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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Heading into the Q1 call, we expected a much more modest cost increase; our expectation proved optimistic as NI now expects a 20% increase from the amount provided just a couple months ago. NI recently reached a settlement on what is likely one of its larger claims, thus taking some risk off the table for large future increases. But there is still a fair amount of uncertainty that remains concerning what’s embedded in estimations for claims yet to be settled / litigated (class action, wrongful death, municipalities); footnote language related to the possibility for further increases makes us a bit weary as well. We would be remiss if not admit that mgmt’s credibility is taking a bit of a hit with respect to this issue.
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.
NI provided initial 2019 guidance of $1.27-1.33, missing consensus at $1.33 (WRe $1.31). As we had expected, NI’s dividend announcement earlier this month was a sign for muted earnings growth off 2018A ($1.30). What we hadn’t expected was a re-basing of the company’s 5-7% annual growth rate off of a weak 2019 – we previously assumed that NI would get back on track by 2021 as the drag associated with MA would largely be offset / removed. To reflect NI’s new growth expectations, we are cutting our 2020E and 2021E to $1.39/$1.48 from $1.45/$1.55. Our PT is unchanged at $28.
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.
On Friday (2/1/19), NI raised its annual dividend to $0.80 from $0.78, representing 2.5% growth – well below the company’s targeted 5-7%. Following up with the company, we sense this as a signal that the drag associated with MA gas explosion fixes are worse than we originally thought likely leading to weak initial ’19 guidance. Issues include higher recovery and carrying costs. As such, we are cutting our 2019E to $1.31 from $1.35. Our updated estimate represents 2.5% growth off our 2018E of $1.28. We feel this is a more prudent growth rate and keeps the company within its 60-70% targeted payout ratio. We are also reducing are 2020E by $0.02 to $1.43 as we feel it may take a bit longer for NI to fully offset / eliminate the drag associated with MA.
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.
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.
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