Momentum has no valuation ceiling while risks and uncertainties have no valuation floor. This is the story within utilities and among the market overall. A choppy Q2 due to unfavorable weather and weaker core sales growth seemed to only exacerbate this trend. A few companies appear to be re-rating on lower risk perceptions – ETR, FE, EVRG, SO, EIX, SRE – but otherwise we continue to see more divergence between the pure play safe regulateds vs those with diversified businesses or project/regulatory risk. Given our value focus, we are resigned to keep focusing on the messy ones.
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Quietly our Wolfe Yieldco Index has become the top income sector YTD and the only one beating the S&P 500 (see Ex 1). Yieldcos have overcome the huge uncertainty caused by PCG’s bankruptcy filing in January. Why have they done so well? 1) long-term contracts that are not subject to ROE resets like utilities so should benefit directly as interest rates fall; 2) the neighborhood improved meaningfully as parent companies changed from distressed owners to higher-quality parents (SunEdison to Brookfield, Abengoa to Algonquin, NRG to Global Infrastructure Partners); 3) Its Renewables stupid – the top growth space in energy with huge economic and tax subsidy momentum. While we are a bit wary of competition and financial discipline in renewables, we think the backdrop remains bullish. There is no better way to play all of this than NEP given their connection to industry leader NEE, huge growth backlog, cost-of-capital advantages and visibility on 15% dividend growth for at least the next 5 y
AWK reported 2Q19 EPS of $0.94 which was in-line with consensus and a little above our $0.90. AWK saw a number of one-time items hit in 2Q – most notable being -$0.04 due to significant precipitation; management noted the past 12 months in the US have been the wettest on record. Offsetting the adverse weather were a few things: +$0.03 related the sale of a legacy investment, +0.04 due to expense timing / other at the parent and another +$0.02-0.03 related to a land sale at AWK’s PA subsidiary. Net-net, AWK came out ahead for the quarter but will have these items to overcome in 2020. AWK reaffirmed its 2019 guidance range of $3.54-3.64 and we expect that the company is tracking in the top half of its range; we move our 2019E up $0.03 to $3.61 as a result.
Wolfe Research's Senior Utilities analyst, Steve Fleishman, hosted a webcast to discuss their PCG downgrade, CA wildfire legislation, risks to utility ROEs, and power market concerns.
Utilities rose 3% in June on the back of continued declines in L-T rates. But the market left utilities in the dust rising 7% for the month. The S&P 500 is now up 17.3% for the first half of 2019, the best performance since 1997. Utilities have held their own up 12.8%, but still trail by 450bps. At least so far, it appears that lower interest rates are helping the broader market more than utilities. Lower rates are a double-edged sword for utilities (see our recent report), as they can lead to lower allowed ROEs in rate cases. Several of the more near-term exposed companies – PNW, CNP, AGR, ED and AEE – were among the worst performers last month.
Utilities have rallied on the large drop in interest rates in recent weeks. For the year, 10-year Treasury yields have dropped to 2.01% from 2.69%. While underperforming the market, utility stocks are up 12% YTD and valuations are at or near all-time highs. This has been great news for investors, but lower interest rates are a double-edged sword for utilities. They increase the risk of lower allowed ROEs in rate cases which have otherwise held pretty stable over the past year. In this report, we identify those most and least at risk to ROE cuts and highlight pending cases with ROE sensitivity.
CAL Watch – Sen Dodd hints at a wildfire fund of $25-50B
CAL Watch – Bill states property losses from fires; costs for 2018 fires appear higher than last update
PCG – Settles with 14 public entities for $1B related to past wildfires; good step
PCG – CPUC seeks comments on proposals to improve safety culture
EIX – Debt issuance pricing reflects wildfire, downgrade risk
SO – GA Court of Appeals hears arguments from advocacy groups against Vogtle
ES – Settlement on temporary rate increase in NH rate case
PEG – Gas explosion at Ridgefield New Jersey home causes 1 fatality; under investigation
POR – OR bill to boost EV adoption heads to Gov; Cap-and-trade bill passes House, heads to the Senate
AWK – AWK in Europe…like selling water in a desert
ENB – Minnesota agencies slow Line 3 Replacement permit review process; not a big surprise
Midstream – Canadian Prime Minister Trudeau approves Trans Mountain pipe expansion; expected
We hosted AWK senior management in Europe last week. In a region very focused on ESG investing and long-term sustainability, the AWK story was well received. The unique aspects of AWK shine clearer in these meetings, especially the scarcity benefit of being the only large cap water utility in the US. And AWK continues to execute well on its 7-10% EPS growth (targeting upper half) and dividend growth (upper end) targets with no prominent risk issues. Valuation remains the one pushback.
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.
AWK reported 1Q19 EPS of $0.61 which matched our estimate but was little shy of consensus at $0.63.The YoY growth was driven by the market-based businesses (+$0.04), largely due to increased contracts from Pivotal; Military Services was also up on the addition of Wright Patt Airforce Base. The regulated utilities were up more modestly (+$0.01); 1Q18 was a tough comp due to the impact of the PA and MO rate cases last year. All told, AWK came out a penny ahead of its internal projections for the quarter and reaffirmed 2019 guidance of $3.54-3.64 (WRe $3.58). AWK continues to expect EPS growth in the top-half of its 7-10% through 2023 (off 2017A).
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