PG&E Corp. (NYSE: PCG). The company emerged from bankruptcy in July 2020 and has a new CEO coming on board in January. However, we believe that the lack of a dividend makes PCG less attractive to utility investors, who are mainly attracted by current income. The company is also seeing slower industrial electricity and gas usage due to the pandemic.
The stock has declined 87% over the past two years, losing about $30 billion in market value due to the company’s wildfire liability, lack of financing, and bankruptcy filing. In our view, PG&E must focus on improving the safety of its power lines. Under the company’s 2020 Wildfire Mitigation Plan, PCG has relocated over 200 circuit miles underground or otherwise made them more resilient, cleared hazardous vegetation, increased inspection and surveillance, and worked to reduce the impact of wildfire-related outages on customers.
PCG shares trade at 13-times our 2020 EPS estimate, below the industry average of 0.5.
The beta on PCG is 0.73.
On October 29, PG&E reported 3Q20 non-GAAP earnings of $4.61 million or $0.22 per share, compared to $590 million or $1.11 per share in 3Q19. We note that as part of its emergence from bankruptcy, PG&E conducted a secondary offering of its common stock and warrants. As a result, average diluted shares outstanding soared to 2.14 billion in 3Q20, up from 489 million in 3Q19. Non-GAAP EPS missed the consensus forecast of $0.26. O n a GAAP basis, the company reported net income of $86 million or $0.04 per share, compared to $307 million or $0.63 per share in 3Q19.
The 2020 wildfire season in California contained some of the largest and most prolonged fires on record. In advance of wildfire season in February 2020, PG&E announced a wildfire mitigation plan that built on work completed in 2019. Elements of the plan include system hardening, vegetation management, increased surveillance, and reduced customer impacts.
Under system hardening, PCG has exceeded its target of relocating 257 circuit miles underground or replacing those circuits with stronger poles and covered conductors. Vegetation management is now at 90% of the company’s 2020 target. To improve monitoring, PCG has added weather stations and high-definition cameras in high-risk areas, and stepped up human inspections. The company is also working to restore power more quickly after outages.
PG&E Corp. and Pacific Gas and Electric emerged from Chapter 11 bankruptcy on July 1, 2020; the company had entered bankruptcy in January 2019. As part of the settlement announced in July 2020, PG&E settled wildfire claims, joined California’s new wildfire funds program, selected a new board, made additional safety commitments, issued new stock, and restructured its debt. Patti Poppe, the former CEO of CMS Energy in Michigan, will become PG&E’s new CEO in January 2021. William Smith, the former president of AT&T Technology Services, is serving as interim CEO until then. In October 2020, Mr. Smith said that the company was focused on building a new PG&E that would deliver on commitments to operate safely, reduce risk, and put customers first.
The pandemic has lowered demand for electricity and gas from industrial and commercial customers while boosting residential usage. Industrial and commercial demand recovered during the summer and early fall, but has now been impacted by new shelter-in-place orders in California. However, the rollout of new vaccines could lead to improved demand in 2021.
EARNINGS & GROWTH ANALYSIS
Electric segment revenues declined 1% to $3.8 billion, while natural gas revenue rose 57% to $1.1 billion. Operating expenses grew 12.0% year, causing the GAAP operating margin to decline to 8.2% in 3Q20 from 12.0% a year earlier.
Along with the 3Q20 results, management reaffirmed its non-GAAP guidance for 2020, which was implemented in July after initial guidance was withdrawn due to COVID-19. The guidance range for core earnings is $1.60-$1.63 per share. Although first-half earnings exceeded that total, some of these earnings have now been restated to reflect the higher share base. We believe the current consensus of $1.93 has been distorted and fails to fully reflect the new share issuance.
Based on the new share total, we are lowering our 2020 non-GAAP EPS forecast to $1.63 from $3.58. Management projected 2021 noncore earnings of $0.95-$1.05 per share, unchanged from midyear despite the challenging 2020 wildfire season. That assumes additional equity issuance of $450-$750 million, resulting in additional share dilution in 2021. On that basis, we are lowering our 2021 EPS forecast to $1.01 from $3.99.
FINANCIAL STRENGTH & DIVIDEND
The adjusted 3Q profit margin of 8.2% was below the average for peers.
Moody has withdrawn its ratings on PG&E’s debt. On January 14, 2020, Moody’s downgraded PG&E’s debt to Caa3 from Ba3, indicating a lower level of noninvestment-grade speculative, or ‘junk’ status. The agency said that the company’s access to capital was uncertain. S&P and Fitch also recently withdrew their ratings on PG&E’s debt after lowering them to junk. PG&E has drawn the full amount of its $3.5 billion credit facility.
PG&E’s last dividend payment, on October 15, 2017, was $0.53 per share. Based on the dividend suspension, we do not expect any payments in 2020 or 2021.
The company last suspended its dividend in 2001 during a wholesale electricity power crisis. PG&E subsequently declared bankruptcy and only resumed paying the dividend in 2005, once it exited bankruptcy.
The company plans to issue up to $25.7 billion of stock over time, which will significantly dilute outstanding shares.
MANAGEMENT & RISKS
The board has announced that Patti Poppe, until recently the CEO of CMS Energy in Michigan, will become the new CEO, effective January 2021. William Smith, former president of AT&T Technology Services, is serving as interim CEO until then. Mr. Smith replaced Bill Johnson, who served in that role for less than a year. Incoming CEO Poppe has deep industry experience and a record of implementing a strong safety culture, according to current CEO Smith. Her five-year contract promises stability after Bill Johnson’s short tenure. We expect investors to approve the transition.
Key risks for stocks in our electric utility universe include commodity price fluctuations (such as the cost of fuel for electric generators).
As discussed above, the company faces liability risks for damages from wildfires in California.
PG&E Corp. is the holding company for Pacific Gas & Electric Co., a utility that provides electricity and natural gas in northern and central California. PG&E is a large operator of underground natural gas storage fields in California. The company serves approximately 16 million customers in northern and central California.
We believe these discounts are warranted given the company’s high debt load, share dilution, and ongoing wildfire mitigation challenges. Given the company’s recent emergence from bankruptcy, along with the reorganization of the company’s management and board, we are maintaining our HOLD rating.
On December 14, HOLD-rated PCG closed at $11.85, down $0.09.