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.
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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.
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 impending bankruptcy will impact a wide swath of companies especially renewables suppliers. These include large ones investors are aware of (CWEN, NEE/NEP, ED) and smaller ones not so obvious (NRG, DTE, likely others). For the other CA utilities, EIX and SRE, investors will be focused on what this means for getting long-term fixes for wildfire risks. Project risk continues to rear its ugly head as we have seen with ACP pipeline delays. Key updates this quarter include D/DUK on ACP, SO on Vogtle, AGR on NECEC and Vineyard Wind, and SRE on Cameron. Pension risk (and OPEBs and NDTs) due to the Q4 market swoon and drop in rates could hurt as D highlighted recently. NI, ETR and others may face some headwind.
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.
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