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AWK reported FY18 adj EPS of $3.30 which was in-line with consensus at $3.30 (WRe $3.29). 2018 was a particularly strong year for the Market-based businesses, which were up $0.09 from 2017. The growth was primarily attributable to HOS (including some benefit from Pivotal) as well as the benefit from the lower corporate tax rate. AWK reaffirmed its 2019 guidance range of $3.54-3.64 (WRe $3.58) and continues to see L-T EPS growth in the top-half of its 7-10% range. Our 2021E of $4.21 implies a CAGR of 8.6% off AWK’s 2017 base year.
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.
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.
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%.
Market volatility in October caught many off-guard and the hope was things would settle down post earnings. Well they got much worse spurred by the disruption of the CA fires. PCG and EIX ended November down 44% and 20%, respectively, on the heels of the destructive fires. These were popular value names in the utility space and their sharp stock collapses clearly caused investor pain. However, the second derivative impact was just as meaningful. The “Anything but California” trade took over amidst utilities, lifting already expensive low-risk utilities to higher levels. Many investors got just as hurt by being short or underweight these names as being long CA. With investors suffering and year end approaching, the last two weeks have showed signs of portfolios shrinking and extreme risk-aversion which has only exacerbated the problem. Everyone needs a holiday.
Last week, as the California utilities collapsed amidst the fire risks, we saw increasing investor focus on second derivative impacts. One of the obvious ones relates to renewables contracts with the CA utilities, especially PCG who drew down their bank lines last week. The primary concern is what will happen to these contracts in the event that PCG files for bankruptcy due to all the fire-related claims. This primarily impacted NEP and CWEN, given they have the most exposure, though there has been somewhat of a relief rally as investors realized the chance of a PCG bankruptcy in the near-term is low. Importantly, even if there was a surprise filing at some point, we believe these power contracts with the California utilities are likely to hold up. We are buyers on the recent weakness and view NEP as a top idea here.
The annual EEI conference will be held November 11-13. Management from most of our covered companies will be there. This report is a helpful guide for investors attending and includes questions to ask each company and summary model information. Some of the industry topics we will be focusing on include:
AWK reported 3Q18 adj. EPS of $1.20 beating consensus of $1.16. The beat was primarily driven by lower integration expenses related to its Pivotal acquisition due to timing and capitalization. AWK narrowed its FY ’18 guidance range to $3.27-3.32 from $3.22-3.32 (WRe $3.29); the new midpoint represents 8.6% growth off of 2017A. The company managed to negate potential earnings headwinds this year as it was excluded from the NJ corp. businesses tax increase and there was no need to front-end load amortization expense related to Pivotal.
This week we take a look at power prices ahead of Q3 reports, as generators often mark their guidance to forward curves around the end of each quarter. This is particularly meaningful for both NRG and VST, who are expected to issue / refresh 2019 guidance. Aside from ERCOT 2018, the forward pricing story in Q3 was largely positive when compared to 2Q18, even amidst flattish natural gas. While ERCOT contracts were down 10% in 2018, further out on the curve (2019-2021) was up 5-10%. This dynamic is likely explained by a summer that failed to yield scarcity pricing despite peak demand records, but the recognition that supply/demand conditions are likely to remain tight for the foreseeable future. Gas plant new build has failed to move forward and core demand growth remains robust. In PJM, contracts were up 5-7% in 2019-2020, while 2018/2021 contracts were up only modestly at 1-2%. Finally, out West (NP-15/SP-15/Mid-C) forwards were up 10% for 2019, while more mixed in outer years.
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