Utility earnings rose 5.0% in Q1, slightly above our 4.9% estimate. No companies changed guidance for 2019 but the same companies that disappointed at year end had issues again such as AGR, CNP, and NI (not EVRG, phew). Earnings quality stuck out to us as weak with tax or other gains driving numbers at SRE, DUK, NRG among others. AEP may have been the most incrementally positive with increasing confidence in the upper half of their 5-7% growth rate. Mega project risk continued to overhang D and DUK (ACP) and SRE (more Cameron delays), though SO kept Vogtle on schedule (for now). Finally, weak renewables conditions hurt in Q1 causing misses at AGR, CWEN, and NEP, but the influence of renewables keeps accelerating overall.
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Wolfe Research's Senior Utilities analyst, Steve Fleishman, hosted a webcast to discuss EIX upgrade, views on CA legislation, and VST reiteration.
We are upgrading EIX stock to Outperform from Peer Perform, making us bulls on EIX, PCG and SRE. Although EIX just announced $1.5B of equity needs, and CA has yet to reform wildfire liability rules, we continue to believe the state this year will fix an untenable situation for utilities and, importantly, victims, ratepayers and the state’s clean energy goals. EIX shares trade at the lowest P/E in the industry other than PCG, and they have trailed peers by over 2000bp since the Nov 2018 fires, including about 500bp last week. We believe the weakness is overdone and see at least 25% upside in the stock. Our $75 PT includes the $1.5B of equity needs and has room to deal with uncertainties, such as fire damages more than our assumed $5B and shareholder contributions to any wildfire fund. Notably, fire officials have not found that EIX violated any laws in the fires, implying possible cost recovery.
EIX announced $1.5B of equity mostly through ATM programs this year to achieve its requested cap structure in the cost of capital proceeding. The increase in equity to 52% from 48% must be approved by the CPUC. EIX wants the flexibility, given uncertainty, including around wildfire liability in CA. Still, the amount is not immaterial, representing 7% of EIX’s market cap. Despite the equity being for accretive investments, it creates some pressure on the stock. We think EIX looks attractive but has less favorable upside than PCG.
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).
The Strike Force report wasn’t the only CA-related news Friday (04/12/19). CPUC ALJs issued a proposed decision in SCE’s 2018 GRC, filed on 9/1/16. At first glance, it was not worth the long wait, particularly with lower 2020 rate base authorized than requested; however, the PD recommends good attrition rates of 6-7% in 2019-20. Parties will file comments, and the CPUC expects to issue a final decision on or after 5/16. The key will be whether SCE can continue to earn at least its allowed ROE from O&M efficiencies, as our rate base estimates are roughly in line with those in the PD, plus EIX’s incremental capex (e.g., wildfire spend). We do not believe EIX shares have the same risk/reward skew as PCG to reductions in wildfire liability risk (We discuss in a separate note takeaways from Gov Newsom’s Strike Force report; see note).
Late Friday (04/12/19), PCG and EIX shares rose 21% and 7% after CA Gov Newsom released a report from his Strike Force that included three high-level concepts to address allocation of catastrophic wildfire costs: 1) a liquidity-only fund, 2) changing strict liability to a fault-based standard, and 3) a wildfire fund. These concepts were largely expected, but we believe the stocks reacted to the Gov’s sense of urgency, his inclusion of potentially changing strict liability (inverse condemnation), and his surprise 90-day deadline for the legislature to deliver a bill. We believe a solution to the wildfire liability risk facing CA utilities must be found before the fire season picks up this fall. There are several unknowns for shareholders, such as how much they will contribute to a future fund. But for PCG we believe there is enough room in its valuation to deal with various scenarios to take on the risk.
In the last earnings call of the YE18 utility reporting season, EIX disclosed a $2.5B ($1.8B after-tax) charge related to wildfire claims. The amount/timing are somewhat surprising, but EIX warned last fall about potential involvement of its equipment in the 2017 Thomas Fire, which caused over $2B of insured losses when including subsequent mudslides. Then, the Woolsey Fire caused damage in Nov 2018, with over $3B of insured losses. CAL Fire has yet to determine the cause of either fire. EIX has underperformed the UTY by around 300bp YTD. We believe any legislation that limits or eliminates wildfire liability risk to utilities would benefit EIX, but the upside to EIX stock is much less than that to PCG (see note).
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.
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