Utilities should largely reaffirm their 2017 outlooks and we project Q2 to be up 2%. We expect cost and delay risks for big projects to dominate attention starting with updates on SCG and SO’s new nuclear plants, SRE’s Cameron LNG, pipelines impacted by lack of FERC quorum such as DTE’s NEXUS, the latest on ES’ Northern Pass, etc. The other focus may be on ROEs post the CA cost of capital saga. Even though this was resolved with a 2-year deal, it appears to have renewed investor attention on ROE risk for all companies.
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Investors are showing more caution on utilities today (7/19/17) with 26% expecting outperformance and 45% underperformance to year end. This flipped from our last poll in April which was 45% outperform and 36% underperform (this was when the Trump trades were unraveling). We think the utility caution reflects a more bullish market view and that the sector has held up relatively well. Within utilities, there has been a notable shift in the regulated vs power mix which had been overwhelmingly weighted to regulateds and now is more balanced. In Power, 38% are overweight in our poll vs only 5% back in April. Regulateds are down to 47% overweight from 76% in April.
This morning (7/19/17) AGR reported Q2 adjusted EPS of $0.46 that beat our above-consensus estimate of $0.42, while reaffirming 2017 guidance at $2.10-2.35. Q2 EPS increased vs. $0.38 last year and was primarily driven by Networks’ new rate plans in NY/CT and higher renewables capacity. Importantly, the company essentially reiterated all of its long-term targets at each business line and continues to strive for 8-10% EPS growth through 2020. Stability and consistency are key to establishing further investor conviction in what is a robust growth plan. Today’s release was another step in the right direction.
It was a relief that the CPUC went back the original cost of capital agreement last week, but two things have changed as we look forward: (1) There will almost definitely be a litigated CoC review in 2019 (for 2020); we are therefore reducing our 2020E to reflect a reduction in the allowed ROEs; and (2) The circuitous path to the CoC decision last week underscores CA regulation has become less predictable for investors under the new tighter ex parte rules and commissioner changes. We like the rate base growth story for CA utilities as the state moves aggressively on carbon. And the ROEs set through 2019 is constructive. But we believe the pure-play CA stocks (EIX, PCG) will struggle to get sustained premium multiples on 2020 earnings, with allowed ROEs nationally averaging 50-55bp below those in last week’s decision. SRE’s allowed ROEs is already lower than the others, and the stock will trade more with the outcome of its Cameron LNG project.
NRG’s aggressive cost cutting and asset sale program has reinvigorated the IPP sector. It’s the first time one of the names has proven it can work in the public markets (i.e., outside of M&A activity). We don’t see a direct takeaway to the other names since most of them have already done cost cutting that is embedded in our numbers. But NRG’s transformation highlights a new IPP model that can hopefully succeed in the public markets.
In recent months, we have seen DOE, FERC, PJM and states all talk to the need to support baseload power plants from shutting, especially nuclear. It is still early on but our discussions with policymakers has been raising our conviction that either subsidies or better market structures (PJM/FERC) will likely happen by 2018. With the stocks not reflecting any real benefits from this (except for EXC’s already approved ZECs), we view this as a potential investment theme into 2018.
In a revised proposed decision filed 7/12/17, two CPUC ALJs and assigned commissioner President Picker recommend approval of the 2/7 agreement between the CA utilities and consumer groups on the cost of capital. Specifically, the revised PD adopts a 2-year extension until the next CoC application is due (4/22/19) in return for cuts in allowed ROEs by up to 15bp and rebased costs of debt, both beginning in 2018. This is a reversal in Picker’s 5/10 PD, which cut the extension to just one year while leaving the other terms intact. The 5/10 PD included language about the need to review the CoC sooner given a full review had not occurred since 2012. The 7/12 revised PD, which is expected to be voted on today (7/13/17), includes similar language and notes a lack of transparency by the parties. Still, the revised PD is poised to be approved by the CPUC, which would be positive for the CA utilities (EIX, PCG, SRE).
NRG’s new business plan calls for a sale of 50-100% of the company’s 47% interest in NYLD, as well as the ROFO assets and renewable development platform. NRG’s two objectives on this front are to create value and simplify. Deconsolidation of NYLD is a focus and could be achieved through a full sale by NRG or a partial sale to a partner with governance changes. NRG’s openness to governance changes could also expand the pool of interested partners. Overall, NRG’s plan creates a binary setup for NYLD into an expected Q4 announcement, but we think with a positive risk / reward skew.
Even after today’s 29% spike (7/12/17), we think investors should put new money to work in NRG stock. The BRC plan was at the high end of expectations, was communicated well, and will be implemented quickly. There is a good bit of execution risk on asset sales and cost cuts / margin improvement. But the upside case is so significant that we see a lot of value even under very conservative assumptions. The NRG story will now offer stronger FCF, lower leverage, and a simpler integrated gen – retail story with a TX focus.
This week we take a look at power prices ahead of Q2 reports, as generators often mark their guidance to forward curves around the end of each quarter. Forward power prices were generally lower in the east but did better in the western markets. In New England, New York, and PJM prices fell across the forward curve in all years. The western markets were higher in all years bouncing off a very weak hydro-influenced start to the year. ERCOT was the most interesting market this quarter, 2017 was weak but the out years were strong, especially in 2019 where prices gapped up about 6% in the quarter. We think this may reflect increasing anticipation of coal shutdowns based on VST comments. Natural gas for 2017 delivery fell by 4% in 2017 but was relatively flat in out years; the curve remains backwardated. On a year-to-date basis, power forwards remain down across the country, with the only exceptions being NEPOOL and ERCOT but only in 2019, where prices are up 1-3% YTD. On pages 14-24 of this report we chart 2018 power/nat gas and in most instances we remain at or near the bottom of trading ranges over the last couple years. There are not a lot of visible positive power price catalysts at this point given natural gas oversupply, a lack of summer scarcity pricing so far, and still slow progress on plant retirements.
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