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.
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XEL reported FY ’18 EPS of $2.42 which was in-line with us / consensus and at the top of the company’s original guidance range. W/A sales were strong in ’18 (electric +1.3%, gas +2.4%); strong C&I sales largely drove the increase on the electric side, particularly at SPS. XEL reaffirmed its 2019 guidance of $2.55-2.65 (WRe $2.61) and annual EPS growth target of 5-7%. Mgmt. sounded highly convicted on being able to achieve growth toward the top-end of the range, particularly through the first few years of XEL’s forecast period as meaningful capex comes online / into rates. Our 2021E of $2.97 assumes a CAGR of 7% off of XEL’s $2.43 base (original ’18 midpt). Following today’s report, XEL outperformed a strong utility tape by 70bps.
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:
XEL reported Q3 EPS of $0.96, in-line with consensus of $0.97 and narrowed its FY ‘18 guidance range to $2.45-2.49 from $2.41-2.51. XEL raised the top-end of its annual EPS growth target by 100bps to 5-7% as we had expected. Going forward, management expects to be able to achieve EPS growth at or above the midpoint of its range through the company’s current forecast period.
Utilities are on a hot streak this month recapturing all of their underperformance for the year in just 2 weeks. While we expect neutral to positive Q3 and Edison Electric Conference (EEI) updates, we remain skeptical that the recent rally can be sustained. We project Q3 up 6.4% driven by favorable summer weather, rate relief and better core sales growth. Our bottom-up 2018/2019 EPS forecasts are 5.7%/6.1% respectively. Several companies will be updating their capital plans – AEP, FE, LNT, WEC, XEL, POR, DTE – with a further upward bias to capex but not much change to EPS growth rates (except XEL). Midterm elections will also be a key topic given importance of state politics for utilities; AZ (PNW) and GA (SO) will be in focus with both having tight commissioner elections and the renewables ballot initiative in AZ.
This week we take a look at power prices ahead of Q3 reports, as generators often mark their guidance to forward curves around the end of each quarter. This is particularly meaningful for both NRG and VST, who are expected to issue / refresh 2019 guidance. Aside from ERCOT 2018, the forward pricing story in Q3 was largely positive when compared to 2Q18, even amidst flattish natural gas. While ERCOT contracts were down 10% in 2018, further out on the curve (2019-2021) was up 5-10%. This dynamic is likely explained by a summer that failed to yield scarcity pricing despite peak demand records, but the recognition that supply/demand conditions are likely to remain tight for the foreseeable future. Gas plant new build has failed to move forward and core demand growth remains robust. In PJM, contracts were up 5-7% in 2019-2020, while 2018/2021 contracts were up only modestly at 1-2%. Finally, out West (NP-15/SP-15/Mid-C) forwards were up 10% for 2019, while more mixed in outer years.
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