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.
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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.
With an uneventful Q1, we expect investor focus to be on pending legislation on several key issues: 1) California – Gov Newsom announced a goal of passing legislation to fix the utility wildfire risks by July 12. While not sure on the timeline, we think this will get done and remain constructive on PCG. 2) Nuclear support legislation has been proposed in PA, OH and IL and all 3 states could address it during the spring sessions. We think IL has the best chance followed by OH and PA but all could potentially slip into later in the year. EXC has the most upside from these while the IPPs could face pressure depending on PJM’s ultimate capacity structure. NJ will decide tomorrow whether to give legislatively approved nuclear ZECs to PEG and EXC. 3) Other states to watch include NC on multi-year rate plans (DUK); TX on expanded AMI (ETR, XEL) and FL on an undergrounding rider (NEE, DUK).
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.
DTE reported 2018 adjusted EPS of $6.30 that fell in-line with consensus and our estimate. This also matched guidance, which was revised upward on several occasions throughout the year. The 13% increase relative to $5.59 last year was driven by a combination of favorable weather and rate relief at the utilities, strong performance across the board at the midstream and P&I segments, and lower taxes. DTE also reaffirmed 2019 guidance of $5.97-6.33, with our unchanged $6.16 estimate near the midpoint. Finally, the 5-7% long-term EPS growth target was reiterated (off 2019 guidance). Mgmt. came across as highly convicted in its ability to execute this year and beyond.
PCG’s threat and subsequent filing of bankruptcy kept utility investors very occupied in January. Even if investors did not own PCG itself they had to deal with knock-on effects on other CA utilities like EIX and on the renewables suppliers NEE, NEP, CWEN, ED, etc. These names dominated the worst performers of the month and were part of the reason why utilities only rose 3.4% in January trailing the market rally by 450bps.
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.
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