Wolfe Research's Senior Utilities Analyst, Steve Fleishman, hosted a webcast to discuss continuing developments in the Utilities Sector
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Our utilities pension review, with help from the Wolfe Research Accounting and Tax Policy team and their comprehensive report, takes a look at the state of pensions and other post-retirement plans in the sector using year-end 2017 data. Utilities remain underfunded for their pensions/OPEB, though the gap narrowed when compared to last year. There is still wide disparity in funding levels and accounting assumptions within the sector.
On Friday (5/25/18), CAL Fire, the lead state agency that determines causes of fires, said PCG equipment caused four small fires in the North Bay last October, and in three of those CAL Fire said PCG was negligent. The four fires in total destroyed over 130 structures. However, there were over 20 fires that comprise the North Bay Fires, which collectively destroyed or damaged over nine thousand structures. CAL Fire has yet to release the findings of the largest North Bay Fires: Tubbs (5,643 structures destroyed), Nuns (1,355) and Atlas (781). CAL Fire's findings of those, particularly the Tubbs, is critical for PCG stock, which currently reflects around $12B of damages/fees. With those releases still to come, and with uncertainty on the legal and legislative fronts, we remain on the sidelines.
CG’s 1Q18 EPS of $0.91 missed consensus but fire liability risk is the focus. As we have seen since the North Bay fires, PCG stock has reacted violently (for a utility) to any news (or rumors) on Cal Fire reports, legislative proposals/pledges, court rulings, earnings, and the like. After today’s call, PCG fell over 3%; the stock has closed up-or-down by over 2% for 20 of the 85 trading days YTD. We do not see that volatility abating till there is a legal or legislative fix to CA’s inverse condemnation law: a utility has strict liability for damages from a fire if its equipment substantially caused the fire. We remain on the sidelines, as we see less than 50/50 odds of success this year.
April was a weird month. Corporate earnings had huge upside and bond yields at one point broke through the magic 3% level, but the stock market did not really respond ending flat (+0.3%). Energy was strong, but most other economically cyclical sectors weakened as investor fears of a coming slow down seemed to bubble up to the surface. So even with bond yields rising, utilities rose 2.1% and outperformed the market by 180bps. Year to date, bond yields have jumped a notable 52bps but utilities have only underperformed by 120bps. Utilities are now back to a slight premium P/E vs the market (1%) and short interest has collapsed close to the lows. So are utilities and the market foreshadowing a coming slowdown, or is this a head fake? We lean head fake and stay cautious utilities here. Most of the $12B of incremental equity needs from tax reform is still to come.
Today (4/26/2018), CA Sacramento Superior Court judge, Allen Sumner, held a hearing on PCG’s renewed motion for a legal determination of inverse condemnation liability in the Butte Fires case. After arguments were held, Judge Sumner said he would adopt his tentative ruling, which was made ahead of the hearing, as he was not persuaded by PCG’s central argument: the 11/30/17 CPUC decision denying SRE recovery of fire costs was new evidence that could allow him to go against two higher court precedents on the application of inverse condemnation to private utilities. Last June, Judge Sumner found PCG is liable in inverse condemnation. At today’s hearing, Judge Sumner suggested that a higher court, possibly the CA Supreme Court, will ultimately review the “fascinating” issue, but he is bound by the precedents (Barham v SoCalEd and Pac Bell v PG&E).
We are introducing our Cal Watch series. There is much investor attention on CA electric utilities related to wildfire risk and inverse condemnation, as evidence by stock moves like today: PCG was up as much as 7% at one point today (04/24/18) on news that a CA Senate committee moved forward a wildfire bill; the stock closed up 2%. We have published a lot of material on CA since last October’s North Bay Fires, including a deep dive report and conference call on the issue last month: see report, call replay and slides. Cal Watch will include the latest on wildfire risk issues.
Tax reform had a negative impact on utility cash flows and credit. Some companies have already issued equity to address – DUK, D – but the market seems unsure if it is sufficient. Others have been waiting for regulatory outcomes or asset sales to act on their equity – SO, PPL, NI, ETR, SRE, etc. We will likely get updates on their calls. While this is an overhang and uncertainty, taking decisive actions to complete equity needs and stabilize credit could ultimately be positive catalysts for these companies.
This spring we expect proposed legislation and court rulings related to CA’s inverse condemnation law: currently a utility has strict liability for damages from a fire if utility equipment substantially caused it. PCG and EIX shares have fallen 36% and 19% respectively since the Oct and Dec 2017 fires. Cal Fire has not determined causes for any of those fires; the findings will be important. But we are also focused on three areas: legislation, courts and the CPUC. In this report, we discuss these in detail. The punchline is with fire season approaching, we hope to see progress. However, none of the paths seems to be an easy fix on existing claims from the 2017 fires. For that reason, we remain on the sidelines on EIX and PCG.
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