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.
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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.
EEI was held in San Fran this week with the Camp Fire still burning and the host utility PCG unable to attend. EIX attended but there was not much they could really say. The CA situation cast a pall over many investors and it made every other utility story sound pretty darn good relative. The other big event was the FE coming out party as a fully regulated utility with an earlier than expected dividend growth resumption. As the CEO said, after 40 years of digging out of holes, FE is finally out and plans to never dig a new one. Higher capital plans, renewables growth, rising equity ratios, and portfolio restructuring were other key themes at the conference.
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:
SRE outperformed 250bp after reporting a Q3 beat and steps forward on the LNG platform. Moreover we thought the company did a very good job highlighting the five near term strategic priorities: (1) top to bottom strategic review; (2) focus on the corporate center costs; (3) review of the South American assets; (4) complete the renewable add midstream divestitures; and (5) update the financial and strategic plan at its analyst day in March. We are hopeful that these initiatives should enhance value above and beyond our current PT; Outperform.
Utilities are on a hot streak this month recapturing all of their underperformance for the year in just 2 weeks. While we expect neutral to positive Q3 and Edison Electric Conference (EEI) updates, we remain skeptical that the recent rally can be sustained. We project Q3 up 6.4% driven by favorable summer weather, rate relief and better core sales growth. Our bottom-up 2018/2019 EPS forecasts are 5.7%/6.1% respectively. Several companies will be updating their capital plans – AEP, FE, LNT, WEC, XEL, POR, DTE – with a further upward bias to capex but not much change to EPS growth rates (except XEL). Midterm elections will also be a key topic given importance of state politics for utilities; AZ (PNW) and GA (SO) will be in focus with both having tight commissioner elections and the renewables ballot initiative in AZ.
This morning (10/18/18) Oncor (80% owned by SRE) announced the acquisition of InfraREIT for $21/sh, or $1.275B. This is an 18% unaffected premium to when Hunt announced it was considering taking HIFR private in January. Note Hunt attempted to acquire Oncor in 2015. Sempra will fund its share of the acquisition with proceeds from its renewable/midstream asset sale plan. The transaction is subject to the usual state and federal approvals and is expected to close in mid-2019. Note there is a 30 day go-shop option for HIFR.
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