Our utility financial “checkup” examines projections for utility balance sheets and credit metrics. Tax reform was the overarching theme in 2018 for utility balance sheets and precipitated a large portion of the equity deals completed this year; in total, we saw +$19B completed across our coverage via blocks, forwards, or internally. Since our mid-year review, we now project slightly better FFO/debt in 2020 (+0.5%) due to equity issuances and asset sales. EV/EBITDA is now a half-turn higher given the run-up in equity valuations. Overall, we continue to see utility financial metrics stagnating with higher leverage at certain companies leading to wide P/E dispersion.
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We had CEO Jim Judge and CFO Phil Lembo on the road meeting with investors. Our main takeaway is management is confident on hitting at least the midpoint of its 5-7% EPS growth target through 2021 based on its 4-year capital plan, which excludes Northern Pass and offshore wind. We upgraded ES in late June, when it was one of the worst performing regulateds at that point. ES has done well since but trades at only a 2% premium to the average utility group P/E (excluding EIX, PCG, PPL), well below other low-risk large cap utilities. We like ES’ story of a high-quality T&D utility with the strongest credit ratings in the sector, constructive LT rate deals in MA/CT, and the ability to find new investments, some of which could be detailed in Feb. Reiterate Outperform.
On Friday (12/14/2018), PJM held a meeting to discuss the latest on potential energy market reforms – publishing an updated white paper (link). Similarly, PUCT will host a meeting to discuss ERCOT energy market reforms on Thursday (see below). In PJM, the focus has been on reserve market procurement and shortage pricing, which if implemented is estimated to add $2.27/MWh to curves (offset by an estimated $5-30/MW-day decline in capacity prices). PJM is targeting a decision by the end of January, as its board had requested it. In both markets, these price reform proposals seem to be coming to a head. All else equal, both should improve pricing. That said, PJM and ERCOT forwards have seemingly continued to climb all year and anticipation of these reforms may be somewhat already embedded at this point.
On 12/14, the SC Public Service Commission orally voted to approve the Dominion-SCG merger proposal with moderate conditions. The PSC accepted D’s latest revised rate plan, dubbed Plan B-L, which would cut SCG's electric rates to $125.26/month for the typical residential customer. This is slightly lower than the temporary 15% rate cut (to $125.34) enacted by the state legislature this summer. Given the apparent approval of the merger, we believe SCG no longer trades on fundamentals and are therefore moving to No Rating from Outperform. Investors should no longer rely on our previous rating, price target and estimates for SCG.
On Friday afternoon (12/14/18) the South Carolina PSC voted to approve Dominion’s acquisition of SCANA, adopting the “Plan B-Levelized” rate structure, upholding the nuclear spend to March 2015, and allowing a 9.9% ROE. Assuming there are no surprises in the written order we believe that D could close early in January. Apart from some earnings accretion we see the acquisition as strategically sound, boosting the regulated earnings mix and adding another platform for long term growth.
As part its Analyst Day, AWK issued initial 2019 guidance of $3.54-3.64 – a slight beat vs consensus $3.55 (WRe $3.58). AWK reaffirmed its 7-10% EPS CAGR and its expectation to be in the top-half of the range through 2023. AWK re-based its growth rate off a weaker 2017 ($3.03), making execution for growing in the top-half of its range easier, all else equal. Our 2020/2021E of $3.89/$4.21 both assume an EPS CAGR near 8.6%.
On 12/14 at its 1pm EST meeting, the SC Public Service Commission is expected to issue a decision on the Dominion-SCG merger proposal and cost recovery for the now-abandoned nuclear project. D's latest revised rate plan, dubbed Plan B-L, would cut SCG's electric rates to $125.26/month for the typical residential customer. This is slightly lower than the temporary 15% rate cut (to $125.34) enacted by the state legislature this summer. The Office of Regulatory Staff, a key intervenor, has been seeking cuts to as low as $114.57/month, in part by disallowing most of the nuke spend previously approved and by allowing lower returns than requested by D-SCG. We believe the PSC is likely to approve the deal, implying about 9% upside. However, surprises are possible, like adoption of the ORS recommendation (modest downside) or no nuke cost recovery (19% downside).
Two weeks ago the IRS submitted a notice of proposed rulemaking to the Office of Federal Register – primarily providing greater clarity on the rules regarding interest deductibility limitations, particularly with regards to the utilities industry. The guidelines included language that interest deduction limitations would apply to the consolidated entity and that there would be a 90% de minimus threshold. For the mostly regulated utilities, this appeared satisfactory to avoid any potential issue, as they would be free of any cap on interest deductibility. For the utilities with under 90% regulated operations, there was to be a cap on interest deductibility set at interest costs up to 30% of EBITDA through 2022. Thereafter, the cap would be set at 30% of EBIT. This all appeared to be in-line with expectations across our coverage.
These calls were in place of a long-planned Sydney investor trip that was understandably cancelled due to the Camp Fire.
Last week, the PA Nuclear Energy Caucus released a report (link), detailing the impact of losing in-state nuclear plants and providing options to save them. Ultimately, the report favors modifying the state Alternative Energy Portfolio Standards (or implementing ZECs) with a “safety valve” that (depending on FERC’s PJM capacity outcome) would allow PA to adopt FERC’s proposed capacity construct designed to accommodate state’s preferred generation programs (Fixed Resource Requirement). The report strongly made the case against “doing nothing” and suggested moving to a carbon pricing program longer-term. The caucus has bipartisan backing heading into the 2019 legislative session. However, opposition is expected to come from the utilities, consumer groups, and strong oil & gas lobby. The IPPs are likely split, as FES and TLN could benefit given nuclear ownership.