INVESTMENT THESIS
PPL Corp. (NYSE: PPL), a regulated electric utility serving customers in Pennsylvania, Kentucky, and the United Kingdom. We are raising our 12-month target price to $33 from $29. As businesses reopen, we expect to see improvement in commercial and industrial kilowatt-hour sales, while residential demand remains strong. We also believe that utilities will see a smaller revenue impact from the pandemic than other sectors.
On August 10, PPL announced that it would sell Western Power Distribution (WPD) in the UK and become a purely U.S.-focused utility holding company. Management believes the sale will unlock significant value for PPL shareholders.
PPL stock has risks. We expect just modest EPS growth over the next two years. We are also concerned about energy prices, which have been low but could rise in the coming quarters. However, PPL shares trade at an attractive valuation of 11.5-times our 2020 EPS estimate, in the lower half of the historical five-year forward P/E range of 7.8-18.5 and well below the peer median of 18.7. Our revised target price of $33 implies a projected 2020 P/E of 13.6, which assumes a return to average valuations over the coming year. We see the potential for a low double-digit total return, including the higher-than-average 5.9% dividend yield.
RECENT DEVELOPMENTS
On August 10, PPL announced that it would sell Western Power Distribution (WPD) in the UK and become a purely U.S.-focused utility holding company. Management believes the sale will unlock significant value for PPL shareholders, and expects it to generate proceeds of $6-$10 billion. Possible suitors for WPD include National Grid Group and Iberdrola SA, as both companies have U.S. operations that could be swapped for PPL’s European assets. The company will use the proceeds to strengthen the balance sheet and enhance long-term EPS growth, or, in the event of an asset swap, to expand its U.S. footprint. Other potential suitors include a consortium led by global Infrastructure Partners, and another led by Macquarie Group. Reflecting uncertainties surrounding a post-Brexit trade agreement between the UK and the EU, PPL now believes it will announce a deal in the first half of 2021. We see some risk that any potential sale could be pushed even further into 2021 due to trade deal uncertainty and the impact of the pandemic.
PPL posted adjusted 3Q20 earnings of $450 million or $0.58 per share, compared to $445 million or $0.61 per share (on a lower share base) a year earlier. The EPS decline reflected lower sales volume, mostly due to milder-than-anticipated weather in the U.S. and the impact of the pandemic on industrial and commercial customers. EPS missed the consensus forecast of $0.60. GAAP earnings fell to $344 million or $0.45 per share from $441 million or $0.60 per share in 2Q19, reflecting higher COVID-related and other costs.
Third-quarter operating revenue declined 2.5% year-over-year to $1.89 billion, reflecting lower industrial and commercial kWh demand. The operating margin fell to 36.5% from 37.6% a year earlier due to lower revenue and higher fuel and purchased energy prices.
The company indicated in August that it expected adjusted EPS to track toward the low end of the original guidance range.
PPL has withdrawn its 2021 EPS guidance, as it plans to sell its U.K. assets in 1H21.
In July 2019, Kentucky Utilities (KU), a PPL subsidiary, filed a request with the Virginia State Corporation Commission (VSCC), asking for a $13 million (18%) increase in annual base electricity revenues. In January 2020, KU reached a partial settlement agreement allowing for a $9 million increase (13%). On April 6, the VSCC approved the settlement.
EARNINGS & GROWTH ANALYSIS
PPL is organized into three business segments: UK Regulated (30% of 2019 revenue), Kentucky Regulated (40%), and Pennsylvania Regulated (30%). We discuss trends and outlooks for these businesses below.
The UK regulated segment reported 3Q adjusted earnings of $0.28 per share, flat with the prior year. That primarily reflected lower commercial and industrial sales volume due to COVID-19, offset by strong residential demand. Weather-normalized commercial and industrial volumes showed improvement relative to 2Q20.
The Kentucky regulated business reported 3Q earnings from ongoing operations of $0.17 per share, down from $0.20 in 3Q19. Residential energy usage remained favorable but only partly offset lower commercial and industrial demand.
In the Pennsylvania regulated segment, up from $0.16 a year earlier. Although residential volume growth slowed from 2Q20, it still offset lower commercial and industrial demand. Pennsylvania regulated commercial and industrial demand declined 4% in 3Q20 following a 10.5% decline in 2Q20.
Although we expect industrial and commercial demand to rise, the third wave of the pandemic is slowing that growth in 4Q20. Our estimates do not factor in the sale of the UK operations given deal-timing uncertainties.
Over the long term, we expect earnings to be driven by infrastructure investments that increase the rate base and by rate mechanisms that reduce regulatory lag. PPL plans to increase its rate base at a 4% compound annual rate through 2024. It also projects approximately $14 billion in capital expenditures over the same time frame.
FINANCIAL STRENGTH & DIVIDEND
Moody’s rates PPL Corp.’s debt as Baa2 with a stable outlook and S&P rates it A-, also with a stable outlook. At the end of 3Q20, debt totaled $24.1 billion and the total debt/capitalization ratio was 65%, compared to an average of 57% for peers.
MANAGEMENT & RISKS
On June 1, Vincent Sorgi, formerly the company’s president and COO, took over as CEO. Mr. Sorgi replaced Bill Spence, who retired after serving as CEO since 2011. Mr. Sorgi has worked for PPL since 2006.
The company’s growth plans include $14 billion in infrastructure investments through 2024, with a focus on developing ‘smart’ energy grids that are more reliable and resilient. In Kentucky, it is spending on environmental upgrades and the retirement of inefficient coal-fired plants, and has filed for a rate increase to cover the cost of this work. It is also making transmission investments in Pennsylvania, where it expects annual growth of 5.4% in the transmission rate base through 2024.
The sale of the company’s U.K. assets would reduce foreign investment risk while also creating a clearer valuation picture for investors. Risks to the deal include failure to obtain a fair price and loss of the company’s most profitable business. The failure of UK and EU authorities to conclude a post-Brexit trade deal is also delaying the sale of these assets.
Other key risks for stocks in our electric utility universe include commodity price fluctuations. Lastly, the coronavirus may reduce demand in commercial and industrial energy.
COMPANY DESCRIPTION
PPL Corp. is based in Allentown, Pennsylvania and delivers electricity on a regulated basis to customers in Pennsylvania, Kentucky, and the United Kingdom. The company serves more than 10 million customers. Its utilities in the U.S. include PPL Electric Utilities, Kentucky Utilities (KU), and Louisville Gas and Electric (LG&E), and, in the UK, Western Power Distribution plc. In August 2020, PPL announced it was exploring the sale of its UK operations.
VALUATION
To value the shares on a fundamental basis, we look at historical price multiples and peer comparisons.
We are raising our 12-month target price to $33 from $29. Our new target implies a projected 2020 P/E of 13.6, still below the peer median. Our target implies a low double-digit return, including the higher-than average 5.9% dividend yield.
On December 17 at midday, BUY-rated PPL traded at $27.75, up $0.43.
Source: Argus
