We are expecting a positive tone at Sempra’s analyst day next week. While we do not believe that there will be a lot of major new announcements at the meeting, management will likely reinforce both the solid underlying growth prospects on the current platform and outline growth opportunities particularly in LNG. The stock continues to trade at a significant discount to the regulated group despite an improving EPS mix and above-average growth potential. We are boosting our TP to $128 from $124 reflecting higher group multiples; Outperform.
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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.
Sempra held an upbeat yearend earnings conference call, beating 2018 numbers, maintaining 2019 guidance, and announcing $50M of corporate cost cuts (with confidence this goes higher). SRE also reiterated the Cameron construction schedule and the increasing likelihood of LNG export at ECA, and did a good job in our view addressing the volatility in Mexico and the planned South American utility sale, as well as a constructive tone on work in California to address wildfires. Overall we think it set a good tone going into the March 27 analyst meeting. Reiterate Outperform.
Earlier this week we held investor meetings with CFO Trevor Mihalik and other members of the management team. Their tone was upbeat, with 2018 a transformational year for SRE business mix and 2019 all about execution. Mexico government interference at IEnova and CA wildfire risks were the main concerns of investors. We believe these concerns are overshadowing SRE’s top tier growth at Oncor, LNG upsides and strong core businesses. We update our numbers for SRE’s recent asset sales, including the likely Latin America sale. Our numbers come down a little, but our S-O-P value rises $1 to $124 even with lower IEnova stock price. Reiterate Outperform.
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 threat and subsequent filing of bankruptcy kept utility investors very occupied in January. Even if investors did not own PCG itself they had to deal with knock-on effects on other CA utilities like EIX and on the renewables suppliers NEE, NEP, CWEN, ED, etc. These names dominated the worst performers of the month and were part of the reason why utilities only rose 3.4% in January trailing the market rally by 450bps.
What does PCG need from CA to avoid a bankruptcy filing? We think they need line of sight to recovery for 2017/2018 fires and structural changes on a much quicker time frame than currently set. They also need to know someone in CA leadership is willing to negotiate a deal with them – either the Gov office or PUC.
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.
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