After close on 11/25, a CPUC ALJ issued a proposed decision in the Cost of Capital applications, which will set allowed returns and capital structures for each CA utility’s respective state-regulated rate base in 2020-22. The ROEs would be unchanged for EIX (10.30%) and PCG (10.25%). SRE’s SDG&E electric would get 10.20% vs 10.15% currently. EIX’s SCE would get a 52% equity ratio (vs 48%) – in line with the other two utilities. Balancing fire and inverse risk against a lower interest environment, we see the PD as in line with expectations. The ROEs would be close to the midpoint between the utilities’ requests and intervenors’ recommendations: 115-220bp increases due largely to wildfire risk vs 150-185bp decreases. And the political backlash from recent shutoffs does not appear to have significantly impacted the PD.
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This morning, it was announced that Dutch energy company Eneco would be purchased by Mitsubishi (80%) and Chubu Electric Power (20%) for $4.1B Euros. This followed a sale process that kicked off almost a year ago, which garnered interest from the likes of Shell, KKR, Macquarie, and EDF as well (Total and Enel dropped out earlier). This got us thinking. Asian investors have already shown a keen interest in U.S. power plant investments, as seen by the readily available financing in CCGT new build. Why couldn’t one of these foreign power companies buy a U.S. IPP? Granted, Eneco is a bit different, in that it has a quasi-regulated gas and electric retail business, as well as growing investments in renewable energy that includes offshore wind. But clearly there is an interest here to diversify out of Asia. When we published our annual power supply update back in September, the number of Japanese and Korean utilities investing in U.S. gas plants was endless.
We’ve now been waiting 17 months for FERC to decide on new PJM capacity auction rules since determining its tariff was unjust/unreasonable. There have been a few false starts, but with Commissioner Glick’s recusal on the issue set to end on 11/29 and James Danly’s nomination as commissioner moving one step closer this week, we feel as though an actual order is finally upon us. In this note, we’re simply reviewing exposures to hypothetical scenarios. At the end of the day, it’s probably fair to say that EXC and VST have the most at stake here. However, it’s important to note that the PJM capacity auction is simply not as important as it used to be. EXC has the most capacity in PJM and addressing its subsidized (and non-subsidized) nuclear plants is critical in how this plays out. VST has the second most capacity in PJM, with about 25% of its EBITDA coming from energy/capacity revenues combined in the region.
FERC issued an order today in two MISO transmission ROE complaints, setting a methodology that differed from its last proposal, establishing a 9.88% base ROE and dismissing the last of the two complaints. That 9.88% base is lower than the 10.3% that FERC set a few years ago under a methodology that has since been vacated. FERC did not rule on the four New England ISO ROE complaints, as Comm. Glick – one of the three seated FERC commissioners (two vacancies) – cannot vote on those. But that base ROE also likely would decline under today’s order. Transmission makes up less than half of earnings for the impacted utilities (FTS and ES almost 40%, AEE 20%). To the negative, the base ROEs are now under 10%, which optically looks bad, given they were around 12% earlier this decade and are now in line with the 9.7% average awarded at the state level. But the MISO names will still earn about 10.4% – when including the 50bp RTO/ISO adder.
EEI the last few years has been overshadowed by shock events such as the CA fires and the Trump election win. This year was more blocking and tackling with a focus on refreshed utility capital plans that never seem to hit a ceiling. AEP, ETR, LNT, DTE, WEC, and XEL all gave new and slightly larger capital plans chock full of grid investment, renewables etc. That said, we are no longer seeing EPS growth rates go up as the law of large numbers and equity needs limit growth upside.
The annual EEI conference will be held November 10-12. 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.
AEP’s 3Q19 of $1.46 beat consensus of $1.31, on rate relief, transmission, one-timers, and weather ($0.12 vs normal). AEP raised FY19 guidance to $4.14-4.24 from $4.00-4.20 vs $4.15 consensus. AEP suggested 2020 guidance of $4.25-4.45 would be unchanged, but detailed drivers will be given at EEI, along with a new 5-yr capital plan and updated 3-yr cash flow forecast. We already know the punchline, however: AEP expects LT EPS growth of 5-7% (off $3.85 in 2018) and will be “disappointed” if growth is not at the top end. AEP stock beat the UTY by 100p and is outperforming by 480bp YTD. We like AEP’s solid EPS growth, driven largely by T&D, and in line dividend growth; plus, upside from renewables and other projects. AEP trades at a modest premium to the group average P/E; we think that could get to 1.5x premium, and thus raise our PT to $101 from $98.
It may have went under the radar, but last week FES reached a settlement with labor unions in its pending bankruptcy proceeding – resolving all issues and filing for approval at a hearing tomorrow (10/15). FES assumes all collective bargaining agreements in the settlement. We now expect the plan of reorganization to be confirmed by the judge. Once complete, the only remaining step before FES can emerge is the NRC licenses transfer for its nukes. FES filed for approval in late-April, with this typically taking 6-9 months. All appears to be on track to emerge by year-end – about one year after the last power generator came out of bankruptcy (GenOn).
The audience told the story at our conference this year. In the past, you used to hear crickets at our Yieldco and Regulated Utilities panels. This year, the Yieldcos were packed and even the smaller utilities were nearly full. Our Keynote lunch with NEE CEO Jim Robo was the most crowded meeting ever at the conference – SRO and we ran out of lunch. Power and diversified utilities used to garner the crowds – not as much this time. Many seem to be on the wrong end of the 80/20 rule – spending over 80% of their time talking on 20% of their business that is non-utility.
We look forward to seeing you at our Wolfe Utilities & Energy conference next week. Participating utilities/power companies are on the right and there is still time this week to register. The conference provides a unique mix of company presentations via panel discussions and guest speakers that provide industry insights. This report is focused on the utilities and power companies with a list of questions to ask, model summaries and industry themes below.
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