Utility earnings rose 5.0% in Q1, slightly above our 4.9% estimate. No companies changed guidance for 2019 but the same companies that disappointed at year end had issues again such as AGR, CNP, and NI (not EVRG, phew). Earnings quality stuck out to us as weak with tax or other gains driving numbers at SRE, DUK, NRG among others. AEP may have been the most incrementally positive with increasing confidence in the upper half of their 5-7% growth rate. Mega project risk continued to overhang D and DUK (ACP) and SRE (more Cameron delays), though SO kept Vogtle on schedule (for now). Finally, weak renewables conditions hurt in Q1 causing misses at AGR, CWEN, and NEP, but the influence of renewables keeps accelerating overall.
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AEP’s 1Q19 results of $1.19 beat consensus of $1.11, possibly on a one-time item and timing of tax benefit. AEP reaffirmed 2019 guidance of $4.00-4.20 vs consensus of $4.12 and WRs of $4.10. Management also reaffirmed their LT EPS growth of 5-7% (off $3.85 in 2018) and again noted that they would be disappointed if EPS growth were not in the top half of that target. Our new 2022E implies 6.6% EPS growth. AEP stock outpaced the UTY by about 50bp and is beating it by 300bp YTD. We like AEP’s transmission growth story, absence of major project overhang and solid EPS/div growth. Regulated renewables opportunities in OH and PSO/SWEPCo would be upside to our estimates. We believe AEP could trade at a one-turn premium to the average regulated P/E. AEP trades at 18.2x on 2021E vs the group average of 18.0x. Reiterate our Outperform.
Our Q1 investor poll shows investors remain underweight utilities even after the sector has already underperformed by 700bps YTD. The poll has eerily similar results compared to our year ahead poll. Only 22% expect utilities to outperform for the rest of 2019 (down from 29%) and 54% expect them to underperform (up from 51%). There is roughly the same preference of midstream vs utilities (60%/40% vs 62%/38%). Power remains the preferred sector within the space (52% overweight vs 53% last poll) followed by Regulateds (43% overweight vs 52%) and then Yieldcos at the bottom (25% overweight vs 33%). Most investors (59%) expect interest rates to stay in the 2.5%-3.0% area though a lot less see rates rising back over 3% (only 5% vs 22% at last poll).
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.
AEP is paying SRE $1,056M (including $343M of project debt) for 724 net MW of wind farms across CO, HI, IN, KS, MI, MN, and PA, most of which are near existing renewables assets or areas served by AEP utilities. The deal is accretive by a few cents in the first full year, after an expected close date of mid-2019. AEP says the deal “further solidifies” its LT EPS growth of 5-7%; AEP last month suggested it is targeting the top half of that growth target. While we prefer AEP to stay fully regulated, the transaction makes sense, given the proximity to AEP’s assets and its expected renewables efforts after the failed Wind Catcher proposal. We also see the deal slightly accretive, with our new 2021E of $4.65 implying about 6.5% growth. We still see AEP’s utility and transmission growth as a premium story, yet AEP shares trade in line with peers. Outperform.
AEP’s 2018 results of $3.95 slightly beat consensus of $3.93. AEP affirmed 2019 guidance of $4.00-4.20 vs consensus of $4.12 and WRs of $4.10. Management reaffirmed its LT EPS growth of 5-7% (off $3.85 in 2018) but noted that there are “more tailwinds than headwinds” to achieve the top half of that growth target. Our 2021E implies about 6.3% growth. AEP stock traded in line with the UTY but is beating it by about 200bp YTD. We like AEP’s regional diversity, transmission growth story, absence of major project overhang and solid EPS/div growth. We believe AEP could trade at a one-turn premium to the average regulated P/E. AEP trades at 16.8x on 2021E, which is in line with the group. Outperform.
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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