CNTHO - Eversource: Concerned About Regulatory Environment

2023-05-06 08:07:24 ET

Summary

• While earnings and dividend growth appear attractive, the 8th largest US-based utility by market cap is being battered by numerous gale-force winds, leaving it financially faltering.
• Offshore wind farm development is becoming an albatross and a growing source of uncertainty for Eversource.
• Regulators are beginning to restructure Eversource’s earnings profile, applying new “performance” criteria such as weather-related power outages.

Eversource Energy (ES) is a Massachusetts-based electric distribution, natural gas, and water utility serving 4.3 million customers in the Northeast. ES had become a darling of the offshore wind power crowd with one project soon coming online and two more under development. South Fork Wind is to be completed this year, with Revolution Wind and Sunrise Wind projects in 2025, but ES's offshore wind profile is in question. Its offshore wind projects is become an albatross for ES, weighing down its future prospects and adding a high level of uncertainty. Utilities thrive based on regulatory oversight and support and the latest move by Connecticut regulators should be worrisome to investors. As the gatekeepers of utility profitability, the actions and directions of state regulators are critical to the future of utility investments - for both the company and retail investors.

Eversource serves the states of Massachusetts, New Hampshire, and Connecticut as a full-service utility, providing the three most popular utility industries. ES is a sizeable utility with over $50 billion in assets, 3.26 million electric customers, 866,000 natural gas customers, and 236,000 water customers. ES is comprised of Connecticut Power and Light, New Hampshire Public Service, NSTAR, Yankee Gas, and Aquarion in the NE states. ES is the 8th largest US-based utility by market capitalization, slightly smaller than American Water Works ( AWK ) and Edison International ( EIX ) but larger than Constellation Energy ( CEG ) and DTE Energy ( DTE ).

Eversource, partnering with the Euroland offshore wind developer Ørsted A/S ( DNNGY ), is leading in offshore wind development off the coast of New York & Rhode Island. Its three projects are: 130 MW South Fork located 35 miles east of Long Island should power 70,000+ homes, 704 MW Revolution located 15 miles south of the Rhode Island coast should power 400,000 homes, and 924 MW Sunrise positioned 30 mile east of Long Island is designed to power 600,000+ homes. ES and DNNGY are in a 50-50 joint venture to develop these three projects and have the lease rights to an additional 175,000 acres of offshore seabed. With a total projected investment of $6.2 billion, management has reported, as of its 1st qtr. presentation , 93% of construction costs have been contracted.

However, all is not well in the New England offshore wind business. Last Dec, Avangrid ( AGR ), developer of Commonwealth Wind off the MA coast, asked Massachusetts utility regulators to void the power purchase agreement AGR has with three utilities, including Eversource, as the current electricity sales price is too low and uneconomical. The Commonwealth project, set to come online in 2028, cannot be financed and built under the current PPA prices, according to Avangrid. Avangrid requested a cancelation of the PPA contracts, which has been approved by the MA regulators, determining the cancelations "are in the public interest", and AGR hopes to re-bid the project in 2024. Commonwealth Wind is not the only East Cost offshore wind farm running into cost problems. According to a Jan 2, 2023, WSJ article , the developers of the 1 million homes-sized Ocean Wind 1 off the southern coast of New Jersey were reviewing their options and project costs before making a final investment decision. On Jan 18, Public Service Enterprise Group (PSEG) decided to bow out of its 25% ownership of Ocean Wind, selling it back to DNNDY for an undisclosed amount.

In mid-2022, ES decided to pare down its offshore wind farm exposure and am currently looking for buyers for some or all its joint venture with DNNGY. Eversource Energy executives recently said the sale process of the utility's offshore wind business is very far along, with a deal likely to be announced in the coming months. However, according to S&P, if the offshore wind sale is substantially delayed, reduced or canceled, management believes the company would for pressed to issue more debt and to wait for tax credits to begin from South Fork coming online this year. Either way, the wind asset sale adds more uncertainty to Eversource's investment profile.

Not only does Eversource have potential profit problems with its offshore wind projects, but Connecticut regulators have turned a bit sour recently. Unlike utilities in the Southeast where hurricanes and massive storms are a regular occurrence, New England states have been historically spared the anguish of a multiple-day destructive storm event. No more. Hurricanes Irene in 2011 and "superstorm" Sandy in 2012, combined with other NE storms, have shown a vulnerability due to a historic lack of "storm hardening" investments. For example , prior to 2011, Consolidated Edison ( ED ), who serves 3 million NYC customers, had never had a storm-induced blackout of more than 200,000 homes. Hurricane Irene caused 204,000 blackouts; Sandy caused 1.1 million power outages. In 2018, the utility experienced winter storms Riley and Quinn which created a combined 210,000 outages, and in 2020, Tropical Storm Isaias caused 330,000 outages in NYC. TS Isaias also caused over 1.1 million power outages in Connecticut. Overall, Northeast utilities have been trying to play catchup with regulatory-approved storm hardening investments. Utilities can beef up their infrastructure, so they are less susceptible to hurricanes, floods ice storms, wildfires, and other weather events. Investments include raising the flood levels of critical assets, replacing utility poles with strong poles and smaller crossbeams, and even placing utility lines underground. However, storm-induced power outages will mostly likely become a overriding factor in future utility rate decisions in Connecticut.

Connecticut recently moved to a "performance-based regulatory" PBR stance for electric distribution companies, which is expected to be phased in next year. CT joins a growing list of states which are drifting towards PBR, including North Carolina, Illinois, Washington, Nevada, Colorado, and especially Hawaii. Next year, CT regulators will consider procedures for "revenue adjustments" and performance criteria, such as number of days of weather-related power outages. As reported in a Feb 6 article in UtilityDive magazine,

Performance-based rules move the regulatory model away from cost-of-service that considers a utility's revenue requirements and rates of return. Marissa Gillett, chairman of the CT Public Utilities Regulatory Authority, stated in the PBR announcement, 'Cost of service regulation really revolves around a utility's perspective on what it means to provide service to its captive customers. There is little to no consideration of what outcomes or value a customer is deriving from that service and rather the focus is on compensating the utilities for its investments. Performance-based regulation is a stark departure from that mindset,' Gillett said. Instead, it's premised on compensating a utility based on progress toward identified goals, outcomes, and considerations.

Considering these above events, last June Moody's placed Eversource on its "negative outlook" list. Driven by the uncertainty of ES offshore wind programs and costs, Moody's issued the following statement:

Eversource's negative outlook reflects the company's persistently weak credit metrics and uncertainty over whether a sale of all or part of its offshore wind business and committed new equity issuance will be sufficient to improve these metrics enough to maintain its current Baa1 rating. Although the company will transition back to a lower risk regulated utility holding company if it exits offshore wind, depending on debt reduction, it may not be able to consistently sustain a ratio of cash flow from operations pre-working capital to debt of at least 15%. The affirmation of CL&P ratings with a stable outlook reflects the closure provided by last year's settlement agreement with state regulators which resulted in a less severe outcome than originally proposed.

Over the last few years, Eversource's financial metrics have been adversely affected by increased debt to finance offshore wind project development costs with cash flow generation from these projects are years away. Eversource's utilities have also been impacted by severe storms over the last couple of years and subsequent delays in cost recovery particularly due to CL&P's distribution rate freeze. Eversource intends to use proceeds from any offshore wind asset sale, as well as a $1.2 billion of planned new equity through its at-the-market program over the next few years, to repay debt and finance future capital investments at its regulated utilities. Although the debt repayment would strengthen Eversource's balance sheet and improve its financial metrics over time, the magnitude and consistency of this metric improvement is uncertain.

On the plus side, Eversource has earned a SPGMI "A" rating for 10-yr consistency in earnings and dividend growth. ES is one of only 13 non-water utility companies to have earned this rating, with no utility earning an A+ rating. Several analysts have a "buy" recommendation on the stock based on a 6% to 7% earnings and dividend growth profile, and a positive resolve to the offshore wind issues.

I have owned two Eversource subsidiary Connecticut Power and Light CP&L preferred issues for several years as part of my preferred stock income portfolio: Connecticut Light & Power 5.28% Series of 1967 Preferred Stock ( CNTHO ) and Connecticut Light & Power $3.24 Series G of 1968 Preferred Stock ( CNLPL ). CNTHO has a par value of $51.43 and pays $2.64 a year in qualified dividends. At a current price of $47.33, CNTHO offers a current yield of 5.58% and trades at an 8.0% discount to par value. CNLPL has a par value of $51.84 and pays $3.24 a year in qualified dividends. At a current price of $53.00, CNTHO offers a current yield of 6.11% and trades at a 2.2% premium to par value. Both issues are decades past call and are callable anytime. However, as with many post-call utility preferred stocks, there is little incentive for management to call these securities as any financial savings realized by reissuing these will be passed on to ratepayers. CNTHO and CNLPL are also relatively minor in value to ES with a combined IPO value of under $25 million. As obscure utility preferred issues, the daily trading volumes are in the hundreds, and some classify these as "trading by appointment only". I have been accumulating these using good till canceled orders and lots of patience. These securities are for long-term buyers only as the limited volumes preclude much trading.

As for the common, I would rate Eversource as a Hold, at best. The Northeast has particularly problematic electric utility issues beginning with a poor, and crumbling, regulatory environment. The lack of natural gas power plants aggravates NE power supply issues, with unholy amounts of foreign LNG (used to be Russian) and coal/petroleum generated power needed to meet basic power needs during cold winter Polar Vortex events.

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