Mild weather, high interest rates and a changing M&A market dampened second-quarter results for many US electric utilities.
Even though 79% of Evercore ISI's covered companies "met or exceeded" expected EPS, numerous management teams emphasized cost reduction plans for offsetting both macroeconomic pressure and weak energy demand, the investment bank advisory firm told clients Aug. 13.
"The theme was that these companies ... think they can make up for that in the second half with cost cuts, but I would say that any kind of initial mild weather throughout the rest of the year could mean some earnings misses," Neil Kalton, managing director of utility equity research at Wells Fargo Securities, said in an interview. "We've been surprised over time at how much companies can dial back [operations and maintenance] spend to meet numbers, but there are limits."
Mitigating weather, interest rates
Mizuho managing director Anthony Crowdell expects the entire sector to struggle with interest rate headwinds into the second half of the year.
"For utility investors I think the 'Goldilocks' scenario would be the economy goes to a hard landing and the Fed begins to cut rates, and I think we actually have the opposite right now," Crowdell said in an interview.
As a strategy for mitigating interest expense while meeting capital needs, utilities including Duke Energy Corp., CenterPoint Energy Inc., Southern Co., PPL Corp., Alliant Energy Corp., CMS Energy Corp. and FirstEnergy Corp. have issued convertible and hybrid securities, Evercore ISI noted.
On CenterPoint's July 27 earnings call, Executive Vice President and CFO Chris Foster pointed to scorching temperatures in the utility's Houston-area service territory in July and August as helping to offset mild weather during the first half, as well as the impact of high interest rates, which management expects will persist through 2023.
Higher rates for longer also mean cost cuts alone will not be enough to maintain equity valuations, according to Crowdell.
"Stocks that need to issue equity in this environment where equity prices are declining or trying to sell assets to potentially fix some of their balance sheet, I think those stocks will underperform the group going into the remainder of the year," he said.
Buyers' market
After a slew of sales in 2022, appetites for utility company M&A are also muted as public firms streamline holdings and private capital dealmaking slows.
Eversource Energy, Algonquin Power & Utilities Corp., Dominion Energy Inc. and American Electric Power Co. Inc. are among those looking to unload regulated and commercial assets in the near future, and Crowdell said those potential sale proceeds "will be on the lower end."
Some companies are reevaluating what their noncore portfolios are worth. Both Eversource, which is finalizing a divestment from its offshore wind portfolio, and Duke, which agreed to sell its contracted renewables holdings to Brookfield Renewable Partners LP in June, have recorded $331 million and $2.3 billion impairments, respectively, on those assets so far in 2023.
"Asset sales don't seem to be the cure-all that they maybe once were and as we've seen, valuations especially for renewable assets have gotten softer and softer," Crowdell noted.
In an Aug. 11 note to clients, Mizuho analysts called Constellation Energy Corp.'s $1.75 billion purchase of NRG Energy Inc.'s 44% stake in the South Texas Project nuclear facility "buyer friendly" and the acquisition of Duke's commercial renewables business as "favorable" for Brookfield.
BMO Capital Markets analysts in July suggested that a 50% stake sale in export terminal operator Cove Point LNG LP to Berkshire Hathaway Energy for $3.3 billion may have disappointed Dominion investors, given that "higher interest rates and lower legacy contract cash flows placed downward pressure" on the sale price.
Dominion, which continues to conduct a strategic review, will likely need to sell additional assets to repair its balance sheet and recover shareholder confidence. But some analysts expect interest in the company's gas local distribution companies, contracted solar portfolio, renewable natural gas business and planned Virginia Beach Offshore Wind Project to be quite limited.
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