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.
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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.
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.
Our upgrade of the stock and the subsequent bankruptcy filing caught a lot of attention this week. Interest is mainly from distressed, crossover and deep value investors. Traditional utility investors care more on CA outlook overall (EIX and SRE) and whether the renewables PPAs will be broken (we are even more convinced they won’t). Most agree there is equity value in PCG but wonder why they need to be involved now. The situation is in tremendous flux, but we see very attractive value ($29 price target) with cushion in our assumptions.
PCG will likely file bankruptcy this Tues 1/29. We view this bankruptcy as a path to maximize equity value, not eliminate it. Benefits include 1) a fairer forum to adjudicate claims in federal vs state courts; 2) cleaner asset sale path for gas business, real estate, etc; and 3) a quicker path to challenge inverse in federal court. We don’t see PCG breaking PPAs – it creates more risk to equity/credit than benefits. We believe much of the negatives of bankruptcy have already hit the stock – uncertainty, messiness and forced selling by indexers and others. At this point, we are not even sure if the stock falls when they file.
CAL Fire said PCG’s equipment did not cause the largest of the 2017 NorCal Fires: Tubbs, sending the market to wonder whether PCG moves forward with its bankruptcy filing next week. PCG indicated its plans have not changed, despite the report and continued pressure from some shareholders who believe a bk filing is premature. Regardless, we view the report as positive, as it likely lowers potential wildfire liabilities in bk court or in state courts (no bk).
What does PCG need from CA to avoid a bankruptcy filing? We think they need line of sight to recovery for 2017/2018 fires and structural changes on a much quicker time frame than currently set. They also need to know someone in CA leadership is willing to negotiate a deal with them – either the Gov office or PUC.
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.
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