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CenterPoint executive turnover, oil exposure has analysts questioning next steps

Utilities are traditionally a safe harbor for investors in turbulent markets. But for CenterPoint Energy Inc., the accelerating COVID-19 pandemic and a potential recession have exacerbated uncertainty for the Houston utility, which has been juggling a recent mega-merger, executive turnover, exposure to the collapsing oil market and may now itself be an M&A target.

On April 1, CenterPoint announced it is cutting its quarterly common stock dividend to 15 cents per share and reducing 2020 capital spending by about $300 million to $2.3 billion. The dividend cut felt abrupt for some, after the company had, just under two months earlier, increased its quarterly dividend to 29 cents per common share from 28.75 cents per share, or a penny increase on an annualized basis.

"I really look at dividend increases as management and the board signaling what is going on," Morningstar analyst Charles Fishman said in an April 6 phone interview.

Wall Street had been concerned about the outcome of an electric rate case in Texas, in which CenterPoint Energy Houston Electric LLC agreed to a lower overall revenue requirement as part of an unopposed settlement. The decision to increase the dividend despite the anticipated lower recovery was seen as a positive sign by investors.

"Obviously, that was before the severity of the coronavirus hit as well," Fishman said.

CenterPoint's stock closed at $12.10 on March 23, down from $23.75 March 2 during a month in which investors apparently questioned the defensive nature of the utility sector.

READ MORE: Sign up for our weekly coronavirus newsletter here, and read our latest coverage on the crisis here.

The company said dividend and spending cuts were needed to strengthen its financial position in response to Enable Midstream Partners' decision to cut its 2020 capital expenditures by $115 million and half its quarterly distribution. CenterPoint owns a 53.7% limited partner interest and a 50% general partner interest in Enable Midstream.

"These actions further support the company's firm commitment to maintaining investment grade credit quality and our strategic focus on growing utility earnings contribution," CenterPoint spokesperson Alicia Dixon said in an April 7 email.

Enable's cash flow decrease is expected to lower distributions to CenterPoint by about $155 million per year on an annualized basis.

Guggenheim Securities LLC analyst Shahriar Pourreza called CenterPoint's moves "a much needed, hard reset on the balance sheet strains, and in our view, has already been represented in the stock price decline: [CenterPoint] down -43% YTD vs. the UTY index -13%."

Indirectly, these cost-cutting measures may also make CenterPoint more attractive to a potential buyer.

"[W]hat may not be as obvious to some is that [CenterPoint] now emerges as a strong acquisition target with [the] financial strengthening moves given current depressed valuation levels ... while operating in jurisdictions that remain sound and constructive in Texas and Indiana," Pourreza wrote in an April 2 report.

In the meantime, Moody's and S&P Global Ratings have changed their outlooks on CenterPoint Energy to negative from stable to reflect Enable's distribution cuts.

CreditSights, meanwhile, had expected CenterPoint to pursue a private placement of an $800 million planned equity issuance to strengthen its financial position, not a dividend cut.

"We clearly would have preferred to see a large equity infusion with proceeds for short-term debt reduction," CreditSights analyst Andrew DeVries wrote in an April 2 research report.

DeVries added that "even after the cut, [Enable] equity is still yielding 27% so the market is clearly pricing in another cut and thus [CenterPoint's] dividend reduction therefore isn't likely to result in any retained earnings savings."

Guggenheim called the move to avoid an equity issuance "an economically sound decision."

"With the stock trading in the low teens, it makes sense to us for [CenterPoint] to retain earnings to fund capex, defer capex and avoid issuing equity to effectively fund dividends," Pourreza wrote.

Dixon said the company remains "committed" to its long-term investment plans.

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Centerpoint's capital spending and dividend cuts occurred during an executive shake-up as well.

On April 2, CenterPoint named Kristie Colvin as interim executive vice president and CFO, replacing Xia Liu who stepped down to pursue another career opportunity. This move came after Scott Prochazka stepped down as president, CEO and a director on Feb. 19.

Dixon said the board of directors "determined that it was the right time for a new leader with a fresh strategic perspective to lead the company through its next phase of growth and value creation."

Dixon also described CenterPoint interim President and CEO John Somerhalder II as "an outstanding energy industry executive with vast utility experience and the skills to ensure that the company continues its momentum during the search for a permanent CEO."

However, Fishman said, "There was obviously some disagreements between management and the board."

The Morningstar analyst said "friction" between the board and management likely revolved around CenterPoint's April 2018 acquisition of Indiana gas and electric utility Vectren Corp.

"It appears the transaction was more dilutive than it actually was," the analyst said.

CenterPoint agreed to acquire Vectren at a takeover price of $72 per share. CenterPoint also assumed more than $2 billion in Vectren debt. Management said the transaction would be funded by $2.5 billion in equity and $3.5 billion in debt.

"As a Vectren shareholder, I thought they overpaid," Fishman said.

The analyst does not think the financial impact of the coronavirus and even the cost-cutting measures at Enable were sticking points between leadership and the board at CenterPoint.

"I suspect if things were not working out well at Vectren, I bet you blame management for that," Fishman said.

Vectren's role

Over the next five years, CenterPoint expects to spend nearly 50% of its roughly $13 billion in planned capital investment on natural gas utilities, mostly to modernize its system and replace aging pipe. The company projects that work will boost its gas utility rate base at an 8.8% compound annual growth rate between 2019 and 2024.

The Vectren acquisition underpins a significant amount of that rate base growth, in part by adding a considerable amount of leak-prone pipe to CenterPoint's portfolio.

Vectren Energy Delivery of Ohio Inc. consistently ranks high on a list of gas utilities most actively repairing gas leaks, while Vectren's other subsidiaries, Indiana Gas Co. Inc. and Southern Indiana Gas and Electric Co., have also tackled a relatively high number of leaks relative to their total pipeline mileage in recent years.

CenterPoint removed the last iron pipe from its legacy system by the end of 2018, the same year it agreed to acquire Vectren, which still had 155 miles of the leak prone pipe across its three subsidiaries that year. CenterPoint expects to continue addressing that iron pipe through 2023 and possibly into 2024.

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CenterPoint's midstream arm, meanwhile, is under pressure to offload debt as its equity value nosedives.

While Enable Midstream Partners slashed its dividend by 50% to 66 cents per unit annually, CBRE Clarion Securities portfolio manager Hinds Howard said it was "less than … a lot of people were expecting," while analysts at energy investment bank Tudor Pickering Holt & Co. noted that reduced volumes and the threat of producer shut-ins "may leave [the] market wishing for a more sizeable … reduction."

The partnership was already struggling before OPEC and Russia failed to agree to a production cut. In February, Enable recorded an $86 million noncash impairment charge for the fourth quarter of 2019 amid oil and gas drilling headwinds in the Anadarko Basin.

CBRE's Howard said in an interview that the "misalignment of interests" facilitated by Enable's ownership structure likely prevented the partnership from announcing a more drastic investor payout cut, because while the general partner is equally controlled by CenterPoint and OGE Energy Corp., OGE owns just 25.5% of the limited partner.

Although analysts at Guggenheim wrote in the April 2 note to clients that "for a large acquirer, [Enable] can easily be absorbed," the new owner would have the same issues.

"The cross-ownership … makes things very challenging in terms of strategic alternatives and I think that's what's been plaguing the stock for a number of years," Howard said.

Any interest in buying CenterPoint's stake in Enable, he continued, would likely come from private equity bidders as opposed to other public companies.

CenterPoint explored exiting its stake in Enable for months but dropped those plans in late 2017 after not being able to reach a "mutually acceptable" agreement. The utility's executives in 2018 doubled down on their stance that the company did not intend to sell its stake in Enable to fund the Vectren transaction.

M&A target?

The question now revolves around what steps CenterPoint may take next.

CreditSights has pointed to Berkshire Hathaway Energy, a subsidiary of Warren Buffett's Berkshire Hathaway Inc., as the most likely candidate to target CenterPoint.

Fishman, however, has his doubts that CenterPoint itself is a target.

"I think there is a higher probability of Enable being sold, even at a reduced price, than there is of somebody buying CenterPoint," Fishman said.

The Morningstar analyst pointed to an intriguing quote from CenterPoint's Somerhalder in an April 1 news release.

"We anticipate utility earnings contribution will approach 90% for 2020 and increase to nearly 100% over the next few years," the CEO said.

"How do you get to 100% if you don't sell [Enable]?" Fishman said. "I took that as a signal that 'we're out of here.'"