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US Utilities Outlook: When Push Comes to Shove
Andrew DeVries, CFA – Co-Head of US Investment Grade Credit / Senior Analyst - Utilities and HY Power
Nick Moglia, CFA – Analyst - US Refiners and Utilities
EXECUTIVE SUMMARY
- We are keenly aware of the relentless pressure on customer utility bills spilling over into political and regulatory backlash combined with a strong aversion to issuing equity but when push comes to shove, as they say, we don’t see a single utility management team sacrificing credit quality to the point that their holdco falls from mid to low BBB.
- Our strong view on holdcos not slipping to low BBB is supported on the quantitative and qualitative front. When most utilities let holdco ratings slip from high to mid BBB it cost them 10-15 bps in financing costs but moving to low BBB in the current market would cost another 40 bps using FirstEnergy as the proxy and we don’t see any utility management team wanting to pay an extra 40 bps in a rising rate environment. On the qualitative side, letting the holdco slip to low BBB would put notching pressure on the opco to fall to high BBB and we don’t see any utility management teams wanting to invite more scrutiny on their perennially A-rated opcos by regulators.
- On the customer bill front, average electric bills are up 21% YTD thru late 2022 with gas utility bills this winter set to soar 30-40% and these increases have led to significant regulatory/political pushback. Making matters even worse, Duke and Dominion are sitting on $2.0 bn and $1.5 bn, respectively, of higher energy costs that they haven’t pushed on to customers yet, which has negatively impacted credit metrics. These deferred energy costs were cited by Fitch and Moody’s in recent negative views on the sector. To top off the negatives, utility management teams are almost universally opposed to issuing new equity in order to support their 5-7% multi-year EPS growth targets.
- On a positive note, the long-term backdrop for electrifying transportation is incredibly positive for the sector and the Inflation Reduction Act should start to help out with customer bills in 2024-25 and beyond. It is incredibly too early but later this decade utility management teams will respond to bill pressure issues by pointing out customers can charge their EVs at a fraction of the cost of filling up their cars so the “energy wallet” is going down in price. The IRA is a bigger benefit to utilities that own generation than for wires-only names as tax credits will flow directly to customer without being shared with third party owners of generation.
- On the data front, which is very positive, we point out four out of the recent five changes in FFO/debt have been positive and 2023 EPS estimates are flat since the end of 3Q. Both of these figures, rising FFO/debt metrics and stable EPS estimates, support our view the negative regulatory/political headlines are manageable. At 3Q22, the group showed an average FFO/debt of 14.4% and FFO after dividends to debt of 9.5% and we view both of these figures as stable for 2023.
RELATIVE VALUE
We expect U.S. utilities to perform in-line with overall Corporates in 2023 but the obvious defensive characteristics of the group mean significant widening for the market will lead the group to outperform and vice versa on a strong rally in corporate spreads.
Specific to the sector, for reasons we flush out in this report, we have a strong view of ratings stability at the holdcos and we are comfortable reaching for the 25 bps of yield in the holdcos over the opcos.
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