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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ES’ 1Q19 of $0.97 beat consensus of $0.91, but ES affirmed 2019 guidance of $3.40-3.50 and its 5-7% EPS growth target through 2023. Investor focus remains on timing of equity issuances; ES said in Feb it would need $2.0B to fund its 5-year $13B capital plan and known offshore wind projects in the outer years. ES said it would be opportunistic on the equity, monitoring cash needs and the equity market. ES also reminded investors that its 5-7% growth target includes the $2B equity but no material earnings from offshore wind; the latter will be significant in 2024 when the two wind projects are in-service. ES has trailed the UTY by over 200bp since Feb’s announcement and is in line with it YTD. Despite the equity overhang and offshore risk, we continue to like to ES’ high-quality T&D/water utility business. Our new 2022E reflects 6% EPS growth and ~$2B of equity. At a 2% premium to peers, we believe ES has room to go once equity is done. Outperform.
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).
Several companies rebased their growth rates that effectively lowered long-term numbers - AGR, EVRG, CNP, DUK and NI. While these were all for different reasons, we see more strain in utilities to keep growing 5% or more. We also saw several companies talk to slower dividend growth for the first time in several years – DUK, PPL, EIX, NI, and D. Mega project risks and event risks seem to be spreading in the sector. Risk-averse investors tell us they are seeing their investable universe shrink as they try to avoid project risk, big equity needs, poor management, higher-risk businesses, and of course, CA. The problem is the “clean” companies keep trading at higher and higher multiples which in and of itself becomes a risk.
ES’ 2019 guidance of $3.40-3.50 missed consensus of $3.49. But ES extended its 5-7% EPS growth target through 2023 from 2021, primarily from $13B of mostly T&D and water capex. The growth is net of 1) $2B of equity needed through 2023 for the capital plan and 2) offshore wind in the outer years without material earnings from offshore until 2024. Still, ES trailed the UTY likely on the new equity and is slightly ahead of it YTD. Although offshore adds risk to ES’ story of a high-quality T&D/water utility, ES’ EPS growth through 2023 would be even higher excluding offshore construction drag. And growth should be robust just from existing contracted offshore projects, with potential upside from new contracts, AMI, grid mod and Northern Pass.
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.
We had CEO Jim Judge and CFO Phil Lembo on the road meeting with investors. Our main takeaway is management is confident on hitting at least the midpoint of its 5-7% EPS growth target through 2021 based on its 4-year capital plan, which excludes Northern Pass and offshore wind. We upgraded ES in late June, when it was one of the worst performing regulateds at that point. ES has done well since but trades at only a 2% premium to the average utility group P/E (excluding EIX, PCG, PPL), well below other low-risk large cap utilities. We like ES’ story of a high-quality T&D utility with the strongest credit ratings in the sector, constructive LT rate deals in MA/CT, and the ability to find new investments, some of which could be detailed in Feb. Reiterate Outperform.
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