Momentum has no valuation ceiling while risks and uncertainties have no valuation floor. This is the story within utilities and among the market overall. A choppy Q2 due to unfavorable weather and weaker core sales growth seemed to only exacerbate this trend. A few companies appear to be re-rating on lower risk perceptions – ETR, FE, EVRG, SO, EIX, SRE – but otherwise we continue to see more divergence between the pure play safe regulateds vs those with diversified businesses or project/regulatory risk. Given our value focus, we are resigned to keep focusing on the messy ones.
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PNW reported 2Q19 EPS of $1.28, missing consensus of $1.42 and our $1.38. The $0.20 YoY decline was largely driven by unfavorable weather. May was the coolest since 1980 and June was the coolest in the past 8 years. As a result, PNW is now expecting to come in at the low-end of its $4.75-4.95 guidance. Other items putting pressure on numbers include the ACC’s inaction on the 4 Corners step increase (worth $0.07) and the customer disconnection moratorium for which PNW expects to incur a $5-10M pre-tax hit. PNW is managing O&M to help offset some of these impacts, but absent significant weather in Q3, it’s unlikely PNW would be able to get back to the midpoint.
We have seen big performance dispersion in the sector this year and widening valuation spreads. What value names can finally wake up? CA legislation should continue to benefit EIX/SRE and the associated Yieldco names NEP and CWEN (still on sidelines on PCG). We think FE can finally get past FES and NI can hopefully move past Columbia MA. SO will have a key update on the Vogtle plant from PSC staff (which tends to have a cautious bias); other project risk stocks DUK, D, AGR likely stay in limbo for now. CNP and EVRG will be focus names on whether they can rebuild credibility in hitting numbers. PNW and ED likely stay pressured by regulatory overhangs. And then there’s Power, which we think stays under N-T pressure into the August PJM auction even as we expect the companies to reaffirm 2019 outlooks.
Utilities rose 3% in June on the back of continued declines in L-T rates. But the market left utilities in the dust rising 7% for the month. The S&P 500 is now up 17.3% for the first half of 2019, the best performance since 1997. Utilities have held their own up 12.8%, but still trail by 450bps. At least so far, it appears that lower interest rates are helping the broader market more than utilities. Lower rates are a double-edged sword for utilities (see our recent report), as they can lead to lower allowed ROEs in rate cases. Several of the more near-term exposed companies – PNW, CNP, AGR, ED and AEE – were among the worst performers last month.
Utilities have rallied on the large drop in interest rates in recent weeks. For the year, 10-year Treasury yields have dropped to 2.01% from 2.69%. While underperforming the market, utility stocks are up 12% YTD and valuations are at or near all-time highs. This has been great news for investors, but lower interest rates are a double-edged sword for utilities. They increase the risk of lower allowed ROEs in rate cases which have otherwise held pretty stable over the past year. In this report, we identify those most and least at risk to ROE cuts and highlight pending cases with ROE sensitivity.
Utilities: PCG, CAL Watch, DUK, Short Interest, PNW, VST, Renewables, Offshore Wind, POR
Midstream: D/DUK/ETRN/NEE, MMP, KMI, WMB, Short Interest
CA Utilities – Gov’s plan, Gov’s plan
CAL Watch – CA nonpartisan advisor issues report on allocating utility wildfire costs for lawmakers
PEG – Selling its stake in Keystone/Conemaugh coal plants
PEG – Ørsted’s Ocean Wind offshore project selected in New Jersey RFP; PEG has option to own
DTE – Elects Jerry Norcia to become CEO effective next month; Gerry Anderson to become executive chairman
Macro – The dividend investing playbook – near term tailwinds for yield-focused investors; AES, D, EVRG, OGE, PNW, and SRE screen attractively
SRE – Files to more than double size of Port Arthur LNG and proposes pipeline to serve it; long-dated options
Midstream of Consciousness – Oil market uncertainty rising – a look at stock correlations; Updates on MVP
Our annual utilities pension review – still underfunded, not much progress
Our utilities pension review, with help from Wolfe’s Accounting/Tax team and their comprehensive report, takes a look at the state of pensions in the sector using year-end 2018 data. Utilities remain underfunded for their pensions/OPEB – with most companies in the same place amid weak equity markets and higher rates. This dynamic has reversed in 2019, with yields sharply falling. There remains wide disparity in funding levels and accounting assumptions within our coverage.
The revival of the US/China trade war stopped the 2019 bull market in its tracks with the S&P 500 falling 6.6% and bond yields declining 36bps in May. Utilities were a place to hide and only fell 1.3% beating the market by 530bps. For the year, utilities are still slightly trailing the S&P 500 (9.4% vs 9.8%) though it feels like they are way ahead. Utilities are back to a 21% P/E premium to the market vs a historic average of 3%. They have hit this level a few times before – including this past December – and its proven to be great selling opportunities since this premium never lasted. So while we worry about the economy and trade wars and bonds going toward zero yields, we still think buying utilities here is buying near a peak and stay Underweight. With rates this low, we are more wary of utility rate cases and ROEs – last month we saw NY PSC staff recommend an 8.3% ROE for ED.
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