2024-01-17 10:00:00 ET
Summary
- We had upgraded Emera's stock from a Sell rating to a Hold/Neutral rating due to the high dividend yield and more benign valuations.
- The rally from the bottom has increased the relative risks for those entering here.
- We look at the change of trajectory announced last and update our view.
Note: All amounts discussed are in Canadian Dollars
On our last coverage of Emera Incorporated ( EMA:CA ), ( EMRAF ), we upgraded it from a Sell rating. The stock had moved lower and given us enough confidence that the valuation would not be a material headwind in the months ahead. Specifically we said,
We are upgrading Emera to a "hold/neutral". Emera has done what it should have since our first article and on the sell ratings the potential returns are never going to be as high as make as they can be on the buy side.
We have to also factor in the extremely hefty dividend yield which is near 6.3% as we write this. To reiterate a Sell, we would need the expected total returns to be at least negative 10%. That means the price would need to fall another 16%, considering the dividend. While possible, we don't think it is probable.
Source: 6.2% Yielding Utility Deserves An Upgrade
That turned out to be a good point to dial down the negativity as the stock had already put in a bottom before the digital ink had even dried.
We update our views based on Q3-2023 results and the new management direction.
Q3-2023
The bulk of Emera's revenues are from highly regulated utilities. So you tend to find very little variance quarter to quarter barring some unforeseen events. Q3-2023 did not provide any surprises on that front and the company reiterated its long term plans.
That strategy has definitely worked over its history and the return profile alongside dividend growth is very impressive.
While the long term growth numbers are impressive, one must not lose sight of the fact that Emera reported operating earnings of $0.75 versus $0.76 in the same for 2022. While the overall trajectory remained on the same path, there were a few small tweaks. The first being that the company provided its 2024-26 capital investment plan of $8.9 billion. This is up $500 million from its previous plan for 2023-2025. The plan will help support their 7% rate base growth and three quarters of it will be in Nearly 75% of the capital will be in Florida. The second tweak was management finally getting the message that their debt load was no longer compatible with the current interest rate environment. We will note here that the third quarter results and the conference call were in early November, 2023. The mini-bear market was still resonating with them and the spike of 10 year US Treasury yields to 5% was still fresh in their minds. They made a decision to look for some asset sales to improve the funding profile of their capital investment plan.
Thirdly, we will raise debt at each of our operating companies to fund their capital programs in line with the regulated capital structure. The fourth and final component of our funding plan is select asset sales. As Scott mentioned, we recognize the cost of capital today is much higher than it was even a year ago. And as such, we are committing to raise equity through asset sales to help fund the robust growth opportunities in our portfolio, while at the same time strengthening our balance sheet.
We expect this prudent and practical approach to our funding plan will improve the business risk of our portfolio, the strength of our credit standing and the overall value we offer to investors.
Source: Emera Q3-2023 Conference Call Transcript
There was more color on this further in the conference call as analysts were trying to clarify what this meant for the company.
Maurice Choy
Thank you, and good morning, everyone. Maybe we could start with the asset sales of up to 15% of the funding plan. Maybe if I could ask you for additional color what brought you to this position? I know you mentioned the higher cost of capital environment, but if you could elaborate on that, or any other factors beyond that? And as a quick follow-up to that, once this asset sale process is completed, what would you view as the successful outcome, be that that credit metrics, EPS dilution or accretion, all that stuff? Thank you.
Scott Balfour
Yes. Good morning, Maurice, and thanks for the question. So, look, the rationale for this, I think you and investors have heard us say many times that we're fortunate enough to have a diverse portfolio with a number of strong and well performing assets. And within that, as we think about on a regular and ongoing basis, the allocation of capital within and across our business to make sure that we are being disciplined in that allocation on the capital, including where that capital is already invested.
And so in this market, we see the opportunity for -- I know the word commonly used now is asset recycling, but effectively redeploying some of that existing capital into the higher-value growth capital that we see across the business.
Source: Emera Q3-2023 Conference Call Transcript
Emera also committed to sell $300 million of equity to further take the stress off the balance sheet. If you read this next part carefully, you can see that the potential for a credit downgrade is up and center.
Maurice Choy
Thanks. And maybe just to finish up on a similar vein, I've seen you would have seen a recent reading action by one of your Canadian peers relating to physical asset risk. Thoughts on what that may mean for Emera and whether the cushion that you're speaking of from potential asset sales will be sufficient?
Greg Blunden
Yes. Hi, Maurice. It's Greg. I don't think the action that you're referring to has much applicability to us. We have a very different physical risk profile in our assets than the peer you're mentioning, albeit I should defer to them to respond directly to that.
If you think of the implications of that reading action, they would have -- previous to the action on Friday, they would have had a downgrade threshold of 10.5%. Ours is 10% today. But of course that downgrade threshold for them was for a rating that was a couple of notches higher than us. So I think it feels from our perspective, and we haven't had any conversations with SMP about any such changes, it feels like it's probably trying to get both us and them probably more aligned from a credit profile perspective.
Source: Emera Q3-2023 Conference Call Transcript (emphasis ours)
So overall, we had a solid direction change by management to focus on what matters most here. The credit structure.
Outlook & Valuation
Emera stands to benefit by deploying most of its capex in Florida, arguably one of the most favorable jurisdictions for utilities. As such, there is likely to be little issue with its return on equity measures over the next few years. On the Canadian side, Nova Scotia has created some issues but Emera's gets a small percentage of its profits from there and the worst case scenario seems to be priced in for return on equity there. At about 17X current earnings, Emera is not cheap, but not expensive either. What does increase its expensiveness here, is the debt to EBITDA flirting with 6.5X. That means that at some point, Emera will likely have to sacrifice growth or create some modest levels of dilution to realign this. Some of this might be happening already. Emera was ready to issue equity even when the price had dropped in November 2023. It is also selling assets that likely it would have preferred to have retained. So the muddle through climate appears likely where growth in earnings per share slows down. Risk remains that this gets rerated to a 13X-15X multiple in case there are tremors in the market.
Verdict
We thought long and hard about it. While at a similar price point in the past we had gone with a Sell rating, today we are a little reluctant. There are three main reasons for this. First being that as roll forward our estimates, things look a little better on 2024-2025 numbers. The second is that while Emera has bounced, it has still lagged the easing of credit conditions. Finally, management is now addressing the risks head-on and that helps us give it a wider berth. We are sticking with a Hold rating here and would look to get on the Sell train about 10% higher. Investors who are long should consider covered calls here to reduce their risk.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
For further details see:
Emera: Asset Sales Would Dial Down Risk, But Valuation Looks Rich