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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We have seen big performance dispersion in the sector this year and widening valuation spreads. What value names can finally wake up? CA legislation should continue to benefit EIX/SRE and the associated Yieldco names NEP and CWEN (still on sidelines on PCG). We think FE can finally get past FES and NI can hopefully move past Columbia MA. SO will have a key update on the Vogtle plant from PSC staff (which tends to have a cautious bias); other project risk stocks DUK, D, AGR likely stay in limbo for now. CNP and EVRG will be focus names on whether they can rebuild credibility in hitting numbers. PNW and ED likely stay pressured by regulatory overhangs. And then there’s Power, which we think stays under N-T pressure into the August PJM auction even as we expect the companies to reaffirm 2019 outlooks.
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.
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
We recently hosted meetings with DTE CEO Gerry Anderson, who maintained an upbeat tone on the company's financial execution thus far in 2019. After a strong Q1, DTE seems well on its way to meeting or beating guidance – which would make it 11 straight years. DTE has one of the best track records in the industry, which has been built through years of careful budgeting and contingency planning. Our Price Target goes up to $129 on group multiples, but we stay Peer Perform given caution on elevated sector valuations.
Our annual utilities pension review – still underfunded, not much progress
Our utilities pension review, with help from Wolfe’s Accounting/Tax team and their comprehensive report, takes a look at the state of pensions in the sector using year-end 2018 data. Utilities remain underfunded for their pensions/OPEB – with most companies in the same place amid weak equity markets and higher rates. This dynamic has reversed in 2019, with yields sharply falling. There remains wide disparity in funding levels and accounting assumptions within our coverage.
This report looks at the numbers – CEO pay, stock ownership, change of control info and much more. Overall CEO pay was up 8% vs 2017 and CEOs averaged 143% of their target ST incentive comp. We review the key drivers of executive compensation for each company. For the most part, utility CEO pay is tied to the things investors care most about – EPS and shareholder return. Several companies also include operational, safety and customer service metrics which we think are important for L-T value in the utility sector. A new wrinkle is carbon reduction which has been a big focus for XEL and recently added by SO for 2019.
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.
DTE reported 1Q19 adjusted EPS of $2.05 that beat consensus and matched our estimate. This was also a step-up versus $1.91 last year primarily on weather at the utilities. While the non-utilities segments saw year-over-year declines in earnings, this was largely expected given above-normal volumes (and AFUDC) realized at midstream last year and REF tax equity transactions. DTE reaffirmed its 2019 EPS guidance of $5.97-6.33 and appears well on track, after materially adding to the contingency balance it started the year with. The company is trying to make it 11 straight years of exceeding original guidance. Longer-term, the 5-7% EPS growth target was affirmed.
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