Last week, ALJ Galvin of the CPUC, issued a proposed decision (PD) in the ongoing Cost of Capital case. The PD recommendation of 10.4% is in-line with expectations in my opinion. It is a 90 bp step down from the current ROE but it was expected due to the changes in the interest rate environment since 2007, the timing of the last Cost of Capital case. The final decision is expected in mid-late December. This decision along with the resolution of the Edison Mission Energy overhang (1) should decrease the valuation discount for EIX, in my opinion. I continue to rate the stock a buy and re-iterate my $51 price target.
What does this mean for the other California utilities: This decision should help to lift the valuation overhang for PCG and SRE as well.
(1) EIX subsidiary EME elected not to make interest payments dated November 15 for numerous unsecured bonds, which sets up for a bankruptcy filing for EME. I believe this is a net positive for the equity story since EME will not be EBITDA positive till 2014 and results in a valuation discount for EIX.
Disclaimer: I am long EIX stock but do not intend to trade it over the next 24 hours.
In a somewhat expected move, Edison International has handed over control of the Homer City power plant to the owner lessor’s and taken an impairment charge of $1.032 bln. The Homer City senior secured bonds (8.137% of 2019 and 8.734% of 2026) are up 5-7 points on the news and more than 10 points since the start of the year.
I believe this is a positive event for EIX equity holders and Homer City senior secured bond holders, however it is bad for the rest of the EME capital structure. Please email me for details.
My price targets and recommendations remain unchanged.
I recommend that all investors read the disclosures provided in the Homer City, EME and EIX 8k’s.
I like the equity and the Homer City pass-through notes. My price target for the equity is $51 based on the value of the regulated utility, Tax NOL’s for EME and corporate drag. I believe the unregulated generation subsidiary, EME, will have positive value, even if it is in the form of tax NOL’s ( I am including $3/ share of tax NOL’s in my price target).
I estimate the debt/ kW for the Homer City pass-through notes is $760/ kW after factoring in environmental expenditure, whereas the replacement value is approximately $1,500/ kW, and therefore it makes sense to buy the PTC’s.
- My sum-of-the-parts analysis indicates a significant discount for EME despite the fact that debt at the EME level does not have recourse to the parent, EIX. (Please see my sum of the parts analysis attached below).
- On a related note, EIX management could use the upcoming maturities of credit facilities to re-negotiate terms that could help keep the EME option value alive. The credit facilities mature in June 2012 and the unsecured notes in June 2013.
- The regulated utility SCE has above-average ratebase growth of 6-8% due to transmission expenditure to meet new RPS mandates. I believe it deserves to trade at a premium to its large-cap regulated peers.
- PJM Capacity auctions for 2015/2016 should provide a lift in my opinion, as I expect clearing prices to exceed $200/ MW-day, a significant premium over 2013/14 and 2014/15 capacity prices.
- The possible restructuring of EME could unlock valuable tax NOL’s. I estimate the tax basis is approximately $2.5 billion. Therefore, I estimate the value of EME is at least $3/ share.
- Major ratecase regarding cost of capital coming up in 2012 and also negotiations with EME unsecured creditors are likely to cast a shadow over valuation and investor interest. Therefore, I believe this stock is more suitable to those investors that can stomach some volatility.
- Most sell-side analysts are already positive and its not clear what is required to revive investor interest in the story. There are 17 analysts covering this stock and as of February 5, 2012, the average rating is accumulate.
- The discount to other large-cap utilities could continue till such a time there is a change in management.
- PJM Capacity auctions for 2015/2016 should provide a lift in my opinion, as I expect clearing prices to exceed $200/ MW-day, a significant premium over 2013/14 and 2014/15 capacity prices. As a reminder results are expected in May 2012.
- Better than expected earnings at SCE, possibly after the resolution of the cost of capital case.
- Resolution of EME debt overhang by 2013.
What to buy in the EME structure? The only securities that I like are the Homer City pass through certificates maturing in 2019 and 2026 because they are covered in a liquidation scenario; I estimate debt after environmental capex of $760/ Kw versus market value of $1,500/ kW. The Homer City Funding 8.137 of 2019 last traded at approximately $90/ 10%.
I do not like the EME 7.5% unsecured notes of 06/15/2013, which is probably the most popular trade in the capital structure. Please email me if you are interested in discussing any of these trade ideas further.
eix sum of the parts
Disclaimer: I am long EIX stock but do not intend to trade it over the next 48 hours.
Based on recent price movements (1), low hedging levels for 2013 and analyst forecasts, it is likely natural gas prices will be lower for the next few years than they were in 2011. In comparison, I estimate oil price forecasts are flat to positive and coal price forecasts are negative.
If forward prices and analyst forecasts for 2012 hold true, I believe it will be another bad year for the independent power producers, another good year for liquids MLP’s and another bad year for the coal miners. On a side-note, I believe the the delay in the implementation of CASPR is temporary and the EPA will succeed in implementing CASPR after some modifications.
In my opinion, it makes sense to remain long regulated utilities and short some coal names.
(1) Jan 2013 contract NG prices have declined approximately 30% over the past year. Producers have only hedged 13% of their total production for 2013 and are unlikely to do so with 2013 calendar strip prices below $4. This lack of hedging should translate into lower capital expenditure.
Disclaimer: I am long some regulated utilities.
The motion for an examiner was made by U.S. Bank NA, as indenture trustee for the Roseton and Danskammer SLOB bonds. In response, Judge Cecila G. Morris, the bankruptcy judge for the Dynegy case has ordered the appointment of an independent examiner for the bankruptcy of Dynegy Holdings. The examiner will study a series of transactions including a restructuring that took place a few months before the bankruptcy filing. As a result of this restructuring, the valuable coal and natural gas assets were re-organized into bankruptcy remote entities while the HoldCo and Dynegy Northeast were forced to file for bankruptcy.
Bankruptcy examiners are appointed to study allegations of fraud, dishonesty and mismanagement. In this particular case, the charge of fraudulent conveyance is the most pertinent in my opinion. In fact, there is a precedent regarding fraudulent conveyance: in mid-2010, the Tribune Company’s exit from bankruptcy collapsed after a bankruptcy examiner identified fraudulent conveyance in the LBO of Tribune Company. However, this case is not as straight forward: Would Dynegy Holdings have survived without the restructuring and have market conditions worsened since the restructuring? Please email me if you are interested in discussing further.
Discalimer: I have no position in Dynegy and do not plan to initiate one in the next 48 hours.
Dynegy, PSEG reached a settlement for $117.5 mm regarding the rejection of the Roseton-Danskammer leases. As per the terms of the settlement, Dynegy will provide an unsecured claim of $110 million and cash of $7.5 mm to a special entity designated by PSEG, Resources Capital Management Corporation, to satisfy certain tax liabilities. In return, PSEG has agreed to a number of stipulations, including support for the bankruptcy plan. Please see the link below for the actual court document. Please email me if you are interested in discussing how this settlement impacts recovery values.
DYN lease rejection bk court 227
Great Plains Energy is a 100% regulated utility in Missouri and Kansas. The combined ratebase of the regulated operating utilities is approximately $6 billion and the equity ratio and allowed ROE are approximately 47.5% and 10%, respectively. Moreover, the company plans to add approximately $1.6 billion to ratebase through 2015 due to environmental retrofits, transmission upgrades and RPS mandates. This results in an earnings potential of $1.83 in 2012 and $2.32 in 2015. However, the company is not expected to achieve its earnings potential in the near-term, for example, the consensus 2012 estimate is $1.49, or 81% of allowed ROE.
My price target is $26, which is predicated on the following assumptions: a) the company achieves 95% of its 2015 earnings potential; b) a 13.0x multiple; and c) discounted to 2013. This implies a total return potential of 30%.
Cons: The company expects to file ratecases in 1q2012, and regulated utility stocks typically under-perform during the early stages of the ratecase filing; Historical discount due to regulatory lag and inability to earn allowed ROE of 10%, however the company has an action plan to address this issue; moderate equity financing needs of $100 mm to 150 mm over the next four years.
Catalysts: filing of ratecases in early 2012 should bring investor interest in the story.
Disclaimer: I am long GXP stock but do not intend to trade over the next 48 hours.