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Tax reform, nuclear subsidies likely among key issues in Q4'16 earnings talks

Donald Trump's surprising victory in the election to become the 45th president of the United States occurred just as the Edison Electric Institute's annual financial conference, when many big utilities release 2017 outlooks and capital expenditure plans, was concluding. That means fourth-quarter 2016 earnings calls represent, for many blue chip names in power, one of the first opportunities for management teams to discuss with the investment community potential changes ahead under the new administration.

Questions over corporate tax reform under Trump, and other elements of fiscal policy uncertainty, are likely to be key topics on fourth-quarter earnings calls, according to Deutsche Bank analyst Jonathan Arnold. He noted in a Jan. 24 report companies with high debt at the parent level could be "squeezed" if Republicans now in control of Congress and the White House move to make interest no longer tax deductible. "With details yet to be defined, we expect most to talk generally about potential implications, but to stop short of actual changes to plans and outlooks," Arnold wrote. "For those yet to provide 2017 guidance, we expect a fairly cautious tone – or at least caveats – will prevail."

Glenrock Associates LLC analyst Paul Patterson agreed that while uncertainty around tax changes and environmental rules has increased since the election, it's still too early to expect utilities to announce changes to CapEx or earnings guidance based on what the Trump administration might do.

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Utility and power executives are also likely to face questions related to how changes to tax incentives and environmental rules might impact their views toward investment in renewable power, particularly since lowering a company's total tax liability could reduce the appetite for tax equity essential to financing many renewable projects.

NextEra Energy Inc., shares of which have been down since the election, is likely to address any possible investor concerns related to the outlook for renewables. "In our view, continued cost declines and existing (and expanding) state renewable portfolio standards likely provide visibility around a continued runway for renewables development," KeyBanc Capital Markets Inc. analyst Paul Ridzon wrote.

This vulnerability to corporate tax reform, coupled with the Federal Reserve's hike in short-term interest rates, has caused shares of utilities with exposure to unregulated businesses like merchant power or gas infrastructure to perform better than those fully regulated utilities with higher parent-level debt. As a result, several analysts favor Exelon Corp. J.P. Morgan assessed Exelon as among the best-positioned companies heading into fourth-quarter 2016 earnings, attributing its strong share price performance since November more to tax reform anticipation and increased near-term gas prices than nuclear asset-related developments in New York and Illinois. J.P. Morgan also questioned whether investors fully appreciate the earnings boost Exelon's regulated businesses are likely to enjoy following the increase in the 30-year Treasury yield.

The resilience of nuclear power subsidies by states and the issue of whether they distort power markets are also likely to be prime topics on the earnings calls for Exelon and Public Service Enterprise Group Inc., particularly in light of challenges to such programs in Illinois and New York, where Exelon is acquiring the FitzPatrick nuclear plant from Entergy Corp.

On the merchant generation side, both Deutsche Bank and SunTrust Robinson Humphrey are bullish on NRG Energy Inc. after an activist investor group seized control of 9.4% of its shares, with an eye toward restructuring opportunities to increase the share price. SunTrust bumped its price target up by a dollar to $15 for NRG, and rates the company "hold." Deutsche Bank rates NRG "buy" and has an above-consensus adjusted EBITDA estimate for fourth-quarter 2016 of $561 million. "While the market would love to hear an update on the [GenOn Energy Inc.] situation, management is unlikely to have much to say given ongoing lawsuits, restructuring talks and perhaps a sale process all proceeding in the background," Arnold wrote.

Among big regulated names, SunTrust analyst Ali Agha flagged Southern Co. as a potential "negative earnings surprise," with risks including stagnant load growth; share price dilution from equity issuances; further delays and cost increases at generation projects in Georgia and Mississippi; and higher-than-expected accretion from the acquisition of AGL Resources, now known as Southern Co. Gas. SunTrust also cut by a dollar its price target for Duke Energy Corp., to $81. Deutsche Bank warned of "potential disappointment" in Duke's 2017 earnings guidance, as a result of the early close of its sale of Latin American assets and tax reform uncertainty.

A positive factor for utilities in fourth-quarter 2016 earnings, however, should be the weather. Most analysts found heating degree days due to colder-than-normal winter weather increased from the fourth quarter of 2015, particularly in the Southeast and South Central regions of the U.S.