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Despite Legal Troubles, PG&E In Best-Case Business Environment Long Term

Summary PG&E is coming off a rough patch with some legal troubles. The interest rate environment is favorable, and PG&E is heavily leveraged. PG&E’s cost of production has declined due to the low cost of energy. Experts have mixed opinions on the stock, but are more bullish long-term. The low interest rate environment coupled with low energy prices is a best case environment for Pacific Gas & Electric (NYSE: PCG ). The utility can use low interest rates to roll over their existing debt and use low energy prices to hedge costs of production at a historically low rates. Not all is rosy, the utility must navigate a complex and tangled legal environment, and placate concerns regarding energy grid security. Even through all these complications, PCG must continue to look forward and embrace innovation if it hopes to achieve its 2020 mandate that 33% of all power is from renewable sources. If PG&E can navigate the risks and take advantage of this favorable business environment, the company should continue to lead the U.S. utility sector. Market Overview PG&E Corporation is a public utility holding company, which means it is subject to regulatory oversight and must provide the regulatory body access to their records and books. The regulatory environment is tangled and complex, different sections of PCG’s business are regulated by one or more of these regulatory bodies: The CAISO , FERC , NRC , CPUC , and CEC . From FERC, which regulates the interstate transmissions of electricity and natural gas, to CEC, which handles energy policy and planning for the state of California. Regulation is central to a utility company like PG&E, even product pricing is done through a ratemaking process with regulators. Ratemaking is when a public utility company, like PCG or FERC, exchange information about the cost of energy production, operating expenses, and regulatory policy goals. Then the two agree on a price rate for energy which will cover all of these costs and provide a ‘fair’ rate of return. The market for energy is not competitive and is centralized is because of the large capital investment required for energy infrastructure and for real-time regulatory oversight. The government would have a difficult time regulating thousands of small electricity companies and it is possible policy demands for infrastructure would not be met. See here for more about how the California energy system works. Business Overview PG&E was founded in 1905 and continues to lead the United States as the largest utility company. The utility currently employees 22,581 people and operates mostly in northern California. The utility is diversified across many energy sectors, with nuclear generation facilities, combined cycle gas turbine electricity generators, wind power installations, natural gas pipeline and even energy storage. PG&E is a legal monopoly because of the strategic advantages of scale in the public utilities sector. Because PG&E is defined as a public utility company, many of its business choices are monitored closely or mandated by the federal and state governments. When making business changes, PG&E must move very deliberately in order to move in step with policy makers. Recently PG&E has been mandated to provide 33% of all energy from renewable sources by 2020. As you can see below, the Utility still has to acquire more renewable resources to achieve the mandate. Further the regulatory bodies have placed a growing target for energy storage. (click to enlarge) PG&E is heavily leveraged in the credit markets, because energy infrastructure is capital intensive and the payoff over long time horizons. Due to the Utility’s stability for more than a century, PG&E has been able to demand favorable terms for credit. Further, PG&E’s main products, consumer natural gas and electricity, are tied to the prices of oil and natural gas. These two energy markets are near historic lows and PG&E should be able to hedge their energy costs for the next few years at favorable prices today. (click to enlarge) Growth Plan (From the Company’s 10-K ) Managing Legal risks: The Utility has many legal risks which are outlined in the Risk section below, it is vital that the Utility effectively manage these legal disputes or future growth could be inhibited. Renewable Power Initiatives: California law requires the Utility to gradually increase the amount of renewable energy to at least 33% of their annual retail sales by 2020. Natural Gas Pipeline: During 2014 the Utility completed its system wide replacement of 847 miles of iron pipelines with plastic pipe. Energy Storage: California law has established initial energy storage targets for the Utility. The Utility currently has 80.5 MW of energy storage which meets the target. The target is expected to increase over the next few years. Additional Transmission: The Utility plans to complete a new transmission line connecting the Gates and Gregg substations. The new line is expected to reduce the number and duration of power outages, improve voltage in the area and increase economic activity in the area. Additional Distribution: In October 2014, the Utility began operations at the first of three new electric distribution control centers. These centers will utilize Smart Grid technologies for added stability to the grid. Risks (From the Company’s 10-K ) Enforcement matters, investigations, regulatory proceedings: The environment for legal risk for PCG is sizable, with a federal criminal prosecution of the Utility. Additionally the rates and tariffs which PCG can charge customers is set by the government through a legal process. Liquidity and Capital Requirements: Since PCG has been around more than a century their credit rating stable, however, the inability to continue to attract favorable lending rates would greatly reduce the profit of PCG. Operations and Information Technology: There are broad array security and cybersecurity risks which come with operating a large utility company. The majority of these risks deal with containment of large accidents, adverse weather preparation and sensitive data protection. Environmental Factors: Both the macro economic environment as well as the physical environment have large impacts on the performance of PCG. Extremely hot summers cause more demand which strains the electricity grid, while extremely cold winters strain the natural gas network. PCG must continue to upgrade the infrastructure of the Utility in order to mitigate these environmental risks. Competition From New Technology: The Utility is subject to increased competition due to the increasing viability of distributed generation and energy storage technologies. The levels of self-generation of electricity by customers (mainly solar) and the use of customer net energy metering, which allows self-generating customers to receive bill credits at the full retail rate, are increasing. Expert Opinion (click to enlarge) Analyst opinion has moved from negative three years ago, to positive in the last year. The mean price target for PCG is $57 per share, which currently gives PCG stock an upside of approximately 10%. Analysts have moved down their EPS estimates over the last 90 days, which is a bearish sign for the stock’s near-term value. However, PCG has a tendency to surprise investors with its EPS announcements. In conclusion, analysts are uncertain about the near-term prospects of PCG, but they are bullish regarding the long-term value of the company. Current Events PG&E recognized by CIO magazine as a CIO 100 Award Winner Gas pipeline explosion near Fresno, CA, which led to a payout of $1.6 billion . A recent blackout in Berkeley, CA. Conclusion PG&E is a utility that is going through a near-term rough patch, but is well positioned to take advantage of long-term trends in the energy industry. Since PG&E requires credit to invest in energy infrastructure, the current low interest rates environment is useful for refinancing current loans and starting new projects at attractive credit rates. Further PG&E benefits from a low cost energy environment which allows them to hedge their costs of production at attractive rates. While PG&E is well positioned, the future growth of PG&E is dependent upon the Utility’s ability to mitigate risks. There are significant risks to growth which PG&E must overcome and manage if they wish to continue to lead the Utility sector. PG&E is exposed to a few major legal cases which could negatively impact the company. Further, the company must integrate renewable energy resources into the grid while maintaining stability. Analysts are aware of these risks and are divided regarding the future price of PG&E. In conclusion, PG&E the largest utility in the U.S. and is well positioned to take advantage of two major market trends if it can manage the risks. The utility should continue to lead the sector and is a buy if an investor is looking for dividend capture and stable growth in the U.S. utility space. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Southern Company: Ready To Bounce

Utility stocks have gone from “hero” to “zero” in a month. Southern Company shows a historical pullback. Despite disappointing earnings, shares of Southern Company look poised to bounce from here. It’s hard to believe, I know, but the strongest sector among U.S. stocks last year was the utilities sector. The normally staid and stuffy Utilities Index returned over 30% in 2014, including dividends. Utility stocks, traditionally a safe haven for risk adverse, long-term investors, were suddenly the go-to place for a very different kind of financial animal: the “momentum stock” trader… at least for a while. All that ended in January this year. We’ve seen a substantial correction in the utilities sector so far this year, with many of the key players trading off 10% or more from their year-to-date highs. Analysts are laying blame on the strong rebound in treasury bond interest rates, which itself has been caused by the end of the Fed’s quantitative easing program (among other things). As rates climb, those looking for income and safety tend to pull money out of interest bearing stocks and put that money to work into safe havens like bonds and treasuries. This is why a chart of the 10-year yield with the utility stock index overlaid, shows a clear tendency of the two asset classes to mirror each other: [Source: MarketWatch ] I’m in the camp that counts this pullback in utilities as a great buying opportunity. Nothing has changed in the fundamentals of the underlying companies; and the lower share price makes their dividends all the more attractive. Right now, you’ll pay less for more utility yield, than at any time in the past 6 months. Among domestic utilities, there are 5 big players: NextEra Energy ( NEP , $46B), Dominion Resources ( D , $42B), Southern Company ( SO , $42B), American Electric ( AEP , $28B), and PG&E ( PCG , $26B). All 5 companies are trading around -10% below their 52-week highs. And all 5 companies have seen their dividend rates climb at least 50 basis points so far this year, making them attractive places to park cash for those looking for discounted income. My favorite among the big 5 is Southern Company . This utility company generates electricity through coal, nuclear, oil, gas, and hydro and distributes it in the states of Alabama, Georgia, Florida and Mississippi. Since peaking at $53.16 in late January as investors sought the relative safety of utilities, the stock has fallen about 14% in less than three weeks’ time, the largest pullback of the top 5. That is a move of statistical importance: it hasn’t been matched since the tail-end of the Great Recession, a time with a very different economic context. Shares are therefore ripe for a bounce from here. As of February 18th, the dividend yield of SO is 4.61%, which is currently about 110 basis points above the large-cap utilities index average. This is also the largest dividend payout among the top 5 utility companies, as the chart below demonstrates: As investors in the company know too well, at the last earnings announcement on February 4th, Southern reported quarterly revenues about 20% lower year on year, but they were, nevertheless, better than what analysts expected ( $4.1B actual vs. $3.7B expected). Quarterly earnings per share were in line with analyst estimates (0.38, adjusted for non-recurring costs, vs. 0.48 the previous year), and fiscal year 2014 showed a modest 3.7% rise in overall e.p.s., but shares still traded lower the next day by 2.6%. The reason for the selloff was that the company also lowered the range of its forward guidance; not by much, but enough to create disappointment. The causes of the drawdown in earnings were higher operating and maintenance costs, which jumped 33.4% to $1.3B, while the company’s total operating expenses for the period were over 10% higher than the prior year. There were also charges related to delays in the building of an $8 billion nuclear plant in Georgia, along with a drop in residential sales. The good news, however, is that industrial sales were up 3.3% quarter on quarter, and forward projected growth for the same is pegged at 1.7%. Both figures are much higher than industry average of 0.6%. The slowdown in retail sales, which hampered sales growth last quarter, is expected to rebound by 1.3% this next year: (click to enlarge) There are 22 Wall Street analysts who cover Southern Company. The majority of those, rate the company as either a “hold” (11) or a “sell” (10). There is only one “buy” rating on the stock (Argus). The consensus 12-month price target for SO is only $48, a mere 4.5% above current trading prices. With expectations so low, it won’t take much of a beat to generate a number of upgrades. As has been pointed out elsewhere, Southern’s management is extremely accurate in forecasting its next quarter’s earnings. In fact, Southern has not missed a forecast in ten years; and it typically predicts the narrowest guidance range in the industry. In the last announcement, the range was $0.08 on earnings of $2.80. The company nailed the top end of the range. With the guidance now lower than expected, it seems an easy task – given that track record – to show a nice upside beat. As the chart below shows, SO is in a deeply oversold condition. Shares have already completed a 61.8% Fibonacci retrenchment of its August to January run. They are also touching its 200-day moving average, which coincides with an area of former price support. The Relative Strength Index (RSI – 13) is printing a rare oversold reading below 30. All the above combine to make Southern Company a compelling buy for long-term investors, especially those looking for income. I consider shares to be attractive at this level, and I expect a rebound toward the 50-day moving average (currently: $49) over the next few weeks. If you buy the shares, you can collect the 4.6% dividend after 12 months. But in the Dr. Stoxx Options Letter, we have a way of collecting even more than that in half the time. Our put-write strategy allows us to collect a 5.5% dividend in 6 months, which annualizes to a 11% yield. This is a low-risk way of adding income to our investing capital, and if we are put the shares, we can always sell calls against the shares to lower our cost basis even further. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.