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 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.
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.
We saw yet another large renewables portfolio sale last week when AEP purchased Sempra’s midwestern wind assets for just over $1B or $1,456/kW (with assumed debt). This follows ED’s purchase of Sempra’s California solar portfolio for $2,157/kW last fall. The market for developers to monetize their investments continues to remain robust, while we fear that some of the pure regulateds are a little late to the party here on scaling up to better diversify into renewables.
It’s been a while since Talen Energy exited the public markets seemingly just as fast as it joined. High leverage, lower asset quality, and a poorly timed acquisition were factors – then Riverstone took it private. Since then, the company has taken steps to improve itself operationally / commercially, with a focus on more stable EBITDA and Free Cash Flow beyond the 2019/2020 capacity revenues cliff.
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.
EXC’s YE18 EPS of $3.12 was in line, as was its 2019 guidance of $3.00-3.30 (vs $3.16 consensus). Utility growth remains 6-8%; and 2021 ExGen gross margins were lower than 2020 but not as bad as feared given hedging levels. In a surprise, ExGen O&M is now expected to be $75M higher going forward due to pension and LNG, causing a drag until 2022 (more on p. 3). EXC trailed the UTY by 135bp on the O&M surprise, possibly giving some a reason to take profit after a solid 52-week run during which EXC doubled the gains of the UTY. EXC awaits rulings from FERC on PJM market reform, as well as efforts for ZECs in PA, all of which could favorably impact its nuke fleet. We do not believe the stock reflects any potential upside. Despite a cut in our estimates, we believe the EXC story is intact. Reiterate Outperform.
The New England capacity auction for the 2022-2023 period began today, with results expected Wednesday/Thursday. This continues to become a less and less meaningful event for our coverage universe. VST (3.5 GW) and EXC (1.8 GW) have the most capacity in the region. NRG has some peaking capacity, PEG has several fossil units, and D/NEE have their nukes. However, a $1/kW-month change in pricing has at most a 1% impact on total EBITDA for these companies. Recently we’ve viewed the auction as a sentiment indicator more than anything. This will be the first year under the Competitive Auctions with Sponsored Policy Resources (CASPR) construct. Looking at drivers, we see prices declining for the fourth straight year, resulting in modestly lower capacity revenues in 2022.
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