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Summary OGE Energy has suffered lately due to its ownership interest in Enable Midstream Partners. This weakness is likely to remain in place in the short term, but the regulated utility business will bolster earnings. Compared to partner CenterPoint Energy, OGE Energy looks to be the more attractive deal currently. OGE Energy (NYSE: OGE ) is another pseudo-utility option for investors, with both a regulated electric business and an equity ownership interest in master limited partnership Enable Midstream Partners (NYSE: ENBL ). The regulated business does substantially most of its business in Oklahoma, serving nearly one million customers throughout the state (including Oklahoma City). Power is provided through the company’s ownership of 6.8GW of mixed electric generation. By peak capacity, OGE Energy has more production available at its natural gas facilities, however in general the company has relied on its coal-fired units for baseload generation due to cost advantages. The equity ownership in Enable and how it came to be is an interesting one. Enable was founded by OGE Energy, ArcLight Capital Partners, and CenterPoint Energy (NYSE: CNP ) ( prior research by myself on CenterPoint is available here on SeekingAlpha ) in 2013. CenterPoint has a majority interest through the limited partner units, but both parties have equal management ownership rights. CenterPoint and OGE Energy elected to spin-off Enable from Centerpoint in April of 2014 to raise capital, while also swapping their common stock ownership to subordinated to appease prospective investors. As I cautioned investors in October when I wrote on CenterPoint, while exposure to midstream operations has been a trend in many utilities lately and can boost the earnings growth, such operations can also bring volatility to the stock price. In the time since that research was published under two months ago, Enable has fallen over 30%, now down 45% over the past six months. This has dragged both CenterPoint and OGE Energy down along with it, compared to a relatively boring performance for the utility sector as a whole over the same timeframe. Is it time to go bottom fishing for a deal in either of these two names? Historical Results For The Utility Business (click to enlarge) I’ve stripped out the results for OGE Energy’s utility assets above, so this is purely the results from the regulated utility segment. Revenue growth has been solid for the company, primarily due to Oklahoma’s relatively favorable economic profile compared to the rest of the country. Oklahoma City and other large cities have seen sizeable inflows of interstate migration, and charge-offs have been low due to below average unemployment and better than average median household incomes. Operating margins, however, have contracted. This is primarily due to increased depreciation and amortization expenses, stemming from additional assets being placed into service throughout the period. Capital expenditures have been quite high, even excluding the midstream pipeline infrastructure, from 2011-2013. This has moderated somewhat in 2014/2015, but further ramp-up is likely in the coming years. The reason for that is the company’s coal power plant exposure. From 2015-2019, the company estimates it has over $1B in capex costs directly related to bringing these coal power plants into emissions and regulatory compliance, while also converting two to natural gas where it deemed upgrades unfeasible. (click to enlarge) * OGE Energy Investor Presentation, EEI 2015 Like many Midwestern utilities that have traditionally used coal as a primary source of power generation, OGE Energy has been engaged in a lengthy dance with federal and state regulators. It recently won a one year extension for compliance for Mercury Air Toxic Rules (through April 2016) and lost many filings and appeals over the EPA’ Federal Implementation Plan, which it tried to push all the way to the U.S. Supreme Court. While these costs will be eventually passed along to utility customers and likely recovered, this recovery will take time and the burden of the costs over the next several years will likely dent short-term cash flow. The likely cash flow shortfalls in the coming years will be a continuation of recent trends. OGE Energy has raised $1B in net debt since 2011, but managed to minimize the impact of this by using proceeds from the spin-off of Enable as an offset. Given the current market appetite for Enable common units being weak at best, it is unlikely management will elect to sell any of its currently held units to the public to raise cash. To pay for 2016-2019 capex, investors should expect the company to turn back to the credit markets again, making good use of its solid credit ratings. While OGE Energy is already paying $150M in annual interest expense, its leverage ratios remain low (roughly 2.7x net debt/EBITDA on 2015 full year expectations). Conclusion Enable’s results are the wildcard here. In my opinion, if you’re willing to shop for or own OGE Energy, you should also be willing to buy CenterPoint Energy, and vice versa. While CenterPoint trades cheaper at 7.9x ttm EV/EBITDA compared to OGE Energy’s 9.7x, I think the risk/reward favors OGE Energy still. You’re getting a lower levered player with a higher quality regulated business. However, in the end, you might end up with both company’s assets anyway as I think OGE Energy and CenterPoint are ripe for a merger. Both management teams already work closely together due to their interests in the Enable entity, and tying the companies’ fates together makes economic sense. The joined company would enjoy further diversification and the companies operate right next door to one another geographically. Utility consolidation has been an ongoing trend, and a merger here is one of the more obvious remaining moves among smaller utility names in my opinion. Scalper1 News
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