EIX - PG&E Reaching Fair Price But Preferreds Remain Undervalued

2024-01-02 03:21:30 ET

Summary

• Recovering PG&E has bucked the generally downward trend of utility stocks over the last two years.
• Consumer anger over rate increases is putting pressure on regulators to get tougher.
• Preferred issues that yield more than those of other major utilities remain a good value.

Since I placed a buy rating on PG&E ( PCG ) stock in February 2022, the stock has risen 59.6%. My thesis, expressed in May 2022, was that wildfire safety improvements that followed the 2019 bankruptcy filing were not being fully appreciated by the market.

Since then, the Northern California electric and gas utility has passed a number of milestones that make it a safer investment.

• In December, the Fire Victim Trust sold the last 67.7 million of the 477 million shares it was issued in the 2020 bankruptcy proceeding. The completion of the sale process, which produced more money to fire victims than the settlement envisioned, removes an overhang to the stock.
• Rains over the last two weeks quenched any lingering fire concerns for this season, with no major wildfires caused by PG&E equipment in 2023. The company is estimating fire risk reduction has reached 94%. Fines from the last disaster, the 2021 Dixie Fire, were finalized at $45 million .
• In November, the California Public Utilities Commission allowed an average 12.8% rate increase for the typical customer, starting January 1, 2024. This settles the general rate case for the current four-year cycle. Smaller increases will be allowed in subsequent years. This is about 70% of what the utility had asked for.
• Soon after the rate increase was approved, the company declared its first dividend since before its bankruptcy, payable January 15. Although the payout is only $0.01, it makes the stock buyable by funds that require dividends.
• The company estimated 2023 earnings at $1.20-$1.23 a share, with an increase of 10 percent plus in 2024. At the midpoint, the forward P/E is around 13.5 times.
• As the chart shows, the recovering PG&E stock has bucked the two-year downward trend in utility stocks that was due to higher interest rates.

Negative Factors

Against these positives, there have been signs that higher short-term interest rates and escalating costs are starting to bite.

In late November, the company sold nearly $2 billion in convertible notes at 4.25%. The proceeds were used to replace floating short-term notes that had reached 8.44%, so the refi makes sense, but there is a potential cost to shareholders. The notes can be converted in September 2027 to common stock at $23.18 a share, which means any stock price higher than that could cause dilution and downward pressure from arbitrage (short common/long notes). The stock had a one-day drop on the news.

Also, just after the rate increase was approved, PG&E filed for another one. The $2 billion request is largely intended to cover the costs of preparing for storms and fires, and together with the one already approved will lead to an estimated increase in average monthly bills of $34.50 this year.

The filing drew immediate cries of outrage.

“A second proposed rate hike, just a few weeks after their initial request to raise prices was approved by the California Public Utilities Commission, is utterly unacceptable,” said Assemblymember Carlos Villapudua, D-Stockton.

It even sparked a call for a ballot initiative to make the CPUC an elective office, rather than one appointed by the governor that is seen to be too generous with rate increase requests.

For if there’s ever been an agency in state government that favors the industry it regulates over the consumers it’s supposed to protect, that is the PUC."

In scanning the 900-page CPUC decision , the regulators are balancing many concerns, including keeping prices affordable for low-income customers, fire safety improvements such as 1,230 miles of underground power lines, and renewable energy goals. They appear less favorable to compensation boosts for utility management and lower rates for customers who can afford it.

Peer Comparison

The closest peer is Edison International ( EIX ), which owns Southern California Edison. Sempra ( SRE ), a more complex holding company, owns Southern California Gas and San Diego Gas & Electric among other businesses.

Source: Yahoo Finance

PG&E's forward P/E, once depressed, has largely caught up to the others as the post-bankruptcy recovery continues. Its profit margin is a little better to Edison's, but it has had to borrow and invest so much money that its return on assets remains by far the lowest. The yield is far worse.

The stock no longer seems obviously undervalued. I've sold my shares and am reducing my rating from Buy to Hold.

Values In Preferreds

The recovery has been less striking for PG&E's eight series of fixed-rate cumulative preferred issues. Two years after paying arrears on their dividends and resuming quarterly payments, they remain stubbornly lower than their peers, with correspondingly higher yields stuck in the 7% range versus around 6%.

With the state-created $20 billion California Wildfire Fund helping pay for wildfire damages that exceed $1 billion, as wells as safety improvements, I don't see much risk of preferred dividends being suspended again.

As previously stated, PCG.PA and PCG.PB are my favorites because they offer attractive coupons and can never be called, which means they can rise well above par if interest rates go back down. I continue to own the B series and rate both a Buy.

For further details see: