To offset impacts of tax reform, management teams of several large electric utilities have indicated their intention to pad their balance sheets with additional cash, setting in motion a forthcoming wave of large equity offerings.
While tax reform is viewed broadly as a strategic win for the sector, some large regulated utilities are feeling the near-term pressure of diminished operational cash flow on their balance sheets. With the benefits of lower corporate taxes set to be passed on to ratepayers in the form of lower utilities bills overall, regulated utilities may feel a squeeze on their ability to service debt, an issue recently flagged by rating agencies as a risk to near-term credit ratings for much of the sector.
In response, management teams in recent earnings calls have outlined plans to pursue sizable equity offerings, beyond their annual capital expenditure needs, at time when utility valuations have trailed off from the broader equities market due to the prospect of rising interest rates.
Utilities have acknowledged discussions with state regulators represent the primary channel to maintaining credit quality on the heels of tax reform, whether through requests for accelerated depreciation or quicker cost recovery. Both Duke Energy Corp. and Southern Co. have flagged these discussions, which executives suggest may not be resolved until late 2018.
But Duke and Southern are wasting no time preparing their re-entry into the equity capital markets. Duke is pushing ahead with a $2 billion equity issuance this year, inclusive of its $350 million of annual equity raised via its dividend reinvestment plan. That represents a $1.65 billion increase in Duke's planned equity issuance in 2018, a decision Executive Vice President and CFO Steven Young said was in direct response to maintaining credit ratings.
While Duke's forthcoming issuance may set it up to execute its strategy through 2022, analysts note that regulatory outcomes will still weigh heavily on the company's ultimate risk profile, with the, "equity financing plan working as a 'down payment' to alleviate some rating agency pressure related to tax reform in the near term," Evercore ISI wrote on Feb. 21.
Southern also hiked its five-year capital plan, moving its annual equity issuance to approximately $1.4 billion, with about half of that set aside to pad Southern's utility subsidiaries with additional equity as a means to strengthen credit, Southern CFO Art Beattie observed on a call. Southern's approach to raising equity may also be tied to a separate strategic action, an approach characterized by Southern Chairman, President and CEO Tom Fanning as "investor friendly." Such an approach could look to avoid new issuance, and associated dilution, with strategic action on potential assets sales within Southern Power Co., on top of favorable regulatory outcomes.
"We talked about a variety of means to raise the equity," Fanning explained to analysts, pointing to Southern's 4% to 6% growth targets. "To the extent we could do, say, more investor-friendly means of raising cash and equity, that certainly would be lumpier and maybe potentially more front-end loaded and may reduce, frankly, the number of shares required."
AEP, FirstEnergy stay the course
Joining Duke and Southern are PPL Corp. and Avista Corp., which also indicated the need for additional cash equity to offset tax reform impacts. PPL on Feb. 22 indicated it will issue $1 billion in new equity in 2018, up from a previously planned $350 million figure, and settle foreign currency hedges, to help support its funds-from-operations-to-debt ratio and credit ratings. Avista similarly plans to issue $85 million in new equity in response to tax reform.
Consolidated Edison Inc. also laid out a $450 million equity issuance plan in 2018, up from $343 million in 2017, according to its Feb. 15 earnings presentation.
And while these companies represent some of the largest names flagged by ratings agencies in January, notably absent from the firms seeking new equity in response to tax reform are American Electric Power Co. Inc. and FirstEnergy Corp.
AEP affirmed its 5% to 7% growth rate, with CFO Brian Tierney on Jan. 25 emphasizing that he does "not anticipate raising incremental equity due to tax reform," and will remain at $100 million in 2018 and 2019, before moving to $400 million in 2020. Without new equity, AEP expects to maintain a 14% funds-from-operations-to-debt ratio, likely keeping its rating unchanged.
For FirstEnergy, a $2.5 billion equity investment in the utility led by Elliott Management Corp. is enough to help shore up its credit metrics at the parent-level. That investment also helped FirstEnergy make a $750 million contribution to its pension program, while giving it some flexibility to examine restructuring opportunities for its FirstEnergy Solutions Corp. subsidiary. The company does not expect to issue new equity to underwrite its growth plan any time soon.
"No additional equity through 2021," FirstEnergy President and CEO Chuck Jones told analysts on Feb. 20. "I can't believe it's only one month after doing $2.5 billion that we're already getting that question again, but there will be none."