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CA Utilities – Gov’s plan, Gov’s plan
CAL Watch – CA nonpartisan advisor issues report on allocating utility wildfire costs for lawmakers
PEG – Selling its stake in Keystone/Conemaugh coal plants
PEG – Ørsted’s Ocean Wind offshore project selected in New Jersey RFP; PEG has option to own
DTE – Elects Jerry Norcia to become CEO effective next month; Gerry Anderson to become executive chairman
Macro – The dividend investing playbook – near term tailwinds for yield-focused investors; AES, D, EVRG, OGE, PNW, and SRE screen attractively
SRE – Files to more than double size of Port Arthur LNG and proposes pipeline to serve it; long-dated options
Midstream of Consciousness – Oil market uncertainty rising – a look at stock correlations; Updates on MVP
This morning (6/19/2019), the OH Supreme Court issued a 4-3 ruling ordering the removal of FE’s distribution modernization rider (DMR) from customer rates. The majority found that in authorizing the DMR, the Public Utilities Commission of OH (PUCO) “failed to place any conditions on the additional funds that would allow the rider to act as an incentive”. Our understanding is that the order is effective immediately, with the DMR benefit ended only on a prospective basis. FE’s $132.5M/yr (post-tax) DMR was originally put into place to help keep its balance sheet healthy while enabling grid mod investment. AES $83M/yr (post-tax) DMR was specifically put in place to de-lever DPL in order to allow for a financially stable utility (prev junk rated). Both have extension requests pending, but only AES embeds approval within its forward guidance.
The revival of the US/China trade war stopped the 2019 bull market in its tracks with the S&P 500 falling 6.6% and bond yields declining 36bps in May. Utilities were a place to hide and only fell 1.3% beating the market by 530bps. For the year, utilities are still slightly trailing the S&P 500 (9.4% vs 9.8%) though it feels like they are way ahead. Utilities are back to a 21% P/E premium to the market vs a historic average of 3%. They have hit this level a few times before – including this past December – and its proven to be great selling opportunities since this premium never lasted. So while we worry about the economy and trade wars and bonds going toward zero yields, we still think buying utilities here is buying near a peak and stay Underweight. With rates this low, we are more wary of utility rate cases and ROEs – last month we saw NY PSC staff recommend an 8.3% ROE for ED.
We hosted investor meetings today (5/13/19) with CFO Gustavo Pimenta. Despite recent stock weakness, the tone of the meeting was constructive with Gustavo highlighting AES focus on de-risking the business and expanding renewable, storage and LNG platforms. Mgmt sees their stock as very cheap on straight P/E, pointing to European peers (eg Ibedrola) which trade near 15x on 2020E whereas AES trades just above 11x. We remain Peer Perform with a $17 PT which is derived using a weighted-average of our three valuation methodologies (SOTP, target FCF, discount utility P/E); see pg 5.
AES underperformed the UTY by 140bps today despite announcing an incremental $100M cost cutting initiative. The cost savings are expected to be realized at the SBUs by utilizing technology (robotics, drones, etc.) to lower maintenance expense and increase plant availability. AES expects to realize the full run-rate by 2022, with the bulk of the savings coming in 2021 and 2022. Our sense is that the incremental costs cuts will be a positive driver within AES’ current guidance or act as an offset to unforeseen issues if needed. Overshadowing AES’ Q1 update was renewed concerns for emerging markets (i.e., Trump trade war rhetoric with China). Recent news stories concerning Argentina’s economy / presidential election have also been unsettling as a Macri loss in October could change the pro-market narrative in the country.
Utilities rose only 0.9% in April, while the market rallied another 3.9%. Utilities are now underperforming the market by roughly 670bps YTD; they have given back their entire 2018 outperformance. So, what should investors do now? The stock market rally in 2019 is becoming historic - this is only the 3rd time in the last 40 years the S&P 500 rose more than 15% in the first 4 months. One of them ended badly - the 1987 crash during which utilities outperformed. The other year was 1983 - the market flattened out the rest of the year while utilities continued to underperform. We also looked at years where utilities underperformed 650bps or more in the first 4 months as well. This has happened 16 times in the last 40 years. Interestingly, 10 of those 16 years utilities continued to underperform into year-end by an overall average of 200bps.
AES reported FY18 EPS of $1.24 beating consensus at $1.21 (WRe $1.23). This marks the second consecutive year that AES has finished near the top-end of its guidance range. The recent track record provides more credibility for the company going forward as it has been mired in the past for missing its financial targets. AES issued initial 2019 guidance of $1.28-1.40, beating consensus at $1.31 but in-line with our $1.34 estimate.
We hosted our annual investor meeting with the Moody’s team to get their latest credit views on the utilities, power and midstream sectors. For utilities, things have quieted down (ex California) as tax reform impacts have largely played out as expected. FFO/D metrics have dropped 150-200bps on average due to lost deferred tax cash flows and currently sit in the 15-16% area and likely stay there. Companies have taken actions to support their metrics (lot of equity) and have better visibility on regulatory treatment of tax reform. So 2019 is about executing on plans, hitting metrics and sticking to balanced funding plans (ie more equity). Moody’s still has a negative outlook on the sector but will likely go back to stable with good 2019 execution.
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