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Amid M&A speculation, analyst says El Paso Electric stock is overvalued

Despite predicting a strong third quarter for El Paso Electric Co. amid renewed M&A rumors, a Wall Street analyst reduced the utility's earnings estimates and said its stock is still overvalued.

Citing an Oct. 2 report by DealReporter that advisory firm Lazard "would be actively shopping El Paso within weeks," Williams Capital Group analyst Chris Ellinghaus wrote in an Oct. 5 note that favorable summer weather is likely to give El Paso Electric "a significant positive [earnings per share] surprise" in the third quarter.

Ellinghaus' pronouncement comes two months after El Paso Electric President and CEO Mary Kipp said the utility does not comment on market rumors, but its board "will consider any such proposal it believes would be in the best interest of our shareholders and customers." During the company's second-quarter earnings call Aug. 2, Kipp said El Paso remains confident in its stand-alone growth plan and made similar comments May 3 during the first-quarter earnings call.

In both cases, Kipp's comments were prompted by questions from analysts.

El Paso stock closed Oct. 4 at $58.73 per share, up 3.7% since market open Oct. 2. The company traded as high as $59.33 per share late morning Oct. 3.

"Regardless of the fairly regular M&A rumors about El Paso, we reiterate that the company's fundamentals simply do not support [El Paso] shares at the current level, in our opinion," Ellinghaus wrote. "While there may be risk of M&A activity, [El Paso] shares simply have not historically traded at anywhere near current valuation levels in a higher interest rate environment and the stock is currently trading at nearly an 18% premium to peer utilities based on 2020 estimates, in our view."

Williams Capital is reducing its 2018 recurring annual EPS estimate for El Paso from $2.45 per share to $2.44 per share and reducing its 2019 recurring EPS estimate from $2.64 per share to $2.48 per share. Ellinghaus made the move for this year's EPS estimate due to the temporary expiration of a certain rates revenue stream and lowered the 2019 estimate due to less chance of favorable weather in 2019.

Ellinghaus said El Paso and its stock are more attractive at this time primarily because of the company's "significant" dividend growth, along with "incremental" EPS and rate base growth and somewhat accelerating load growth. El Paso also has increasing free cash flow generation, which will give management "great flexibility for both investment and dividend growth."

There are reasons El Paso and its shares are less attractive, Ellinghaus added, including its overvaluation and a "challenging" regulatory environment in New Mexico, where the utility is expected to file a rate case in 2020. He also cited the Trump administration's trade tensions with Mexico, which could adversely affect the border economy shared by El Paso, Texas, and Juarez, Mexico.

The company, headquartered in El Paso, Texas, serves 417,000 customers in a corner of southwestern Texas and southern New Mexico. It owns about 2,600 MW of generating capacity, mostly gas-fired but including a share of the Palo Verde nuclear plant, according to S&P Global Market Intelligence data.

Ellinghaus reiterated Williams Capital's "sell" rating and $49-per-share price target for El Paso, adding that both outlooks could be affected by rising interest rates and continued effects of federal tax reform.