We’ve discussed this on numerous occasions, but we continue to find the balanced business mix in the new power sector to be attractive. Both NRG and VST are built to withstand the cyclical nature of power markets, as retail provides a natural hedge to wholesale power. In the table below we put numbers around how much retail contributes from an EBITDA and load perspective by company, then talk valuation.
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We are reiterating our Overweight rating on the IPP sector, as we continue to see attractive value at both VST and NRG – relative to our sector coverage and the broader market. We’ve refreshed our screen in the table below – searching across the S&P 1500 for stocks that exhibit strong free cash flow generation supported by a solid balance sheet – setting parameters at Free Cash Flow yield > 15%, Net Debt / EBITDA < 3x, and EV/EBITDA under 8x. Only 15 companies (1%) in the S&P 1500 fit.
We hosted a fireside chat with PSEG CEO Ralph Izzo last week, who came across as upbeat on the utility growth prospects, cautiously confident in ZECs approval, and generally satisfied with the company’s strategic fit. We continue to see long-term fundamental value in the stock, as utility earnings become a bigger overall percentage and power uncertainties resolve. The full replay can be listened to here. A summary of the most important talking points is below. While a more detailed review of the call is on page 4.
Wolfe Research's Senior Utilities analyst, Steve Fleishman, hosted a Fireside Chat with Fireside Chats with Ralph Izzo - Chairman of the Board, President & CEO of PSEG.
We came out of earnings season seeing little conviction, from both companies and investors alike, as to when and how FERC will ultimately rule on the PJM auction’s treatment of subsidized units. Prior communications had been that a decision was required by March-end in order to keep the August date for the auction as scheduled. March 17 is the first date a capacity resource intending to offer into the auction must certify whether it is subsidized – for now PJM is suggesting a parallel path – operating under the assumption that both the old auction format and PJM’s proposal are possible, particularly as it relates to a MOPR. Of course, FERC could ultimately decide on neither option. We continue to view PJM structural changes as important, but less of a gamechanger given the diversification of the power companies – Integrateds with growing utilities business and IPPs with significant ERCOT exposure.
Several companies rebased their growth rates that effectively lowered long-term numbers - AGR, EVRG, CNP, DUK and NI. While these were all for different reasons, we see more strain in utilities to keep growing 5% or more. We also saw several companies talk to slower dividend growth for the first time in several years – DUK, PPL, EIX, NI, and D. Mega project risks and event risks seem to be spreading in the sector. Risk-averse investors tell us they are seeing their investable universe shrink as they try to avoid project risk, big equity needs, poor management, higher-risk businesses, and of course, CA. The problem is the “clean” companies keep trading at higher and higher multiples which in and of itself becomes a risk.
PEG issued 2019 guidance at $3.15-3.35 today – beating consensus after many investors expressed concern that power earnings would be weak. Even better was 74% of expected earnings next year are projected to come from regulated businesses. PSE&G is one of the highest quality utilities in the sector – targeting 7-9% rate base growth through 2023 with five years of regulatory certainty. As PSE&G becomes a bigger percentage of total EPS, the stock should continue re-rating and power concerns will abate. The stock outperformed by 210bps on the strong update. Remain Outperform.
As we head into the last week of earnings, PEG, VST, and NRG are all set to report. VST and NRG will report on Thursday where we anticipate continued focus on shareholder-friendly capital allocation and bullishness into another tight Texas summer. Guidance ranges look to be mostly on track. PEG will kick things off on Wednesday, where 2019 guidance may disappoint on headwinds at Power, but we maintain a constructive view of the company’s long-term value proposition.
ETR’s 2019 guidance, which now only reflects its utility net parent (UPO) segment, is $5.10-5.50, twenty cents higher than its previous $4.90-5.30 guidance, as ETR moved to an effective tax rate (22.5%) from a statutory rate (25.5%). For 2020-21, the tax assumption change raised ETR’s outlook by $0.10 from its previous UPO EPS outlook. Other drivers appear largely unchanged from the outlook provided last fall. We are raising our estimates on the tax assumption change in line with ETR’s outlook (see table). ETR beat the UTY by 80bp but trails it by 60bp YTD. The stock is among the most popular names under our coverage on the long-side. We like ETR’s move to a fully regulated utility, which should be complete by YE22.
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