Wolfe Research Senior Utilities Analyst, Steve Fleishman, and MLP Analyst, Keith Stanley, hosted a webcast discussing takeaways from the PJM auction.
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PJM auction prices were somewhat favorable overall. The headline RTO price of $77 was very weak, but strong premium prices across ComEd ($188), EMAAC ($188), and DEOK ($130) were positive. 59% of capacity owned by the 6 largest publicly traded PJM generators is in these 3 premium zones. That said, PJM capacity revenues are now set to decline for every generator in both 2019 and 2020 off a 2018 peak (Exhibit 1). We also worry zonal premiums may be difficult to maintain over the long run.
Earlier today (5/23/17), the Kansas Corporation Commission issued an order rejecting GXP’s petition for reconsideration on the Westar merger. The KCC once again echoed its Staff recommendation and noted that a new merger agreement would have to be substantially different and provide a wealth of new information to pass the standards – requiring a new application. That said, the KCC encouraged GXP/WR to continue working together on a deal that addressed its concerns around price and leverage, welcoming the filing of a new application that would satisfy merger standards and advance the public interest. Importantly, the KCC did not specify a timeline for a new merger application. Recall Staff/CURB pushed for a new 300-day process and WR’s CEO made comments (link) indicating this would be an “obstacle” and “challenging.” Statutorily, a new merger application would have a 300-day time clock, but GXP/WR appear to remain hopeful that some sort of expedited timeline would be used.
We attended the American Gas Association (AGA) conference in Florida the last few days. M&A activity has noticeably changed the players at AGA. The big electrics – SO, DUK and D – attended for the first time after recent gas LDC acquisitions. So did several of the Canadian utilities. Investor attendance seemed notably higher too. We found ourselves talking a lot more on electric issues with companies than gas. Why? The gas businesses have such solid growth and visibility that there is just not much to talk about. Other key takeaways: 1) less M&A scuttlebutt; 2) everyone is still waiting for a FERC quorum, hopefully resolved soon; 3) midstream projects still face siting risks but not insurmountable; and 4) utility ratebase growth appears never ending.
Last Thursday (5/18/17), the WSJ reported VST had made a takeover approach to DYN, citing shareholder desire to increase liquidity in the stock. DYN stock popped 25% on Friday and VST (along with other IPPs) was up modestly. This wouldn't shock us longer-term but it seems premature given DYN's need to delever and VST’s focus on optimizing its ERCOT position. If we assumed a takeout of DYN at $12/share, we would see the pro forma entity trading at 3-4x Net Debt/EBITDA and 7x EV/EBITDA. We remain skeptical something is imminent though.
The PJM capacity auction results for June 2020 – May 2021 will be released AMC on May 23. Fundamental power sentiment is at a record low, but recent M&A and activism potential has provided some enthusiasm. We see RTO clearing around $120, which is toward the top end of market expectations of $100-120. This is up modestly from $100 last year, but would still lock in a second consecutive year of lower capacity revenues in CY 2020. Thus, we see an upside surprise in the auction as possible, but would lean toward taking gains on any post auction rally as investors focus on challenged 2020 outlooks.
Wall Street Journal reports Vistra considering Dynegy bid Thursday night (5/18/17), WSJ reported that VST had made a takeover approach for DYN. Talks appear to be in the preliminary stages. The article cited a desire by equity owners to increase scale and liquidity. The news isn't shocking – both companies have talked about each other as potential partners for a long time, DYN's stock price is depressed, and VST's stock is now listed and their balance sheet is well-positioned to be a consolidator. But VST seems focused on optimizing its ERCOT position at the moment and DYN needs to show de-levering progress. We are a bit skeptical on the timing of this.
We lower our EBITDA estimates slightly for 2017-2019 primarily due to first quarter results being slightly below our expectations as well as a modestly more conservative acute care outlook (+7% growth vs. 8% previously despite strong Q1’17 results). Our estimates decrease by ~1% in 2017 and ~2% in 2018 and as a result our price target also decreases by $2 to $147. Looking at the stock, from here performance will be tied to trajectory of behavioral turnaround and whether Q1’17 length-of-stay weakness is transitory or continues to weigh on results thru the rest of the year. In addition, repeal/replace uncertainty will weigh on provider stocks in general. That said, UHS remains our favorite provider stock, with risk/reward positively skewed given a FCF yield of 6%+ and limited leverage at ~2x Debt/EBITDA, which should provide downside protection even if bull case scenario of behavioral turnaround and psych investigation settlement takes longer to play out.
A Dow Jones press report last week suggested that CPN has started a sales process for the company with PE firms as the likely acquirers. The stock rose 24% on the week and ignited a 8% rally in the left-for-dead IPP sector. CPN has still not confirmed or denied this. We addressed our take in a recent note (link) which said that CPN may have given up on the public markets ever giving it credit for its assets and cash flow. This raises a question that investors ask all the time; ”What do private equity firms see in power assets that the public markets do not?
We are downgrading PCG to Peer Perform from Outperform due to the CPUC’s new proposed decision shortening the agreement on cost of capital to 1 year from 2 years. Although we continue to like PCG’s rate base growth story and strong B/S, we believe the cost of capital proceeding next March will be a headwind for PCG to reach a decent premium multiple versus peers. Moreover, PCG has solidly outperformed peers since the original deal was approved 2/7. The material revision to an all-party settlement is unsettling, and puts the utilities in a no win situation. They cannot withdraw from the deal (one year certainty better than none). Still under the new PD they give up 15bp ROE but get only half the certainty agreed upon.
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