Post their success with NRG and FE, Elliott and Bluescape (John Wilder) took a 5% stake in SRE and sent a letter proposing board changes and a strategic review. The news was ironic since SRE just finished buying Oncor from Elliott. SRE was up 15.5% following the announcement, reflecting the activists’ past success and maybe a short squeeze. In our view, a strategic review of SRE makes sense, as there is a lot of value in Sempra’s underlying assets. We stay Outperform.
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Wolfe Research's Senior Utilities Analyst, Steve Fleishman, hosted a webcast to discuss continuing developments in the Utilities Sector
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.
We attended the American Gas Association (AGA) conference in Arizona this week. The AGA has started to turn into a spring version of EEI as more of the electrics have bought gas utilities. The main growth avenues for these companies are renewables and grid monetization, not gas. There’s not much to talk about in gas these days…new pipeline announcements have largely come to a halt, construction projects like Nexus and ACP are finally moving forward, and gas LDCs keep chugging along quietly. Credit ratings and tax reform were in focus since a lot of the electrics levered up to buy gas utilities and face credit pressure. Most of them have already issued equity this year – D, DUK, NI, etc. And then there’s SO who cancelled on AGA for an “unexpected emerging conflict” which turned out to be the sale of Gulf Power in place of equity needs.
Tax reform is still a key focus in utilities as they work through the regulatory process of passing it back to customers. So far this has generally proceeded smoothly. The bigger impact has been equity needs for the affected companies – NI and PPL both completed large offerings to complete balance sheet fixes. With the exception of Dominion, equity issuers have seen their stocks perform in line or modestly better than the sector subsequent to equity issuance (see Ex 6 on page 5). However, we think these large equity deals are putting downward pressure on the overall group. SO, ETR, ED and CNP (deal financing) are still to come. It may take until late this year or early next to get stabilization of credit ratings.
Sempra had a messy Q1. The Oncor financing timing and the impact from the rally in the peso at the end of Q1 were expected but the magnitude was larger, including the impact of taxes from the Global Intangible Low-Taxed Income (GILTI) provisions. That said the ultimate long term picture still appears intact. While California regulation remains an ongoing risk and the ultimate financing plan for Oncor needs to be resolved, we see Sempra’s strong growth from Cameron and its improving earnings mix as attractive as it trades at a nearly 2 turn to the group on 2020 earnings. We reiterate Outperform.
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.
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.
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