PCG - PG&E Is Tempting But I Still Refuse To Buy

2023-03-09 12:39:07 ET

Summary

• With climbing revenues and net income, the company is recovering well from its bankruptcy.
• If current trends continue, the company should eventually offer a dividend.
• They have mitigated some of the risk of wild fires, but not enough to make me a buyer.

Thesis

PG&E Corporation ( PCG ) has had a troubling past but seems to have gotten back on its feet. This apparent turnaround story was forced to file bankruptcy in 2019 and struggled immediately afterwards but has become financially viable over the last two years. Even though the company has induced a mitigation program, I believe they are still at risk from bankruptcy inducing fires. I am assigning a recommendation of Hold to PG&E because even though it has improving margins and increasing revenue, it's just too risky for me.

Company Background

PG&E Corporation provides natural gas and electric service to 16 million people in northern and central California. With around 23,000 employees, it is one of the largest such companies in the US.

The company was found guilty of negligence and obstruction after interfering with the investigation of a 2010 natural gas explosion that killed 8 people. Since 2017, PG&E has had to pay out $25.5B for damages incurred as a result of over 30 fires that destroyed more than 23,000 homes and businesses and killed more than 100 people.

Long Term Trends

Normally this is where I would cite the CAGR on Natural Gas and give a few facts about how I like that the company is embracing Hydrogen , and then also cite its CAGR ; but instead I'm going to talk about drought.

The western United States is currently experiencing the worst drought in over 1000 years and it's projected to last through 2030 . Prolonged droughts carry an increased risk of fire and Nasa is projecting the rate of wildfires to increase. Even after January's record rainfall , significant parts of the state, are still critically threatened.

Financials

As of Q4 2022, the company had $734M in cash and equivalents and was generating $513M per quarter in net income.

Looking over the last decade of operations, this company has been steadily growing revenue and maintaining gross profit margins. The wave of bankruptcy inducing lawsuits that hit the company in 2018 and 2019 show up clearly in its financials.

Looking at them quarterly, revenue varies seasonally but is steadily climbing. Net Income has also shown a nice improvement.

The quarterly margins also look good. Gross and net are both choppy, but seem to be steadily improving over time.

This is what I am referencing in the title when I say this company looks tempting. At first glance, without understanding the situation the company is in, its financials are giving me most of the things I look for when I look to buy growth companies.

Valuation

As of March 8th 2023, PG&E had a market capitalization of $32.46B and had traded at $16.21 per share. Seeking Alpha gives the company a D+ on Valuation. I suspect the reason it shows as undervalued on most of the individual scores, but overvalued on the overall score, is because the company does not offer a dividend and most Utilities do.

Risks

Besides the risk of their transmission lines causing additional wild fires, the company also has earthquakes in its service area. Natural gas lines are notorious for causing fires after being damaged by earthquakes. Although rare, the potential does exist for a natural disaster to be large enough to negatively affect the company.

Catalyst

PG&E has a steadily improving balance sheet and does not yet offer a dividend. If they ever do, I expect the share price and market capitalization to go up significantly.

The company is an advocate of burying most of their lines and this is a fantastic long term solution to solving their wild fire problems but I am not sure if they are merely talking about it in interviews or if this plan is already being implemented. Maximizing fire mitigation is critical for the long term health of the company.

Conclusion

This company seems to have a healthy and improving financial situation, but it operates in a place that has challenges that other utility providers don't face. The consequences of which have already forced this company into bankruptcy once, and still have a small chance to do it again.

If I hear that this company has buried a majority of their lines and is almost done converting the last of them, I will abandon my thesis and consider becoming a buyer.

How Would I Invest Into PCG?

If I were going to buy any PCG stock, I would make sure to buy in increments of 100 shares so I could run a collar calendar spread. By selling a covered call with about two weeks to expiry, and at the same time buying a put with about two months of time on it, one can protect themselves from catastrophic losses. This is not a strategy that protects against small losses, it's really only good for dealing with huge moves in share price.

As this strategy plays out over time, old puts start accumulating. After two months, you should be up to 4 puts. Owning one put protects you from losing more than $324, multiple puts means that if a catastrophic event does happen, you are very likely going to make way more from the puts than you lose in share value.

If the catastrophic event is not one that directly affects the operations of the business, say a global liquidity crisis, then sell the puts and buy more shares while they are cheap. If the event is something that will negatively affect the business, like another major town-erasing wild fire , then sell the puts and the shares, then go look for other opportunities.

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