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.
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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
CAL Watch – Sen Dodd hints at a wildfire fund of $25-50B
CAL Watch – Bill states property losses from fires; costs for 2018 fires appear higher than last update
PCG – Settles with 14 public entities for $1B related to past wildfires; good step
PCG – CPUC seeks comments on proposals to improve safety culture
EIX – Debt issuance pricing reflects wildfire, downgrade risk
SO – GA Court of Appeals hears arguments from advocacy groups against Vogtle
ES – Settlement on temporary rate increase in NH rate case
PEG – Gas explosion at Ridgefield New Jersey home causes 1 fatality; under investigation
POR – OR bill to boost EV adoption heads to Gov; Cap-and-trade bill passes House, heads to the Senate
AWK – AWK in Europe…like selling water in a desert
ENB – Minnesota agencies slow Line 3 Replacement permit review process; not a big surprise
Midstream – Canadian Prime Minister Trudeau approves Trans Mountain pipe expansion; expected
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.
POR reported 1Q19 EPS of $0.82 beating us/consensus at $0.78. While still a $12M headwind, power costs proved to be less of a drag than we originally had expected. POR was able to offset the high power costs out West largely due to favorable weather. This was particularly impressive given the high demand amidst the backdrop of poor hydro and wind conditions which were 22% and 43% below normal, respectfully. POR had 98% availability from its thermal plants during the quarter, allowing the company to strategically dispatch its facilities and take advantage of the volatile pricing through its wholesale operations. POR reaffirmed its 2019 guidance of $2.35-2.50 (WRe $2.45) and also narrowed its targeted payout ratio to 60-70% from 50-70%. It was nice to see POR successfully navigate through the volatile weather / power conditions – this has not always been the case. POR outperformed the UTY by 100bps on Friday following the report.
With an uneventful Q1, we expect investor focus to be on pending legislation on several key issues: 1) California – Gov Newsom announced a goal of passing legislation to fix the utility wildfire risks by July 12. While not sure on the timeline, we think this will get done and remain constructive on PCG. 2) Nuclear support legislation has been proposed in PA, OH and IL and all 3 states could address it during the spring sessions. We think IL has the best chance followed by OH and PA but all could potentially slip into later in the year. EXC has the most upside from these while the IPPs could face pressure depending on PJM’s ultimate capacity structure. NJ will decide tomorrow whether to give legislatively approved nuclear ZECs to PEG and EXC. 3) Other states to watch include NC on multi-year rate plans (DUK); TX on expanded AMI (ETR, XEL) and FL on an undergrounding rider (NEE, DUK).
On the earnings call, mgmt. provided a L-T EPS growth target of 4-6% for the first time. The new growth target is through 2021 and is off a 2018 base year ($2.37). POR opted to provide the new guidance for a few reasons 1) no rate case this year 2) YoY growth in 2019 is not indicative of the future and 3) to better align their disclosures with other utilities. Our 2021E of $2.67 implies an EPS CAGR of 4%. With rate base growth modestly above 4% for the same period and 80bps of structural lag still inherent to the company, we struggle to reconcile how POR can achieve growth at or above the midpoint of its range without adding additional capex or creating new operational efficiencies.
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