend Discount Model, was selected based on Avista’s track record of maintaining a dividend since 1988. Based on the declared dividend of $1.27, the team computed discount rate, and the team computed growth rate, we found a valuation of $26.47 for the equity, only a few dollars off from the book value of the share. (See Appendix 15)

Residual Income Model The second model used was the Residual Income Model. The reason for the selection of this model is because of its ability to show an equity’s economic value based on its ROE. For the model calculations, we used Avista’s 12-month-trailing ROE of 9.08%, instead of its historical ROE, in order to determine whether there is any current economic value inherent in the stock. Based on the 9.08% ROE, the equity’s book value, the team computed discount rate, and the team computed growth rate, we found a valuation of $23.75, equal to the book value. (See Appendix 15)

Low ROE and Economic Value Avista has a low historical ROE of 6.64%. Due to this low level of ROE, Avista doesn’t provide any economic value to the market place. The Residual Income Model shows that because historical ROE is roughly equal to the cost of equity, or the discount rate, Avista’s stock price should be evaluated at a price equal to their book value.

Interest Rate and AVA Price Correlation Appendix 16 contains a chart depicting the correlation between the Avista stock price, from the year 2000 to current, and the 10-year t-note interest rates. There is a -.58 correlation, showing a moderate-high negative correlation; Avista stock price and interest rates move in opposite directions. As interest rates decrease, via Fed regulation, Avista’s stock price becomes more attractive due to the higher dividend yield, comparatively. An investor can earn a higher return from Avista stocks over the interest they would obtain from investing money into a U.S. Treasury Bond. Currently, the T-note interest rates are at an all-time low; we estimate that the Fed will increase them sometime in 2015, as the U.S. economy continues to improve. This means that interest rates will increase and Avista stock price will become less attractive; when demand goes down, price goes down. As a result, the current stock price for Avista is overinflated due to the temporary increase in demand.

Year ROE

2002 4.20%

2003 5.92%

2004 4.67%

2005 5.86%

2006 7.98%

2007 4.21%

2008 7.39%

2009 8.29%

2010 8.21%

2011 8.45%

2012 6.12%

2013 8.43%

Average 6.64%*

Avista ROE from 2002 - 2013

Source : Yahoo! Finance, Team Calculation*

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Stock Fair Value Estimate Taking the two values from the two different models and averaging them, our group came up with a price target of $25.11 for Avista’s stock. As previously stated, Avista’s stock price is currently inflated due to the temporary increase in demand. This increase in demand is due to the very low Fed interest rates. Avista has consistently had a very low ROE, resulting in low to no economic value added to the market. Avista’s stock price is over magnified and should only be considered worth a price equal to or close to its book value.

Investment Recommendation We recommend a sell of the Avista stock with a target price of $25.11 and a downside of 29.23%. Due to the low interest rate era, Avista provides a stable, and somewhat riskless return. Currently, Avista’s dividend yield is higher than a 10-year T-note interest rate, but it should be noted that the price of the equity and the interest rate of the T-note are negatively correlated with a Pearson’s coefficient of approximately -.6. Due to the negative correlation and the interest rates potentially rising this year, the equity is at risk of decreasing in market value. In conjunction to the correlation statistics, the average of the Dividend Growth Model and the Residual Income Model show that the current price is too high and the historical ROE, in comparison to the ROE caps of the states in which Avista operates in, does not provide any economic value. Therefore, the equity should be valued at the same price as their book value.

Investment Risk Factors Interest Rate and Avista Price Correlation The correlation between interest rates and Avista’s stock price is a huge risk factor. A graph can be found in Appendix 16 that provides more of a visual. According to history, there is a trend; when interest rates go down, Avista stock prices go up. As stated before, the U.S. economy is currently in a “zero” interest rate environment, if you will. Generally, people who are looking for a “riskless” investment put money into U.S. Treasury Bonds; with the current all-time lows, people are searching for alternatives. Avista stock, and utility stock in general, are returning much higher returns; customers view these stocks as the next best alternative because utilities are a commodity. The commodity factor gives customers the assumption of a relatively riskless investment. Demand has increased for Avista stock; when demand increases, price goes up. Demand and supply are positively correlated, basic economic rule; this proves that because of the increase in demand the Avista stock is temporally increased. When the Fed increases interest rates, demand for Avista stock will decrease and U.S. Treasury Bonds will increase. This is a risk from an investor standpoint because if the Fed raises interest rates, which we believe will happen in 2015, Avista stock price will significantly decrease.

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Power of Larger Customers Avista’s larger customers, industrial and commercial buyers, prefer long-term contracts; thus, locking in their price for electric services. In turn, if Avista’s costs increase, and even upon winning a rate case, these particular customers are grandfathered in. This shifts the risk of price changes from the customers back to Avista. Avista must carefully maintain and plan for their increases in their costs because of these long-term contracts. This is a risk from an investor standpoint because if the contract term lengths are too long and prices significantly increase during that time, Avista will not be able to make enough money from their main customers.

Acquisition Uncertainty As previously stated, in 2014 Avista acquired a company in Alaska, AEL&P. AEL&P is located in an area that Avista has not previously conducted business in and with that comes uncertainty. With any acquisition, there is worry as to whether or not it was a good move for the company and whether it will be a downfall or a triumph for Avista. Alaska is also far away, if you will, from the other states Avista participates in (Washington, Oregon, and Idaho). If for some reason Avista is having trouble with their power sources in Oregon, they can easily pull power in from Washington and Idaho to offset the deficit. Alaska, on the other hand, does not have any sort of connections to this territory and Avista needs to find a way for backup generation. While acquiring AEL&P may or may not be a good move for Avista, it is too soon to tell, and, therefore, it is a risk from an investor standpoint.

Low Snow Fall Seasonal precipitations are a significant risk factor for Avista. In Spokane, the current (2014-2015) winter season has been very mild with minimal snowfall. This heavily affects Avista because they must plan around the seasonal trends, as they cannot control Mother Nature. With the low snowfall this year, there is less water precipitation and Avista needs to plan for changes in their usage of Hydropower generation. Avista’s generation capacities are almost 50% composed of Hydro and without a lot of snow, there might be some difficulties for the summer of 2015. Avista might have to use alternative sources or buy from the outside market in order to maintain their customer’s demand for electricity. This is a risk from an investor standpoint because if Avista doesn’t plan accordingly, they may have to purchase electricity from the wholesale market and at a much higher cost. A revised rate case would help Avista offset the higher costs, but the cost and time needed to propose and get a revised rate case to pass in such a short time period would not be feasible at this point, which means Avista may lose potential profits in the upcoming year.

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Disclosures Ownership and material conflicts of interest: The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue. Position as an officer or director: The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject company. Market making: The author(s) does not act as a market maker in the subject company’s securities. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with Eastern Washington University, CFA Institute or the CFA Institute Research Challenge with regard to this company’s stock.

CFA Institute Research Challenge

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Appendices Appendix 1: Historical Balance Sheet

Period Ending 2011 2012 2013

Assets Current Assests

Cash and Cash Equivalents 74,662$ $ 75,464 $ 82,574

Net Receivables 249,303 230,741 253,914

Inventory 52,006 47,455 44,946

Other Current Assets 238,585 152,134 168,245

Total Current Assets 614,556$ $ 505,794 549,679$

Long Term Investments 93,040 81,006 66,903

Property Plant and Equipment 2,906,463 3,070,258 3,260,980

Goodwill 39,045 75,969 76,257

Intangible Assets 34,622 46,256 39,576

Other Assets 505,018 514,978 354,578

Deferred Long Term Asset Charges 21,787 18,928 13,950

Total Assets 4,214,531$ $ 4,313,179 4,361,923$

Liabilities Current Liabilities

Accounts Payable 166,954 198,914 182,088

Short/Current Long Term Debt 235,467 205,176 286,882

Other Current Liabilities 224,753 172,059 156,370

Total Current Liabilities 627,174$ 576,149$ 625,340$

Long Term Debt 1,202,629 1,250,205 1,319,856

Other Liabilities 641,090 679,875 547,228

Deferred Long Term Liability Charges 505,954 524,877 535,343

Minority Interest 174 17,658 20,001

Total Liabilities 2,977,021$ 3,048,764$ 3,047,768$

Stockholders' Equity Misc Stocks Options Warrants 51,809 4,938 15,889

Common Stock 855,188 889,237 896,993

Retained Earnings 336,150 376,940 407,072

Other Stockholder Equity 5,637- 6,700- 5,819-

Total Stockholder Equity 1,185,701$ 1,259,477$ 1,298,266$

Net Tangible Assets 1,112,034$ 1,137,262$ 1,182,433$

Historical Balance Sheet

Source: Yahoo! Finance

All Numbers are in Thousands

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Appendix 2: Historical Cash Flow Statement

Period Ending 2011 2012 2013

Net Income 100,224$ 78,210$ 111,077$

Operating Activities

Depreciation 152,182 149,849 141,458

Adjustments to Net Income 28,617 24,280 37,004

Changes in Accounts Receivables 30,616 8,100 (32,675)

Changes in Liabilities (18,220) 23,715 438

Changes in Inventories (3,388) 4,551 2,509

Changes in Other Operating Activities (23,881) 27,258 (18,471)

Total Cash Flow From Operating Activities 269,465.00$ 316,553.00$ 242,557.00$

Investing Activities

Capital Expenditures (243,372) (275,974) (303,113)

Investments (127,963) (12,685) (12,989)

Other Cash Flows from Investing Activities 89,054 (6,009) 3,885

Total Cash Flow from Investint Activities (282,281.00)$ (294,668.00)$ (312,217.00)$

Financing Activities

Dividends Paid (63,737) (68,552) (73,276)

Sale Purchase of Stock 20,284 31,876 502

Net Borrowings 71,545 33,079 146,320

Other Cash Flows from Financing Activities (10,027) (17,486) 3,224

Total Cash Flows from Financing Activities 18,065.00$ (21,083.00)$ 76,770.00$

Effect of Exchange Rate Changes 0 0 0

Change in Cash and Cash Equivalents 5,249$ 802$ 7,110$

Historical Cash Flow Statement

All Numbers are in Thousands

Source: Yahoo! Finance

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Appendix 3: Pro Forma Income Statement

Period Ending 2011 2012 2013 2014* 2015* 2016* 2017*

Total Revenue 1,619,780$ 1,547,002$ 1,618,505$ 1,683,083$ 1,750,238$ 1,820,073$ 1,892,694$

Cost of Revenue 790,048 693,127 689,586 717,100 745,713 775,467 806,408

Gross Profit 829,732 853,875 928,919 965,983 1,004,526 1,044,606 1,086,286

Operating Expenses

Research Development 0 0 0 0 0 0 0

Selling General and Administrative 488,128 537,403 551,337 573,335 596,211 620,000 644,738

Non Recurring 0 0 0 0 0 0 0

Others 113,600 126,402 133,189 138,503 144,030 149,776 155,752

Total Operating Expenses 601,728 663,805 684,526 711,839 740,241 769,777 800,491

Operating Income or Loss 228,004 190,070 244,393 254,144 264,285 274,830 285,795

Income from Continuing Operations

Total Other Income/Expenses Net 3,433 5,025 6,677 6,943 7,220 7,509 7,808

Earnings Before Interest and Taxes 231,437 195,095 251,070 261,088 271,505 282,338 293,603

Less Interest Expense 71,266 75,034 75,546 78,560 81,695 84,954 88,344

Income Before Tax 160,171 120,061 175,524 182,527 189,810 197,384 205,259

Less Income Tax Expense 56,632 41,261 63,230 65,753 68,376 71,105 73,942

Minority Interest (3,315) (590) (1,217) (609) 0 0 0

Net Income 100,224 78,210 111,077 116,166 121,434 126,279 131,318

Preferred Stock and Other Adjustments 0 0 0 0 0 0 0

Net Income Applicable to Common Shares 100,224$ 78,210$ 111,077$ 116,166$ 121,434$ 126,279$ 131,318$

Pro Forma Income Statement

Source : Yahoo! Finance, Team Forecasting*

All Numbers are in Thousands

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Appendix 4: Sales Forecast

Year Actual Op Revenues Forecast Error Abs Error

2002 $1,062,916,000 $1,151,213,128 ($88,297,128) $88,297,128

2003 1,123,385,000 1,201,824,544 (78,439,544) 78,439,544

2004 1,151,580,000 1,252,435,960 (100,855,960) 100,855,960

2005 1,359,607,000 1,303,047,376 56,559,624 56,559,624

2006 1,506,311,000 1,353,658,793 152,652,207 152,652,207

2007 1,417,757,000 1,404,270,209 13,486,791 13,486,791

2008 1,676,763,000 1,454,881,625 221,881,375 221,881,375

2009 1,512,565,000 1,505,493,041 7,071,959 7,071,959

2010 1,558,740,000 1,556,104,457 2,635,543 2,635,543

2011 1,619,780,000 1,606,715,873 13,064,127 13,064,127

2012 1,547,002,000 1,657,327,289 (110,325,289) 110,325,289

2013 1,618,505,000 1,707,938,705 (89,433,705) 89,433,705

MAD = $77,891,938

MAPD = 5.45%

r = 0.8675

2014 Op Revenue Forecast: $1,758,550,121

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Appendix 5: Net Income Forecast

Year Actual Op Revenues Forecast Error Abs Error

2002 $31,307,000 $30,012,090 $1,294,910 $1,294,910

2003 44,504,000 36,830,740 7,673,260 7,673,260

2004 35,154,000 43,649,390 (8,495,390) 8,495,390

2005 45,168,000 50,468,041 (5,300,041) 5,300,041

2006 72,941,000 57,286,691 15,654,309 15,654,309

2007 38,475,000 64,105,341 (25,630,341) 25,630,341

2008 73,620,000 70,923,992 2,696,008 2,696,008

2009 87,071,000 77,742,642 9,328,358 9,328,358

2010 92,425,000 84,561,293 7,863,707 7,863,707

2011 100,224,000 91,379,943 8,844,057 8,844,057

2012 78,210,000 98,198,593 (19,988,593) 19,988,593

2013 111,077,000 105,017,244 6,059,756 6,059,756

MAD = $9,902,394

MAPD = 14.67%

r = 0.8906

2014 Net Income Forecast: $111,835,894

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Appendix 6: Balance Sheet Margin

Liquidity 2013

Current Ratio 0.88

Quick Ratio 0.81

Cash Ratio 0.13

Total Debt Ratio 0.7

Debt-Equity Ratio 1.02

Equity Multiplier 3.36

Long-Term Debt Ratio 0.5

Profit Margin 6.86%

Operating Margin 15.10%

ROA 2.55%

ROE 8.56%

Financial Leverage

Profitability

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Appendix 7: Historical Dividends Chart

$-

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20

$1.40

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

A m

o u

n t

(D o

ll a

rs )

Year

Avista's Dividends from 2000-2014

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Appendix 8: Capital Expenditures Chart

$303

$276

$243

$355 $355 $350

$-

$50

$100

$150

$200

$250

$300

$350

$400

2011 2012 2013 2014 2015 2016

A m

o u

n t

(B il

li o

n s

o f

D o

ll a

rs )

Year

Avista's CapEx from 2011-2016

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Appendix 9: Maturity Structure Chart

$90.0

$273.0

$90.0

$52.0

$250.0

$13.5

$0.0

$50.0

$100.0

$150.0

$200.0

$250.0

$300.0

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

A m

o u

n t

(M il

li o

n s

o f

D o

ll a

rs )

Year

Avista's Maturity Structure

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Appendix 10: P/E versus T-note Closing Price

0

5

10

15

20

25

30

35

T -N

o te

P ri

ce &

A V

A P

/E

Year

Avista P/E vs. T-Note Closing Price

T-Note Closing Price

AVA P/E

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Appendix 11: Historical Return on Equity Chart

4.20%

5.92%

4.67%

5.86%

7.98%

4.21%

7.39%

8.29% 8.21% 8.45%

6.12%

8.43%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

A v

is ta

R O

E (

P e

rc e

n ta

g e

)

Year

Avista ROE from 2002 - 2013

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Appendix 12: Historical Profit Margin Chart

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

2010 2011 2012 2013 2014 Q1 2014 Q2 2014 Q3

P ro

fi t

M a

rg in

(P

e rc

e n

ta g

e s)

Year, Quarter

Avista's Profit Margin 2010-2014 (Q1-Q3)

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Appendix 13: Sales Analysis

Sales Dollars are in Thousands

Source: Yahoo! Finance, Team Forecasting*

$-

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

$1,400,000

$1,600,000

$1,800,000

$2,000,000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014*

S a

le s

(T h

o u

sa n

d s

o f

D o

ll a

rs )

Year

Sales Analysis

Actual Op Revenues Forecast

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Appendix 14: Net Income Analysis

Net Income Values are in Thousands of Dollars

Source: Yahoo! Finance, Team Forecasting*

$-

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014*

N e

t In

co m

e (

T h

o u

sa n

d s

o f

D o

ll a

rs )

Year

Net Income Analysis

Actual Op Revenues Forecast

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Appendix 15: Stock Valuation Model

Sustainable Growth Rate Calculation

Avista ROE from 2002 - 2013 Year ROE 2002 4.20% 2003 5.92% 2004 4.67% 2005 5.86% 2006 7.98% 2007 4.21% 2008 7.39% 2009 8.29% 2010 8.21% 2011 8.45% 2012 6.12% 2013 8.43%

Historical ROE (Avg.) 6.64%* Source: Yahoo! Finance, Team Calculation*

𝑆𝑢𝑠𝑡𝑎𝑖𝑛𝑎𝑏𝑙𝑒 𝐺𝑟𝑜𝑤𝑡ℎ 𝑅𝑎𝑡𝑒 = 𝐻𝑖𝑠𝑡𝑜𝑟𝑖𝑐𝑎𝑙 𝑅𝑂𝐸 ∗ 𝑃𝑙𝑜𝑤 𝐵𝑎𝑐𝑘 𝑅𝑎𝑡𝑖𝑜

𝑆𝑢𝑠𝑡𝑎𝑖𝑛𝑎𝑏𝑙𝑒 𝐺𝑟𝑜𝑤𝑡ℎ 𝑅𝑎𝑡𝑒 = 6.64% ∗ 60% = 3.99%

Determining Discount Rate 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑅𝑎𝑡𝑒 (𝑘) = 𝑅𝑖𝑠𝑘 𝐹𝑟𝑒𝑒 𝑅𝑎𝑡𝑒 + 𝛽 ∗ 𝑀𝑎𝑟𝑘𝑒𝑡 𝑅𝑖𝑠𝑘 𝑃𝑟𝑒𝑚𝑖𝑢𝑚

𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑅𝑎𝑡𝑒 (𝑘) = 4% + .83 ∗ 6% = 8.98%

Dividend Discount Model Calculation

𝑉𝑎𝑙𝑢𝑒 = 𝐷𝑜 ∗ 1 + 𝑔

𝑘 − 𝑔

𝑉𝑎𝑙𝑢𝑒 = $1.27 ∗ 1 + 3.99%

8.98% − 3.99% = $𝟐𝟔. 𝟒𝟕

Residual Income Model

𝑉𝑎𝑙𝑢𝑒 = 𝐵𝑉0 + 𝑅𝑂𝐸 − 𝑘

𝑘 − 𝑔 ∗ 𝐵𝑉0

𝑉𝑎𝑙𝑢𝑒 = $23.75 + 9.08% − 8.98%

8.98% − 3.99% ∗ $23.75 = $𝟐𝟑. 𝟕𝟓

Weighted Average Stock Value (50% × $26.47) + (50% × $23.75) = $𝟐𝟓. 𝟏𝟏

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Appendix 16: Closing Stock Price Correlation with Interest Rate Chart

0

1

2

3

4

5

6

7

8

0

5

10

15

20

25

30

35

40

45

50

3-Jan-00 3-Jan-01 3-Jan-02 3-Jan-03 3-Jan-04 3-Jan-05 3-Jan-06 3-Jan-07 3-Jan-08 3-Jan-09 3-Jan-10 3-Jan-11 3-Jan-12 3-Jan-13 3-Jan-14

1 0

Y e

a r

T -N

o te

I n

te re

st R

a te

A v

is ta

S to

ck P

ri ce

s

Dates

Weekly Closing Prices from 2000 - 2014 AVISTA CLOSE PRICE 10YR T-NOTE ADJ. CLOSE

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Appendix 17: Geographic Map of Service Territory

NOTE: The above map does not include coverage areas in Alaska.

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Appendix 18: Institutional Ownership

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Appendix 19: Insider Trades

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Appendix 20: References ^TNX Historical Prices. (n.d.). Retrieved November 25, 2014, from http://finance.yahoo.com/q/hp?s=^TNX

Historical Prices

AVA Historical Prices. (n.d.). Retrieved November 25, 2014, from http://finance.yahoo.com/q/hp?s=AVA Historical Prices

Avista Corp. (AVA). (n.d.). Retrieved November 20, 2014, from http://finance.yahoo.com/q?s=ava

Avista Corp - Investor Relations - Event Details. (2014, December 1). Retrieved from http://investor.avistacorp.com/phoenix.zhtml?c=97267&p=irol-EventDetails&EventId=5176648

Avista Logo [Web Graphic]. Retrieved from http://www.guidespark.com/wp-content/uploads/2014/01/Avista- logo-trans-back.png

Avista Utilities. (2012, November 1). Retrieved from https://www.avistautilities.com/savings/dsm/dsmhistory/Documents/2013%20DSM%20Business%20Pl an%20FINAL.pdf

Das, Udaibir S, Michael G. Papaioannou, and Christoph Trebesch. Sovereign Default Risk and Private Sector Access to Capital in Emerging Markets. Washington: International Monetary Fund, 2010. Internet resource.

Electric Power Supply Association. (2014). EPSA: Electricity Primer: What Is a Wholesale Electricity Market? Retrieved from https://www.epsa.org/industry/primer/?fa=wholesaleMarket

Electricity. (n.d.). Retrieved January 6, 2015, from http://www.greaterspokane.org/infrastructure/119- electricity.html

Hansen, Don R, Maryanne M. Mowen, and Liming Guan. Cost Management: Accounting and Control. Mason, Ohio: South-Western, 2009. Print.

Harris, Z. (2014, September). IBISWorld Search Results. Retrieved from https://www.ibisworld.com/search/detail.aspx?st=22121%20Natural%20Gas%20Distribution%20in%20 the%20US%20Industry%20Report%20(1)

Investopedia staff. (2014, December). The Industry Handbook: The Utilties Industry | Investopedia. Retrieved from http://www.investopedia.com/features/industryhandbook/utilities.asp

Morris, S. (Director) (2014, November 25). CFA Regional Company Meeting. Lecture conducted from CFA Institute and Avista Corp., Spokane, WA.

Nasdaq staff. (n.d.). Public Utilities North America Companies - NASDAQ.com. Retrieved December 12, 2014, from http://www.nasdaq.com/screening/companies-by- industry.aspx?industry=Public+Utilities=North+America

Public Utilities - encyclopedia article about Public Utilities. (n.d.). Retrieved December 12, 2014, from http://encyclopedia.thefreedictionary.com/public+utilities

Plunkett, W R. Management: Meeting and Exceeding Customer Expectations. Mason, OH, 2013. Print.

Revenue, EPS, & Dividend - Avista Corporation (AVA) - NASDAQ.com. (n.d.). Retrieved January 3, 2015, from http://www.nasdaq.com/symbol/ava/revenue-eps

Ulama, D. (2014, September). IBISWorld Search Results. Retrieved from https://www.ibisworld.com/search/detail.aspx?st=22112%20Electric%20Power%20Transmission%20in %20the%20US%20Industry%20Report%20(1)