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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WEC posted 2Q19 EPS of $0.74 – beating consensus’ $0.70 and our $0.72, while also topping $0.70-0.72 guidance. Q2 was up versus $0.73 last year on cost cutting and wind PTCs, offsetting mild weather. Mgmt. raised 2019 guidance to $3.50-3.53 (from $3.48-3.52) and still expects being at the top-end of the range – likely extending its streak of beating guidance every year since 2004. The stock outperformed the group by 200bps in a severe risk-off tape – the ideal scenario for a high-quality utility sector bellwether.
Quietly our Wolfe Yieldco Index has become the top income sector YTD and the only one beating the S&P 500 (see Ex 1). Yieldcos have overcome the huge uncertainty caused by PCG’s bankruptcy filing in January. Why have they done so well? 1) long-term contracts that are not subject to ROE resets like utilities so should benefit directly as interest rates fall; 2) the neighborhood improved meaningfully as parent companies changed from distressed owners to higher-quality parents (SunEdison to Brookfield, Abengoa to Algonquin, NRG to Global Infrastructure Partners); 3) Its Renewables stupid – the top growth space in energy with huge economic and tax subsidy momentum. While we are a bit wary of competition and financial discipline in renewables, we think the backdrop remains bullish. There is no better way to play all of this than NEP given their connection to industry leader NEE, huge growth backlog, cost-of-capital advantages and visibility on 15% dividend growth for at least the next 5 y
Wolfe Research's Senior Utilities analyst, Steve Fleishman, hosted a webcast to discuss their PCG downgrade, CA wildfire legislation, risks to utility ROEs, and power market concerns.
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.
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.
WEC posted 1Q19 EPS of $1.33 that easily beat us/consensus at $1.25 and was well ahead of WEC’s $1.23-1.25 guidance. The quarter was driven by favorable weather, wind tax credits, and AFUDC / investment gains; partially offset by fuel, depreciation, and interest costs. Given the fast start, WEC is already tracking toward the top-end of its $3.48-3.52 guidance range in 2019. Our estimate and consensus are already there at $3.51. WEC is looking to extend its streak since 2004 of beating original guidance.
WEC posted 2018 EPS of $3.34 that slightly beat consensus/us and came in above $3.32 guidance (revised upward). The increase relative to $3.14 in 2017 was driven by lower O&M, sales growth, and weather. WEC reiterated 2019 guidance of $3.48-3.52. Long-term the EPS target remains 5-7% using original 2018 guidance as a base ($3.28). Dividends are expected to grow in-line with earnings and there are no equity needs. Given its latest wind farm acquisition, WEC pushed out its cash taxpayer expectation to 2020.
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