DUK 1Q19 EPS of $1.24 was in line but included $0.06 from a tax gain. DUK affirmed 2019 guidance of $4.80-5.20 and its 4-6% EPS growth through 2023 off 2019. DUK trailed the UTY by 100bp and is among the worst performer YTD, as it faces several overhangs (below). NC legislation could improve sentiment. We see DUK trading at a 7-10% discount to peers, given overhangs, higher leverage and subpar div growth.
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Our Q1 investor poll shows investors remain underweight utilities even after the sector has already underperformed by 700bps YTD. The poll has eerily similar results compared to our year ahead poll. Only 22% expect utilities to outperform for the rest of 2019 (down from 29%) and 54% expect them to underperform (up from 51%). There is roughly the same preference of midstream vs utilities (60%/40% vs 62%/38%). Power remains the preferred sector within the space (52% overweight vs 53% last poll) followed by Regulateds (43% overweight vs 52%) and then Yieldcos at the bottom (25% overweight vs 33%). Most investors (59%) expect interest rates to stay in the 2.5%-3.0% area though a lot less see rates rising back over 3% (only 5% vs 22% at last poll).
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).
DUK’s YE18 EPS of $4.72 slightly missed consensus, but 2019 guidance of $4.80-5.20 was in line with consensus of $4.95. However, DUK rebased its 4-6% EPS growth target through 2023 off $5.00 in 2019, implying LT estimates nearly a dime lower than that implied by DUK’s previous forecast. The ACP delay/overrun is weighing on 2019-20 earnings and rate base projections are lower than last year. DUK’s roughly $0.30 of earnings from its nonutility Commercial Renewables segment is a function of tax credits, which are lower quality. DUK modestly raised its equity needs by $150M/yr, as its B/S remains one of the weakest among regulated peers. We cut our 2020-21E by $0.09. DUK is the worst performing regulated under our coverage YTD aside from PCG and AGR. We see the stock continuing to trade at a one-turn discount to peers, given ACP risk, higher leverage and below avg div growth.
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.
PCG’s impending bankruptcy will impact a wide swath of companies especially renewables suppliers. These include large ones investors are aware of (CWEN, NEE/NEP, ED) and smaller ones not so obvious (NRG, DTE, likely others). For the other CA utilities, EIX and SRE, investors will be focused on what this means for getting long-term fixes for wildfire risks. Project risk continues to rear its ugly head as we have seen with ACP pipeline delays. Key updates this quarter include D/DUK on ACP, SO on Vogtle, AGR on NECEC and Vineyard Wind, and SRE on Cameron. Pension risk (and OPEBs and NDTs) due to the Q4 market swoon and drop in rates could hurt as D highlighted recently. NI, ETR and others may face some headwind.
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.
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.
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.
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