Wells Fargo on Utilities: Brief Thoughts On Outperform-Rated Names Part II

Wells Fargo on Utilities: Brief Thoughts On Outperform-Rated Names Part II

5) PG&E Corp. (NYSE: PCG)

Expect EPS To Rebound In 2014 – Driven by $200MM of annual unrecoverable costs to improve operations and customer service, we expect 2012 and 2013 EPS to drop to $3.16 from $3.54 in 2011. However, we expect EPS to rebound sharply in 2014 to $3.60 as the company’s next general rate case (covering 2014-2016) becomes effective and these unrecoverable costs are eliminated.

California Regulation – Although we forecast that the CPUC will reduce allowed ROEs by 75 basis points when the existing cost of capital mechanisms expire at the end of 2012, we continue to expect the overall regulatory environment in California to remain constructive.

Valuation Comments – PCG currently trades at 11.5x our 2014 estimate versus a median 2014 P/E multiple of 13.4x for its regulated peers. While we believe a discount is warranted, we think the current roughly 14% discount is overdone. At the midpoint of our $43-45 valuation range, PCG would trade at a more reasonable 8% discount to its peers, in our view.

6) SCANA Corp. (NYSE: SCG)

Reasonable Valuation - Shares trade at a 4-8% P/E multiple discounts to the Regulated Electric peer group median based on our 2012-14 EPS estimates.

COL Issuance In Sight – The NRC approved the AP1000 design on 12/22 which clears the way for the issuance of a COL for Summer units 2 and 3. While SCG’s EPC contract envisioned COL receipt roughly six months ahead of the current timeline, issuance of the COL represents a major milestone and we believe an adequate mitigation plan will be announced in Q1 that protects the cost integrity of the project.

Constructive Regulation – SCG maintains constructive relationships with its regulators. In addition, SCE&G’s constituents have demonstrated considerable support for its new nuclear strategy. Cash recovery of CWIP under the BLRA has not only minimized SCE&G’s regulatory lag but helped make the financing of SCG’s roughly $5.6B share of the project manageable, in our view.

Attractive Yield – Shares offer a 4.3% yield on the common dividend, which is higher than the Regulated Electric peer group multiple of 3.9%. We project annual dividend growth of 2% through 2015.

7) Westar (NYSE: WR)

EPS Growth Prospects – We project 5-year annual EPS growth prospects of 5% driven by rate recognition of planned infrastructure investment including environmental upgrades and transmission. Importantly, approximately two-thirds of WR’s capital spending is authorized rider type recovery that greatly reduces regulatory lag.

Constructive Regulation – We consider Kansas Corporation Commission regulatory principles to be generally constructive. In addition, FERC-regulated transmission accounts for nearly 20% of annual earnings.

Attractive Yield – Shares offer a 4.4% yield on the common dividend, which is higher than the Regulated Electric peer group median of 3.9%. We project annual dividend growth of 3% through 2015.

Reasonable Valuation – Shares trade at 13.7x our 2013 EPS estimate of $2.10, which is a modest discount to the Regulated Electric peer of 14.0x.

8) Wisconsin Energy (NYSE: WEC)

Transparent EPS Growth Prospects - We project 5-year annual EPS growth of 5% driven by a combination of rate recognition of infrastructure investment and share buybacks. We have a relatively high degree of confidence in our EPS growth forecast for WEC versus other Regulated Electric names given clear investment plans, a constructive regulatory environment and strong cash flow profile, in our view.

Strong Cash Flow Outlook - We project WEC will generate free cash flow (FCF) of $900 million during the period 2012-15. We define FCF as operating cash flow less capex and dividend requirements. The FCF profile provides management with great flexibility to pursue incremental regulated investment opportunities or return capital to shareholders via higher common dividends and share repurchases. We currently forecast share buybacks totaling $600 million during the period 2012-15.

Dividend Growth - We project annual dividend growth of 10% during the period 2012-15 off the current annual rate of $1.04/share. By 2015, we project WEC's payout ratio will increase from the current level of 49% to approximately 60%, which is consistent with the Regulated Electric group median.

9) Xcel Energy (NYSE: XEL)

Strong EPS Growth Prospects – We project compound annual EPS growth of 5% during the period 2011-15 driven by regulated infrastructure investment. However, we believe XEL could achieve a modestly higher EPS growth rate via improving earned returns and/or asset acquisitions.

Diverse Capital Plan – XEL’s capital plan includes a wide variety of projects that encompass transmission, nuclear uprates, new generation (gas and renewables) and environmental upgrades. As a result, we believe XEL’s capex and EPS outlook is not overly reliant on any one project.

Constructive Regulatory Environments – Approximately 80% of XEL’s rate base is located in Colorado and Minnesota. We view both states as having constructive regulatory environments with positive attributes including average-to-above average allowed ROEs, rider mechanisms for large capital projects and the use (or the ability to use) forward looking test years.

Valuation Comments – Shares trade at 15.4x and 14.5x our 2012 and 2013 EPS estimates of $1.80 and $1.90, which are roughly in line with the Regulated Electric peer group medians. We believe a premium valuation is warranted in light of potentially higher than peer group average EPS growth (6-7% vs. peers of 5-6%) and better regulation.

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