What does PCG need from CA to avoid a bankruptcy filing? We think they need line of sight to recovery for 2017/2018 fires and structural changes on a much quicker time frame than currently set. They also need to know someone in CA leadership is willing to negotiate a deal with them – either the Gov office or PUC.
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Can utilities keep the defensive rally going? We’re skeptical. Utilities beat the market by 1500bps in Q4 2018 and outperformed 670bps for the year. This may continue near term given a host of negative macro signals, but these big defensive utility moves have historically been good times to take profits in the group.
Press reports late Friday (01/04/19) unnerve investors but aren’t that surprising. PCG is considering filing bankruptcy in weeks and selling its gas business, said the reports. The stock fell nearly 30% after-hours. We believe it is logical for PCG to explore all options given the fire liability risk. But we are skeptical of a N-T filing as there is no imminent trigger event. Leadership changes appear a foregone conclusion, as alluded to in PCG’s 1/4 release. Key is whether this helps to get state support, to which PCG’s value is tied.
On 1/2, Dominion closed the transaction to acquire SCANA. We therefore terminate coverage of SCG. We moved to No Rating from Outperform following regulatory approval of the merger last month. Investors should not rely on our previous ratings, price targets or estimates for SCG.
Utilities eked out a small 0.5% gain for 2018 on the heels of a massive Q4 rally as the market turned decidedly defensive ending the year down 6.2%. Utilities 670bps outperformance came despite a lot of headwinds on the group including higher interest rates (10-yr up 23bps), lack of tax reform benefits, over $15B of equity issuance, and the CA fires impact. Investors were looking for any place to hide and utilities fit the bill especially given their lack of exposure to tariffs and recession fears. Utilities came in second among income sectors for the year trailing only Pharma which was up 5.2%. Interestingly, all other income sectors underperformed the market in 2018 (see Exhibit 1). We remain cautious on utilities going into 2019 given their heavy dependence on a negative macro call and very high relative valuations (20% adjusted P/E premium vs the historic avg of 3%). In our view, buying defensive sectors at historically large premiums is not defensive.
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.
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 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.
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).
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