Greg Gordon, CFA
Citigroup Global Markets
The Citi utility index was down 24.4 percent in 2008 vs. 36.1 percent for the S&P 500 on a total-return basis, beating the market for a fifth consecutive year.
Lacking conviction on a "theme," we are recommending a barbell approach. Weak power-market dynamics continue to be an overhang on the outlook for integrated utilities. Our favorite ideas in this space can either still grow earnings due to below market hedges rolling up over time, or are credit-worthy and the stock is inexpensive enough to argue that investors are paying very little to get leverage on a future economic recovery.
Looking at the financing picture for the industry, access to the credit markets over the last two quarters has allowed the net liquidity position for the group to improve markedly (under a worst-case scenario most companies have adequate cash flow and access to capital to "ride out" '09 with minimal capital market access).
One of the supportive factors we are seeing is a (modest) improvement in authorized return on equity over the past 12 months after a seven-year decline.
Public Service Enterprise Group Inc. (PEG): Like most integrated utilities, PEG looks undervalued to us. Despite an earnings profile that grows only modestly over the next several years due to several headwinds, we believe that the stock has relatively low downside risk at current levels and provides an expected total return of greater than 15 percent to our target prices of $32, which is 11.5 times '09 utility earnings, a nominal value for holdings, and 6.2 times our "open" EBITDA estimate for PSEG Power based on a long-term gas price assumption of $7.25/mmbtu.
Despite current market conditions, we believe PEG will be able to maintain a strong balance sheet throughout our forecast horizon.
Deutsche Bank Securities
Current open enterprise value/EBITDA multiples for the independent power producers, or IPPs, average 5.4 times and open EV/EBITDA multiples for the diversified utilities average 5.5 times.
The IPPs and diversified utilities free-cash-flow yields currently average 21 percent for IPPs and 12 percent for the diversified utilities. The IPPs continue to exhibit higher free-cash-flow yields due to their lower capital-spend requirements and lack of regulated utility capital-spending needs for rate-base-driven earnings growth.
Exelon Corp. (EXC): A disciplined hedging program insulates EXC from weak commodities prices.
EXC reaffirmed its '09 EPS guidance of $4 to $4.30 despite the significant fall in commodity prices that has taken place since the company provided its '09 EPS guidance on November 9, 2008. The company has been able to maintain its '09 outlook due to its disciplined approach to hedging and is now over 90 percent financially hedged for 2009-2010.
EXC reiterated its intent to aggressively pursue its previously announced acquisition of NRG Energy Inc.
We reiterate a Buy rating on EXC and maintain a $74 price target. Our EXC price target is based on our discounted cash flow and sum-of-the-parts analysis. Primary downside risks include long-term commodity price risk, Pennsylvania/Illinois political risk and uncertainty related to the potential NRG acquisition.
EXC reported 4Q 2008 earnings of $1.07 per share, which was slightly ahead of our estimate of $1.05 per share and consensus estimates of $1.03 per share, largely on the strength of better-than-expected performance at EXC Generation and lower book taxes.
Our updated 2009, 2010, 2011 and 2012 EPITDA estimates for EXC are $6.8 billion, $6.9 billion, $7.3 billion and $7.1 billion respectively. Our 2009, 2010, 2011 and 2012 EPS estimates are largely unchanged and now stand at $4.03, $4.01, $5.33 and $5.22 respectively. n