FHB - Is Hawaiian Electric A Basket Case Or In The Bargain Bin?

2023-08-29 14:20:58 ET

Summary

• Hawaiian Electric is facing multiple lawsuits and potential liabilities in the billions due to the fires in Lahaina, Maui.
• Several factors warrant consideration, potentially alleviating Hawaiian Electric from certain responsibilities.
• Hawaiian Electric shares may be deeply undervalued if the company will not be deemed fully liable.

In the aftermath of the fires that destroyed most of the town of Lahaina on the island of Maui, Hawaii, a guilty verdict had already been reached and the media circus sentenced Hawaiian Electric ( HE ) for causing the disasters; observers, even before any thorough investigation was completed, compared this event to the 2018 fires in California , where energy company PG&E ( PCG ) was held responsible and, facing potential liabilities of up $30 billion, had to file for bankruptcy in 2019.

A minimum of four legal actions have been initiated against Hawaiian Electric by attorneys. These lawsuits claim that the company displayed negligence in the management and upkeep of its transmission lines and refrained from implementing power shutdowns to prevent the ignition of fires by power cables during instances of elevated wind and arid conditions.

The conclusion is that Hawaiian Electric is a basket case; it will face claims in the billions and will surely suffer from the same fate that hit PG&E and, as a consequence, the share price dropped 75% between August 9 and August 25, 2023.

In our opinion, being contrarians, we see this as a once in a lifetime opportunity to snatch up shares in HE at a favourable price, because we believe that the company will be able to prove it is not fully responsible for all the damage and loss of life that these sad events visited on the island of Maui.

How much is Hawaiian Electric worth?

HE comprises two businesses: a utility business and a regional bank; assuming the company had to be broken up and put for sale, let's try to come up with a simple sum-of-the-parts valuation.

Utility Business

By looking at the latest quarterly report, we can see that the company has property and equipment worth 5.5 billion dollars, about $900 million in current assets and $400 million in other assets. Long term debt stands at 1.7 billion dollars, current liabilities at $700 million and other liabilities at 1.9 billion. Subtracting debt from liabilities, the utility business is roughly worth 2.5 billion dollars.

American Savings Bank

American Savings Bank is a fully owned subsidiary of Hawaiian Electric; founded in 1925, it is a robust bank and has been growing profits quarter over quarter and year over year; in the latest quarterly report (Q2 2023) it declared $20.2 million in net income and $495 million in shareholder equity. For fiscal year 2023 it reported net profits of $80 million; its closest competitors, Bank of Hawaii ( BOH ) and First Hawaiian ( FHB ), are trading at an average price to earnings ratio of 10 and an average price to book ratio of 1.4; if we apply this ratios to American Savings, we arrive at a value for the bank between $700 million and $800 million.

By adding the value of the utility business to the bank, we can estimate the valuation of the holding company to be approximately $3.2 billion.

Is Hawaiian Electric to be considered fully responsible for the fires and the ensuing deaths and destruction?

In comparing the events in California that brought PG&E to file for bankruptcy to the events in Hawaii, a significant difference must be considered: laws in California simplify the process of attributing liability to utilities for wildfires triggered by their equipment, irrespective of whether negligence is established. Conversely, in Hawaii, plaintiffs must prove the negligence of Hawaiian Electric in order to establish the utility company's liability.

Besides that, PG&E has been deemed liable for a long list of wildfires that destroyed a total of 550 thousand acres, 22 thousand structures and caused a total of 102 deaths. In comparison, the fires attributed to Hawaiian Electric burned a total of 2,100 acres (27 times less) and destroyed 2,200 structures (a tenth). While every single life has to be considered invaluable and the death toll in Maui is likely to be higher than 102, when it will be tasked with assessing the monetary compensation for the disaster, a jury must duly consider the contrasting extent of damage caused by PG&E over multiple instances throughout the years in comparison to the singular incident associated with HE.

Despite the sheer amount of damage attributed to PG&E and facing liabilities of over $30 billion, the company reached a $13.5 billion settlement.

According to Fitch , Hawaiian Electric could face claims up to $3.8 billion; if it reaches a settlement in the same terms as PG&E, it can expect to pay about 1.5 billion dollars.

In calculating liabilities of $3.8 billion though, Fitch assumed that it will be proven beyond any reasonable doubt that Hawaiian Electric is fully liable for starting the events that caused such a catastrophe.

Yet, is HE to be considered responsible for everything that happened after the fires began spreading or some of the responsibilities in relation to the ensuing damages and loss of life have to be attributed to someone else?

To begin with, why were the public emergency sirens not activated ? According to officials "The sirens are used to alert the public to seek additional information; they do not necessarily indicate an evacuation" so residents had to rely on three other forms of emergency warnings: alerts sent to mobile devices, to local radio and television stations and via Maui County's opt-in resident notification system.

Is this acceptable? Emergency sirens are designed to convey an immediate and highly-audible alarm to the population; you don’t hear them sound every day of course and when they do, people are instantly alerted that something bad is happening and are prompted to take action.

Are the other listed warning systems as effective in conveying the message that there is an immediate danger? Not in our opinion, for the following reasons:

• Alerts sent to local radio and tv: what if my tv and radio are turned off or the volume is low or I am in the bathroom or outside? Result: Ineffective

• Alerts sent to mobile devices: children and elderly citizens are less likely to hold a mobile phone in their hands most of the time; besides that, even if I heard my phone notification sound, since it goes out many times a day, I probably wouldn’t pay much attention to it as I would to a public alarm siren. Result: Ineffective

• Opt-in resident notification system: we assume that this system relies on phone notifications as well, so the above applies. Besides that, what percentage of the population had subscribed to the service? Result: Ineffective

Why was there not enough water to extinguish the fires? Is this also HE’s fault or maybe aging water infrastructures (and those in charge of maintenance) are also somewhat responsible?

It's also possible that authorities were ill-equipped to handle fires of such extensive scale. In an emergency management plan issued by the state of Hawaii in February 2022, wildfires were assessed as presenting low to medium risks across various dimensions, including their impact on individuals, property, the environment and the efficacy of emergency management program operations.

On August 27th, HE officially confirmed that the origin of the morning brush fire in Lahaina was, indeed, attributed to power lines being toppled by high winds; but they also blamed the Maui County Fire Department because after responding to the incident, they declared it contained and left the scene, without realizing that a second wildfire was about to break out nearby.

In relation to this event, the utility company asserted that the power lines, by that time, had already been de-energized, and that it possesses documented evidence to uphold this claim. As a result, the company maintained that it should not bear liability for this particular fire.

An investigation by the Wall Street Journal details that over the course of several years, concerns among local fire authorities grew regarding the proliferation of invasive grasslands that were encroaching upon the abandoned sugar plantations situated above Hawaii's historic capital. These invasive grasses, characterized by their high flammability, had already been responsible for igniting a series of fires in the uncultivated fields during past seasons. Over a span of nearly ten years, a succession of reports consistently cautioned both State and Maui County officials about the imminent fire risks associated with these grasses. These concerns were well documented in transcripts from county meetings held over the course of several years but both county and state authorities neglected to take action.

Risks

As is customary, opportunity is intertwined with risk. Should the company fail to successfully counter the plaintiffs' argument, which posits that the fires resulted from live power lines impacting the ground due to strong winds and inadequate infrastructure maintenance, it is highly probable that it could face claims totaling a minimum of four billion dollars, and it will be forced to declare bankruptcy. Moreover, there exists the possibility that the ongoing inquiry might uncover further instances of misconduct within the company or that the eventual tally of damages and loss of life might surpass initial estimates, thereby imposing a greater compensation payout. As a consequence, the current valuation may even be too optimistic, and the share price may drop significantly as the picture becomes clearer.

Conclusions

It is probably going to take months before a final report on the fires in Maui will be issued by the authorities; meanwhile, the shares of Hawaiian Electric are poised to experience considerable volatility, owing to the uncertainty encompassing both the extent of liability attributed to the company and the magnitude of the compensation it may be compelled to provide.

In our opinion there are significant disparities between the events in California, where PG&E was found fully liable in relation to the series of fires that caused huge devastation and deaths in the course of many years, and this single event, where different state legislations apply, a definitive cause-effect relationship has not been established in relation to the second fire that eventually spread to the town of Lahaina, and the full extent of responsibilities for the events that followed the initial spark has yet to be determined.

These differences are poised to play a pivotal role in shaping the ultimate resolution of these unfortunate occurrences. They could potentially enable Hawaiian Electric to engage in negotiations and arrive at a settlement that falls significantly below the estimated $3.8 billion projected by Fitch, possibly less than $1 billion in our opinion.

Considering that the company has a book value of $2.5 billion, the volatile price that the shares are experiencing may offer valuable opportunities to initiate a long position.

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