This week NEP put the question of California risk to the sidelines following the 600 MW asset drop and attractive portfolio financing announced on Monday (see details in note). The cash flow from these transactions will more than offset the ~$100M of CAFD at risk from PCG-exposed projects and drive the 15% distribution growth in 2019. We continue to see NEP as highly attractive, especially with the increased certainty from the asset dropdown. We are not aware of another income vehicle with the distribution growth potential and duration – 12-15% through at least 2023 – with such a strong parent. 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.
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.
Between stakeholder comments and meeting with PCG on Wednesday (see note here) we believe that the risk that PCG seeks to reject its renewable PPAs is low. Overall this increases our conviction that NEP will not see any long-term negative impact from the PPAs. This helps NEP’s case on addressing near term cash traps, and we also note all of NEP’s PG&E exposed projects have DOE loan guarantees, which also mitigates the foreclosure risk discussed by ED in its 8K on 1/31. We continue to see a visible pathway to 12%-15% annual distribution growth through at least 2023 and NEP remains a best idea; the relative weakness surrounding the PG&E concerns is an opportunity. Outperform.
NEP units fell 6.3% on Friday (1/25/19) after reporting 2018 earnings. While the numbers were short of consensus, the main reason for the underperformance appeared to be more concern on NEP's exposure to a potential PG&E bankruptcy. However we believe FERC’s action late on Friday should mitigate this concern and we still see NEP as a highly attractive combination of long-dated income growth with a highly supportive parent and is one of the best ways play renewables. Reiterate Outperform.
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.
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.
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