Utility earnings rose 5.0% in Q1, slightly above our 4.9% estimate. No companies changed guidance for 2019 but the same companies that disappointed at year end had issues again such as AGR, CNP, and NI (not EVRG, phew). Earnings quality stuck out to us as weak with tax or other gains driving numbers at SRE, DUK, NRG among others. AEP may have been the most incrementally positive with increasing confidence in the upper half of their 5-7% growth rate. Mega project risk continued to overhang D and DUK (ACP) and SRE (more Cameron delays), though SO kept Vogtle on schedule (for now). Finally, weak renewables conditions hurt in Q1 causing misses at AGR, CWEN, and NEP, but the influence of renewables keeps accelerating overall.
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Sempra had messy Q1, significantly beating the street but mainly on one-time tax items. That said the tax gains are in 2019 guidance so it was not a surprise the stock was weak on the EPS quality. Despite this SRE continues to be set for significant growth from Cameron and the utility investment story, especially Oncor. Moreover, the next few months should be constructive with Cameron 1 entering service and some clarity on California. We still see the stock trading at a discount to regulated peers and remain Outperform.
Utilities rose only 0.9% in April, while the market rallied another 3.9%. Utilities are now underperforming the market by roughly 670bps YTD; they have given back their entire 2018 outperformance. So, what should investors do now? The stock market rally in 2019 is becoming historic - this is only the 3rd time in the last 40 years the S&P 500 rose more than 15% in the first 4 months. One of them ended badly - the 1987 crash during which utilities outperformed. The other year was 1983 - the market flattened out the rest of the year while utilities continued to underperform. We also looked at years where utilities underperformed 650bps or more in the first 4 months as well. This has happened 16 times in the last 40 years. Interestingly, 10 of those 16 years utilities continued to underperform into year-end by an overall average of 200bps.
Our Q1 investor poll shows investors remain underweight utilities even after the sector has already underperformed by 700bps YTD. The poll has eerily similar results compared to our year ahead poll. Only 22% expect utilities to outperform for the rest of 2019 (down from 29%) and 54% expect them to underperform (up from 51%). There is roughly the same preference of midstream vs utilities (60%/40% vs 62%/38%). Power remains the preferred sector within the space (52% overweight vs 53% last poll) followed by Regulateds (43% overweight vs 52%) and then Yieldcos at the bottom (25% overweight vs 33%). Most investors (59%) expect interest rates to stay in the 2.5%-3.0% area though a lot less see rates rising back over 3% (only 5% vs 22% at last poll).
Late Friday (04/12/19), PCG and EIX shares rose 21% and 7% after CA Gov Newsom released a report from his Strike Force that included three high-level concepts to address allocation of catastrophic wildfire costs: 1) a liquidity-only fund, 2) changing strict liability to a fault-based standard, and 3) a wildfire fund. These concepts were largely expected, but we believe the stocks reacted to the Gov’s sense of urgency, his inclusion of potentially changing strict liability (inverse condemnation), and his surprise 90-day deadline for the legislature to deliver a bill. We believe a solution to the wildfire liability risk facing CA utilities must be found before the fire season picks up this fall. There are several unknowns for shareholders, such as how much they will contribute to a future fund. But for PCG we believe there is enough room in its valuation to deal with various scenarios to take on the risk.
SRE hosted its annual Analyst Day in San Diego yesterday. It was relatively uneventful, a relief after several years of analyst day disappointments. Management highlighted the change in business mix to a North American utility focused strategy with better visibility. They are committed to execute on numbers (which were unchanged from last year) and improve the balance sheet. Finally, management was most excited on its high growth potential at the utilities (9% ratebase growth at So Cal Gas, 6% at SDG&E and 8% at Oncor) and their massive growth opportunity in LNG export. The Oncor story in particular sounded very compelling.
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.
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.
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