INVESTMENT THESIS
We are maintaining our BUY rating on Sempra Energy (NYSE: SRE). The company recently divested assets in South America and is ramping up its Cameron LNG operations. We look for the Cameron LNG pipeline to provide a boost to earnings and support future dividend growth.
While the dividend yield of about 3.2% is below the peer average of 4.0%, management has raised the dividend at a compound annual rate of 6.7% over the last five years, including an 8.1% hike in February 2020. We believe that SRE merits a premium valuation based on its above-peer-average sales and earnings growth, as well as margin expansion.
RECENT DEVELOPMENTS
Sempra shares have underperformed the S&P 500 over the past three months, declining 3%, compared to a 15% gain for the index. The shares have also underperformed over the past 52 weeks, declining 13.9%. SRE has also underperformed the utility industry ETF (IDU), which is down 8% over the past year. The beta on SRE is 0.85.
Sempra Energy recently reported results that missed analysts’ expectations. On November 5, Sempra reported 3Q20 adjusted earnings of $380 million, down from $425 million in 3Q19. The declines were attributable to a loss of earnings following the sale of the company’s South American operations, partially offset by contributions from the Cameron LNG joint venture. Adjusted EPS fell to $1.31 from $1.50 a year earlier, and missed the consensus of $1.47.
Sempra completed the sale of its South American operations in 2Q20, marking the conclusion of its two-year capital rotation plan, and generating proceeds of $5.8 billion. Sempra’s investments are now focused on transmission and energy distribution in the most attractive markets in North America, including California, Texas, Mexico, and the liquefied natural gas (LNG) export market.
During the second quarter of 2020, Sempra entered into a joint venture with Cameron LNG. Sempra has a majority 50.2% stake in the JV.
Concurrent with earnings, management reiterated its 2020 adjusted EPS guidance of $7.20-$7.80, which it raised from $6.70-$7.50 on June 30. The revised forecast implies 11% non-GAAP EPS growth at the guidance midpoint, and management is guiding towards the top end of the range. We view this growth as impressive given the impact of the coronavirus on commercial and industrial electricity demand. Sempra also reaffirmed its 2021 non-GAAP EPS guidance of $7.50-$8.10, which assumes continued strong execution in its U.S. utility business.
EARNINGS & GROWTH ANALYSIS
Third-quarter revenue fell 4% year-over-year to $2.64 billion on lower sales at SoCalGas, which reflected lower natural gas prices.
The decrease in GAAP EPS was attributable to nonrecurring line items in 3Q19. Sempra has five segments: SDG&E, SoCalGas, Sempra Texas Utilities, Sempra Mexico, and Sempra LNG. We review 3Q results for these businesses below.
SDG&E provides electric and natural gas service in San Diego. Third-quarter GAAP earnings totaled $178 million, down 32% from $263 million in 3Q19 as a challenging comparison was partly offset by stronger margins.
The segment posted a 3Q GAAP loss of $24 million, down from earnings of $143 million in the prior-year period due to a difficult prior-year comparison and higher legal expenses. These negatives were partially offset by the impact of an impairment charge in 3Q19.
Sempra Texas Utilities is an investment vehicle that holds the company’s 80% stake in Oncor and 50% interest in Sharyland Holdings. Oncor and Sharyland are electric transmission and distribution utilities based in Texas. Third quarter GAAP earnings decreased slightly to $209 million, down 1% from $212 million in the prior-year period as Oncor’s earnings were softer.
The declines were attributable to an unfavorable comp versus the prior year period and higher litigation expenses. Oncor’s declines were primarily attributable to unfavorable weather and higher operating costs, partially offset by increased revenues from higher authorized rates.
Sempra Mexico is also an investment vehicle that takes stakes in regulated utility and transmission companies. Third-quarter GAAP earnings totaled $50 million, down 40% from the prior year due to unfavorable currency translation and higher interest expense, partly offset by the return to full capacity of a commercial pipeline. Sempra LNG consists of liquid natural gas transmission assets, most of which are related to a $450 million VIE that exports LNG from the Gulf Coast. Earnings increased substantially in this segment as the Cameron LNG began phase 1 operations.
On growth, we expect Sempra’s long-term earnings to be driven by a robust capital plan and effective cost controls. In particular, we expect earnings to get a boost from the Cameron facility. We also see additional potential upside to our long-term earnings forecast based on new pipelines and solar projects in Mexico, and note that several new pipelines have already entered service. These projects follow changes in the Mexican energy sector that allow private sector participation in exploration and production; oil and gas transport; petrochemicals; refining; storage; and electricity generation transmission and distribution. We are raising our 2020 EPS estimate to $7.67 from $7.53 based on management’s optimistic guidance. We are also boosting our 2021 estimate to $8.05 from $8.01. Our long-term EPS growth rate estimate is 6%.
FINANCIAL STRENGTH & DIVIDEND
Moody’s rates Sempra’s debt at Baa2/stable, while S&P and Fitch rate it at BBB+/negative and BBB+/stable, respectively.
Total debt was $24.7 billion at the end of 3Q20, up from $24.5 billion at the end of 2019. Third-quarter operating income did not cover interest expense due to earnings seasonality and nonrecurring line items.
Sempra pays a quarterly dividend of $1.045, or $4.18 annually.
MANAGEMENT & RISKS
Jeff Martin became Sempra’s CEO in May 2018. Mr. Martin had served as CFO since January 2017. He is also the company’s chairman. Trevor I. Mihalik is Sempra’s executive vice president and CFO. He joined Sempra in 2012, serving as an accounting executive before being promoted to his current role in 2018.
Specific risks to Sempra include credit issues, commodity price fluctuations, currency fluctuations/inflation (especially with the Mexican peso), the effect of adverse weather on revenue, regulatory risk (especially construction cost recovery), and potential environmental and safety liabilities. In addition, the capital-intensive nature of the utility industry creates ongoing liquidity risk that must be actively managed by each company.
COMPANY DESCRIPTION
Sempra Energy have 18,000 employees serve more than 35 million customers worldwide. The company’s main regulated utilities are San Diego Gas & Electric and Southern California Gas.
VALUATION
Sempra shares appear attractively valued at current prices near $130, near the midpoint of their 52-week range of $88-$162. The shares are trading at 17.1-times our 2020 adjusted EPS estimate, below the average multiple of 18.8 for comparable utilities and below the midpoint of the five-year historical range of 11.8-24.6. They are also trading at 16.3-times our 2021 adjusted EPS estimate. Our relative value analysis yields a fair value of $150 per share, which is our target price. Our target implies a projected two-year blended average P/E of 19.1 for 2020-2021, which we believe is appropriate given the company’s above-peer-average sales and earnings growth and strong margins.
On December 16 at midday, BUY-rated SRE traded at $130.68, down $0.27. Report created Dec 16, 2020 Page 4 OF 5 Please see
Source: Argus
