EVRG issued 2019 guidance and updated its long-term plan on Friday (2/22/2019), both of which missed expectations and the stock fell over 700bps. Guidance for the year of $2.80-3.00 missed our estimate and the midpoint of the long-term growth rate by a dime, half because of a major ice storm in January. Longer-term, EVRG re-based the growth rate off the 2019 midpoint and extended the outlook to 2023 at 5-7%. This was down from 6-8% over 2016-2021 previously, with mgmt. now pointing to the lower-half of this range. The implied earnings miss in 2021 of $0.08 was disappointing, but communication around the financial outlook was weak – likely exacerbating the stock move. While frustrating, the stock reaction seems overdone relative to the outlook changes
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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.
We are downgrading our rating on PNW to Underperform from Peer Perform due to the risk of a deteriorating regulatory environment in Arizona. Recent comments / actions from some members of the ACC have been particularly bothersome. Chairman Burns recently asserted that “regulatory capture” was evident in the state and that it is a “problem that needs to be addressed” when referring to PNW. Newly elected Comm. Kennedy echoed similar sentiment during her swearing-in ceremony. This type of abrasive rhetoric is rare and is simply something most other utilities don’t have to deal with. We would become particularly concerned if another commissioner’s view were to flip (5 total) and align with Burns / Kennedy on key issues. We are cutting are PT by $6 to $83 and now apply a 5% discount to PNW’s multiple to reflect this risk.
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.
Market volatility in October caught many off-guard and the hope was things would settle down post earnings. Well they got much worse spurred by the disruption of the CA fires. PCG and EIX ended November down 44% and 20%, respectively, on the heels of the destructive fires. These were popular value names in the utility space and their sharp stock collapses clearly caused investor pain. However, the second derivative impact was just as meaningful. The “Anything but California” trade took over amidst utilities, lifting already expensive low-risk utilities to higher levels. Many investors got just as hurt by being short or underweight these names as being long CA. With investors suffering and year end approaching, the last two weeks have showed signs of portfolios shrinking and extreme risk-aversion which has only exacerbated the problem. Everyone needs a holiday.
Last week, as the California utilities collapsed amidst the fire risks, we saw increasing investor focus on second derivative impacts. One of the obvious ones relates to renewables contracts with the CA utilities, especially PCG who drew down their bank lines last week. The primary concern is what will happen to these contracts in the event that PCG files for bankruptcy due to all the fire-related claims. This primarily impacted NEP and CWEN, given they have the most exposure, though there has been somewhat of a relief rally as investors realized the chance of a PCG bankruptcy in the near-term is low. Importantly, even if there was a surprise filing at some point, we believe these power contracts with the California utilities are likely to hold up. We are buyers on the recent weakness and view NEP as a top idea here.
The annual EEI conference will be held November 11-13. Management from most of our covered companies will be there. This report is a helpful guide for investors attending and includes questions to ask each company and summary model information. Some of the industry topics we will be focusing on include:
PNW reported 3Q18 EPS of $2.80, slightly beating consensus $2.72 (WRe $2.78). Despite strong YTD results, PNW reaffirmed FY ’18 guidance of $4.35-4.55 largely because of an unseasonably mild October that will offset the benefit realized in September. PNW provided initial 2019 guidance of $4.75-4.95, which was well above the Street’s $4.74 and our previous $4.78. Next year the company will see tailwinds from its SCR step increase and lower planned outage spending as 2018 levels were unusually high. Following today’s report, PNW outperformed the UTY by 290bps on the strong 2019 guide and constructive election results on Tuesday.
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