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HAL shares finished up 6.5% yesterday (01/22/2018), almost doubling the OSX that finished up 3.4%. Investors looked through what’s likely conservative guidance, instead focusing on a strong 4Q beat and positive outlook commentary, this time for both NAM and International. And with >40% of revenue generated outside of NAM, HAL’s leverage to international, a theme we favor this yr, is obviously not inconsequential. Reiterate OP & new $65 YE18 PT (10.8x ’19 EBITDA) – see pgs 2-4 for detailed valuation discussion.
Our survey is universally positive this quarter including record-high expectations for TL, Intermodal and FedEx rate increases. Pricing expectations for Rails and LTLs, as well as volume expectations broadly, also reached multi-year highs. So our survey is clearly indicative of very strong freight fundamentals.
Tax reform has been a big relative drag on utilities vs the market. Why? It’s a windfall for the market, and its complex mixed bag for utilities. We expect the tax reform discussion to dominate earnings season with a focus on 5 key impacts: 1) Earnings – some good, some bad; 2) Cash flow and credit metrics - negative for the most part; 3) Financing needs - we expect more equity; 4) Ratebase and capital plans - a nice positive due to less deferred taxes and more rate headroom to invest capital; and 5) Regulatory strategy on tax – some may simply pass it through, others may seek cash flow protection, higher equity ratios, and using rate headroom to accelerate investments. Following is our latest view of winners/losers on tax into earnings:
The AMZ is up more than 10% year to date and has outpaced the broader market by about 400 bps. Investors have started the year on a cautiously optimistic note. Fundamentally, things look attractive and we think a return to DCF/unit growth with Q4 earnings should set an encouraging tone while sector valuations still appear reasonable. KMI kicked off the season with a solid print, a good read-thru for the broader space, although project issues were a downside. We will be looking for companies to maintain discipline around self-funding plans, de-leveraging, higher coverage, and simplification. Tax reform will also be a focus for cost of service pipelines as well as the long term evolution toward C-corps. Looking forward, we see roughly 6% DCF/unit growth in 2018, which when coupled with 7% average distribution yields offers attractive total return for a sector with an improving fundamental backdrop.
BA announced a seating JV with leading car seat supplier Adient. The new venture called Adient Aerospace will develop, manufacture, and sell a wide portfolio of aircraft seating, including potentially lucrative premium seats. It’s no secret that BA has been long frustrated with Zodiac over its persistent execution issues. Zodiac suffered from deficient quality, reliability, and on-time performance with its seating products that caused delays to some 787 and 777 deliveries, angering key BA customers like AAL, for one. Through the JV, BA will have more control and can steer airlines and lessors to its product offerings. In addition, BA’s subsidiary Aviall will be the exclusive spares distributor for Adient Aerospace giving BA an opportunity to capture higher-margin aftermarket sales, in line with its strategy.
This morning (01/23/2018) FE announced that a group of investors including Elliott Mgmt, Bluescape (John Wilder), GIC, and Zimmer Partners had invested in a $2.5B equity offering by the company. Both the $1.62B convertible preferred and $850M common priced at discounts of $27.42/sh and $28.22/sh respectively, which will be used to reduce holdco debt and shore up the pension. This essentially clears the deck, with no incremental equity needed through 2020. Further, it adds an experienced group of investors to lead the looming FES restructuring process. Finally, FE was able to reaffirm its 5-7% EPS growth through 2019 at the utilities despite tax reform and equity dilution headwinds. We view this as a turning point for FE, which now has a cleaner path in its transition to be a pure play utility. The stock jumped 10% ($3) on the day.
Today (01/22/2018) H put out a press release announcing its earnings release date and noted they will “also provide a supplemental presentation, including 2018 guidance, and an update on the Company’s growth and capital strategy… The Company expects the call to last approximately 90 minutes, including an extended question and answer session.” H made reference to an “expanded” call on its last earnings call last November, so this isn’t new information, but perhaps overlooked information. We also went back and checked and H has never held a 90-minute call or planned an “update on growth and capital strategy.” This is also the first time earnings will be reported after the close with the call the next morning. This could be a catalyst for the stock. We wouldn’t rule out an increase to the $1.5B asset sale target now that tax reform makes low basis asset sales more palatable. We also expect to hear about significant capital returns to shareholders.
This afternoon (01/22/2018) Politico reported that the short-term continuing resolution passed by the Senate and House of Representatives (H.R. 195) to fund the gov’t post shutdown would also suspend the Health Insurer Fee (HIF) for 2019. The continuing resolution also suspends the Medical Device Tax and Cadillac Tax for 2 years, as well as fully funding the Children's Health Insurance Program (CHIP). President Trump signed the bill into law late this evening. As discussed below, we see the repeal as a meaningful benefit to all plans given that the lack of fee should lower the cost of all major products by 2-3%, with Med Adv the biggest winner. In addition to improving benefits we expect Medicare focused plans to see greatest potential EPS upside (HUM/WCG). Look for the industry to remain focused on a permanent HIF repeal but for the time being the HIF suspension is a clear win for 2019 and importantly should work to alleviate concerns about near term competitive pressures/offsets to tax reform benefits beyond 2018.
We continue our quest for unique and orthogonal sources of information. In the New Year of 2018, we shift our attention to an interesting textual database – S&P Capital IQ’s Call Transcripts. We showcase how our suite of proprietary and sophisticated NLP (Natural Language Processing), machine learning (e.g., deep learning via Convolutional Neutral Networks), linguistic, and psychological research are used to extract salient information from conference calls.
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