Wolfe Chief Investment Strategist Chris Senyek published a report recently with more detailed thoughts on the individual Democratic candidates for the 2020 presidential election. For now, the race looks tight and we likely won’t have clarity on the nominee for at least another 3-4 months. Below, we highlight some core tenants of each individual’s energy policy, particularly as it pertains to utilities and power.
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1-10 out of 545They say bull markets climb a wall of worries and this year has been a great example. November was a breakout month for the S&P 500 (up 3.4%) and a breakdown month for defensive sectors like utilities (down 2.3%). The market is now up 25.3% for the year beating utilities by 680bps. This is despite a nearly 100bps decline in 10-year Treasury bond yields YTD. In retrospect, utilities moved ahead of bonds with their strong yearend 2018 move so they had less room to run once it happened. And lower bond yields and Fed easing have helped the market even more than utilities. While there is a lot to worry about in 2020, not the least of which is the election, we remain underweight utilities and wait for the current 10% premium to get closer to its historic 4% average.
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.
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.
In our view, both NRG and VST made compelling cases on Q3 calls when discussing future EBITDA and Free Cash Flow growth based on real capital allocation flexibility.
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.
NRG and VST both had strong Q3 earnings updates this week – mostly meeting or beating consensus expectations on financial metrics across the board. VST posted in-line Q3 EBITDA, 2019 guidance narrowed higher (ahead of consensus), 2020 guidance above consensus (slightly below us), and talked about a flattish 2021 on its own fundamental view. NRG’s Q3 EBITDA was also in-line, 2019 guidance was narrowed at the midpoint, and 2020 guidance slightly beat consensus. These were solid numbers across the board. Additionally, VST talked to only 5-8% of EBITDA being “at-risk” long-term, with only modest reinvestments (as a percentage of cash flow) needed to more than replace this. NRG surprised with a fresh dividend policy of 3% yield plus 7-9% growth, while targeting a high-level capital allocation framework of 50% growth and 50% shareholder return over time with growth still subject to very high return thresholds (12-15% unlevered returns).
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.
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