Post close, CAL Fire issued a press release saying PCG’s transmission lines caused the Nov 2018 Camp Fire, which killed 85 and destroyed 18,804 structures. CAL Fire found a second ignition source, also involving PCG’s equipment. CAL Fire did not publicize the report, referring it to the Butte County DA. In some 2017 investigations, CAL Fire referred its reports to local DAs if there was evidence of violations; those reports were not made public, and many of the prosecutors did not bring charges. In those press releases, CAL Fire said that it found evidence of violations; it did not say that in today’s release. Still, the Butte DA and CA AG already are conducting criminal probes. PCG said last Feb that it was “probable” its equipment caused Camp. With PCG accepting CAL Fire’s determination, focus is on damages/fees from Camp and the 2017 fires on which CAL Fire has blamed PCG. Implied pretax damages/fees in the stock is $36B. Although the Camp headline is negative, we believe the stock
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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.
PCG reported 1Q19 earnings today (5/2/19), among other things raising wildfire prevention spend by ~$400M, which we view favorably given fire risks. But the main investor focus of late has been on a legislative solution this year that reduces or eliminates the wildfire liability risk facing utilities. PCG is cautiously optimistic, but historically major legislation tends to come together late in the session. Gov Newsom asked for wildfire legislation by summer recess (7/12). This week EIX suggested 7/12 may be aggressive, particularly given the SB 901 Commission is on track to issue its report to the Legislature in early June. We remain confident that legislation will get done in 2019 but would not be surprised to see slippage past 7/12. PCG lagged the UTY by 315bp today, but we still like the risk/reward skew and reiterate our Outperform.
Utilities rose only 0.9% in April, while the market rallied another 3.9%. Utilities are now underperforming the market by roughly 670bps YTD; they have given back their entire 2018 outperformance. So, what should investors do now? The stock market rally in 2019 is becoming historic - this is only the 3rd time in the last 40 years the S&P 500 rose more than 15% in the first 4 months. One of them ended badly - the 1987 crash during which utilities outperformed. The other year was 1983 - the market flattened out the rest of the year while utilities continued to underperform. We also looked at years where utilities underperformed 650bps or more in the first 4 months as well. This has happened 16 times in the last 40 years. Interestingly, 10 of those 16 years utilities continued to underperform into year-end by an overall average of 200bps.
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).
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.
PCG did not come with a pitch or agenda but simply to update large holders on the bankruptcy. They see two potential paths: the expedited path and the long dated one. PCG should know in 90 days whether the expedited path can work – thus June madness. If expedited, a plan of reorganization could come summer 2019 and bankruptcy exit by Q3 2020. If not, dates could move out a year. Our Outperform essentially counts on the expedited path since it’s premised on a timely resolution ahead of the next fire season.
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.
PCG said it is probable that its equipment will be determined to be an ignition point of the 2018 Camp Fire; PCG took a $10.5B pre-tax charge in 4Q18. To date, PCG has charged $14B related to Camp and the 2017 North Bay Fires. PCG said fire liabilities could exceed $30B. We believe the stock reflects over $35B. PCG shares trailed the UTY by 470bp. But we believe the decline was tied more to a WSJ article implying PCG deferred maintenance on a suspected line in the Camp Fire and concern over potentially negative headlines related to pending CPUC investigations and critical rulings from Judge Alsup (federal judge overseeing PCG post San Bruno conviction). We remain optimistic a deal can be worked out with key stakeholders ahead of fire season this fall.
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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