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We have downgraded our recommendation on TECO Energy Inc. (TE - Analyst Report) to Underperform from Neutral, due to its over-reliance on weather patterns, unstable commodity prices, strict federal regulations related to underground mining operations and waste management, and unsold tons of coal at TECO Coal.

As we know that performance of the utility providers, to a great extent, depends on weather patterns and TECO is no exception. Demand for energy is sensitive to unpredictable variations in weather conditions. Periods of volatile weather conditions not only dampen the demand, but severe weather can cause interruptions in coal production or transportation, thereby increasing cost of operations of the company.

Secondly, TECO’s businesses are commodity price sensitive. Changes in coal, gas, oil and other commodity prices could impact the company’s financial performance, including operating costs and margins. For example, the company’s unit Tampa Electric’s fuel costs for electricity generation might be negatively affected if cost of coal and natural gas rise in the future. The company normally recovers incurred costs of fuel through retail customers’ bills. Sometimes, rise in customer bills damage Tampa Electric’s competitive advantage in comparison to its peers in terms of customer switch.

As far as positive factors are concerned, we expect these negatives to some extent get diminished by gradual revival of Florida’s economy, strong customer growth in TECO’s operating territory as well as strong thermal coal contracts pipeline.

Currently, TECO is also skeptical about a possibility of removal of the provision for depletion tax deduction on coal mines and other hard minerals. In the FY13 Federal Budget, the government is planning to eliminate the provision for depletion tax deduction for coal mines and other hard minerals and fossil fuels. If such a thing happens, then the effective tax rate will rise to 37% from 20 - 25%. This would have an adverse effect on TECO Coal’s financial performance in the near future.

Tampa, Florida-based TECO Energy Inc. is involved in the generation, purchase, transmission, distribution, and sale of electric energy in Florida. One of the peers of the company is GenOn Energy Inc. . TECO Energy Inc. currently has a short-term Zacks #5 Rank (Strong Sell rating).

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