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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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.
PCG’s impending bankruptcy will impact a wide swath of companies especially renewables suppliers. These include large ones investors are aware of (CWEN, NEE/NEP, ED) and smaller ones not so obvious (NRG, DTE, likely others). For the other CA utilities, EIX and SRE, investors will be focused on what this means for getting long-term fixes for wildfire risks. Project risk continues to rear its ugly head as we have seen with ACP pipeline delays. Key updates this quarter include D/DUK on ACP, SO on Vogtle, AGR on NECEC and Vineyard Wind, and SRE on Cameron. Pension risk (and OPEBs and NDTs) due to the Q4 market swoon and drop in rates could hurt as D highlighted recently. NI, ETR and others may face some headwind.
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:
ETR’s 3Q18 of $3.77 beat consensus of $3.00, mostly due to a $0.71 tax gain and $0.50 of NDT earnings at EWC. ETR raised 2018 guidance to $6.75-7.25 from $6.25-6.85. But ETR is tracking around the midpoint of its utility net parent (UPO) outlook of $4.50-4.90 for 2018 and affirmed 2019-21 ranges. On 10/30, ETR trailed the UTY by about 135bp on news that the utility knew of plans to use paid actors at past New Orleans City Council meetings to show support for a proposed power plant. While the NOLA Council voted to fine ETR $5M, the stock recovered more than the hit earlier this week, beating the UTY by 235bp following today’s earnings call (10/31/18). We believe the NOLA issue is minor. Importantly, ETR will provide 2019 drivers and 3-yr capital plan at EEI. Using a half-turn discount to our utility group P/E, ETR looks nearly fairly valued on our 2020 UPO EPS of $5.40.
Last Thursday (10/25/2018), PUCT held a workshop that featured a review of ERCOT’s summer 2018 performance. Importantly, PUCT decided that any changes to ERCOT’s Operating Reserve Demand Curve (ORDC) or scarcity pricing mechanisms, will be made by the end of this year. The primary change being advocated for by generators is shifting the loss-of-load probability higher. EXC said the change would bring $4B in additional revenue to ERCOT over 4 years. Much of the debate on Thursday was over ERCOT’s ability to replicate its 2018 performance, when record peak demand was met with exceptionally low outage rates (~2 GW during 2018 peak vs. ~5 GW during 2017 peak vs. ERCOT’s ~4 GW base case assumption).
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