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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.

Utilities rose only 0.9% in April, while the market rallied another 3.9%. Utilities are now underperforming the market by roughly 670bps YTD; they have given back their entire 2018 outperformance. So, what should investors do now? The stock market rally in 2019 is becoming historic - this is only the 3rd time in the last 40 years the S&P 500 rose more than 15% in the first 4 months. One of them ended badly - the 1987 crash during which utilities outperformed. The other year was 1983 - the market flattened out the rest of the year while utilities continued to underperform. We also looked at years where utilities underperformed 650bps or more in the first 4 months as well. This has happened 16 times in the last 40 years. Interestingly, 10 of those 16 years utilities continued to underperform into year-end by an overall average of 200bps.

SO’s 2018 EPS of $3.07 beat consensus, and its 2019 guidance of $2.98-3.10 topped consensus of $3.02. SO raised its 5-yr capital plan, reallocating most to its utilities. But SO affirmed its 4-6% EPS growth target through 2023 off $2.87 in 2018, with growth on the low end of its target in 2021 due to Vogtle ROE penalties. SO said it was ahead of internal project targets and aims to sustain productivity levels over the next year. SO was 115bp higher than the UTY on the Vogtle comments and is 665bp ahead YTD. We remain cautious going into a rebaselining of the project by 5/15 and the GaPSC Staff’s response by 7/31; the next year is critical for SO to meet its accelerated schedule.