2Q12 Earnings Preview.pdf

Electric Utilities Industry: 2Q12 Earnings Preview
KeyBanc Capital Markets Inc. Paul T Ridzon: (216) 689- 0270— pridzon(ikeyanccm.com
Member NYSEJFINRAISIPC Timothy Yee: (216) 689- 0385 —[e-mail]
ACTION STATEMENT
On average, we expect that the companies in our coverage universe will report higher 2Q12 quarterly earnings, up 4.3% compared to
2Q11. Our EPS growth expectations for our coverage universe are for average annual earnings growth of 1.7% in 2012 and 3.6% in
2013. Our coverage universe currently trades at an average peer group 2013 P/E multiple of 15.2x compared to the broader market
S&P 500 index P/E multiple of 12.3x.
This quarter, we anticipate two potential earnings upside surprises [Ameren Corporation (AEE-NYSE), CMS Energy Corporation (CMS-
NYSE)] and one potential earnings downside surprise [FirstEnergy Corp. (FE-NYSE)] relative to current consensus expectations.
We also highlight Duke Energy Corporation (DUK-NYSE), IDACORP, Inc. (IDA-NYSE), NiSource, Inc. (NI-NYSE), Northwestern
Corporation (NWE-NYSE), and Pinnacle West Capital Corporation (PNW-NYSE) as names to focus around the earnings release or
conference call due to Company-specific issues that we feel bear watching.
KEY INVESTMENT POINTS
Preview Focus Names - We anticipate two potential earnings upside surprises [Ameren Corporation (AEE- NYSE), CMS Energy
Corporation (CMS- NYSE)] and one potential earnings downside surprise [FirstEnergy Corp. (FE- NYSE)] relative to current consensus
expectations this quarter. We also highlight Duke Energy Corporation (DUK- NYSE), IDACORF Inc. (IDA- NYSE), NiSource, Inc. (NI-
NYSE), Northwestern Corporation (NWE- NYSE), and Pinnacle West Capital Corporation (PNW- NYSE) as names that may trade
around specific issues likely to be discussed during their company's earnings conference calls. We discuss our focus names in the
detailed sections that follow.
Earnings Expectations - We expect that companies in our coverage universe will generally report higher 2Q12 quarterly earnings, up
4.3% on average over 2Q11. Our EPS growth expectations for our coverage universe are for average annual earnings growth of 1.7% in
2012 and 3.6% in 2013. This quarter, we believe that earnings will primarily be driven by warmer weather impacts, merchant headwinds,
and higher non- fuel operating and maintenance expenses, partially offset by rate increases or riders in effect, cost management
efforts, and still sluggish core retail demand growth.
By and large, we feel that solid 2Q results (and hot July weather to date) could lead companies in our sector toward considering revising
2012 earnings guidance with an upward bias tempered somewhat by 1 Q1 2 results that were generally weaker. Earnings conference
calls this quarter may also be more concentrated on the following themes: spring/summer weather and storm impacts, tow merchant
power pricing and hedging updates; regulatory updates; cost management; retail sales trends (with particular focus on commercial
and industrial customers); and the local economy.
Sector Thoughts - Year- to- date, our sector has underperformed broader market indices, with the Philadelphia Utility Index (UTY)
returning 3.9% compared to the S&P 500 (SPX) index's 9.2% return. However, more recently, during the quarter- ended June 30, the
UTY returned 5.1% vs. a decline of 3.3% for SPX. We attribute recent strength in our sector as a defensive safety play amid broader
market economic concerns of a global industrial slowdown, anemic U.S. job growth, and the still unresolved European sovereign debt
crisis. As 2Q12 earnings season comes to pass, we will ultimately turn our attention in 2H12 to U.S. Congressional inability to address
the impending "fiscal cliff," the upcoming U.S. presidential election, potentially improving housing sentiment, and dividend tax and wind
PTC policy implications for our sector.
Recent Trading Trends - More recent (over the past month) performance of the utilities appears to be driven by two trends. We believe
improving natural gas pricing has erased some of the negative sentiment around the unregulated generators. Within our coverage,
commodity focused names have had average price appreciation of 2.7%. We are becoming modestly more positive on this group.
FOR IMPORTANT DISCLOSURES AND CERTIFICATIONS, PLEASE REFER TO PAGE 7 OF THIS NOTE.
Company Note
July 20, 2012
However, for the time being, we await a stronger signal that natural gas pricing gains are sustainable and not merely a response to
extremely hot weather across most of the country.
The other subset that has demonstrated outperformance is the smaller regulated names. In our view, investors looking for the
combination of safety and yield to weather the current economic uncertainty appear willing to forgo some of the attractiveness of
liquidity for lower valuation metrics (this subgroup trades at one P/E multiple point below larger regulated names). The average one
month performance of the smaller and larger regulated names are 3.9% and 1.0%, respectively.
Among our BUY- rated names that we believe can benefit from the above trends are NI (which would benefit from a stronger gas tape
through its Utica shale exposure) as well as CMS, IDA, and NI, which fall among the smaller cap regulated names.
2012 EARNINGS PREVIEW
For 2Q12, we anticipate two potential upside surprises and one potential downside surprise, relative to current consensus expectations:
POTENTIAL UPSIDE SURPRISES
Ameren Corporation (AEE- NYSE; HOLD; 20 estimate of $0.67 vs. $0.59 in 2011; consensus is $0.58)— We believe that new
rates, the rolloff of 2Q11 storm costs, and hotter weather help offset merchant headwinds and could drive 2Q earnings above consensus
expectations.
CMS Energy Corporation (CMS- NYSE; BUY, $25.50 price target; 20 estimate of $0.41 vs. $0.26 in 2011; consensus is $0.34)—
We believe that new rates, lower operating and maintenance expenses following 2Q11 storms and an aggressive tree trimming effort,
and favorable weather partly offset by higher depreciation and dilution may lead to 2Q results exceeding consensus expectations.
POTENTIAL DOWNSIDE SURPRISE
FirstEnergy Corp. (FE- NYSE; HOLD; 20 estimate of $0.62 vs. $0.65 in 2011; consensus is $0.69) - We believe that lower
capacity pricing and increased nuclear outage days partly offset by higher competitive retail direct sales volumes could lead to 2Q
earnings being below consensus expectations.
ISSUES TO WATCH
Company- specific issues that bear further watching include:
Duke Energy Corporation (DUK- NYSE; HOLD) - We will be focused on the Company's perspective on the North Carolina Utilities
Commission (NCUC) investigative hearings into the post- merger change of CEO. While we believe the NCUC ultimately would not
rescind its merger approval and would allow the new post- merger Duke to survive, we feel the investigation could add increased
regulatory risk to upcoming rate cases and that potential litigation and other employee issues could somewhat detract from the
Company fully achieving merger synergies. We believe these issues bear watching as the situation remains fluid.
IDACORP, Inc. (IDA- NYSE; BUY, $44 price target) - We will look for any discussion around the trajectory of dividend growth as the
Company works toward its formal dividend policy of achieving a long- term 50- 60% payout of sustainable earnings. IDA last increased
its dividend 10% in January 2012 to an annualized rate of $1.32 per share. We believe that following June 29, 2012 approval of new rates
to recover the Langley- Gulch natural gas plant investment, the Board may now have more discretion to review the dividend this year.
NiSource, Inc. (NI- NYSE; BUY, $26.50 price target) - We will be focused on a status update from the Company on discussions with
interstate pipeline customers regarding the Columbia Gas modernization project that will spend $4 billion plus over 10- 15 years to
enhance reliability and flexibility of the Columbia Gas Transmission system, with major spending ($300 million- $400 million annually)
commencing in 2013. (Recall that this project was one of the upcoming catalysts we had cited as the basis for our March 21, 2012
upgrade of NI shares). Also, we look to learn more about NI's joint- venture investment program with Hilcorp and any follow- on capital
needs from additional phases to develop Utica Shale infrastructure and acreage. We believe weak share price performance immediately
following the JV announcement was driven in part by lower capital than expected. We note the $300 million cited was for the first phase.
Investors will be likely keen to learn about potential for further phases.
Northwestern Corporation (NWE- NYSE; HOLD) - We will look for Company sentiment toward acquiring additional amounts of
natural gas reserves as recent intevenor testimony in NWE's Montana pending Battle Creek natural gas reserve rate base proceeding
support rate- basing natural gas reserves. We view this capital prospect favorably and expect Commission support to opportunistically
hedge gas supplies at historically low prices.
2
Company Note
July 20, 2012
Pinnacle West Capital Corporation (PNW- NYSE; HOLD) - We expect the Company will provide 2012 earnings guidance and
provide a longer- term (2013- 2015) earnings trajectory outlook following Arizona Commission approval of the settlement in its 2011
base retail rate case filing. We believe the Company is considering the forward forecast to address investor concerns around the risk
of the four year base rate stay out provision in its rate settlement. We look for the Company to give drivers to sustaining the higher
earned ROE the settlement enabled.
ANNUAL ESTIMATE CHANGES
Increases
Ameren Corporation (AEE- NYSE; HOLD) - We are increasing our 2012 EPS estimate to $2.40 from $2.35 as weather and new
rates help offset merchant headwinds.
Consolidated Edison, Inc. (ED- NYSE; HOLD) - We are increasing our 2012 EPS estimate to $3.75 from $3.70 as cost saving
initiatives and higher rates help offset higher operating costs. Additionally we look for modest cost saving around the current labor
dispute.
Duke Energy Corporation (DUK- NYSE; HOLD) - We are increasing our 2012 EPS estimate to $4.25 from $4.20 as new rates
and weather help offset higher expenses.
Pinnacle West Capital Corporation (PNW- NYSE; HOLD) - We are increasing our 2012 EPS estimate to $3.40 from $3.35 and
increasing our 2013 EPS estimate to $3.55 from $3.50 due to improved year- to- date weather and new post- settlement rates in
effect.
Decreases
MDU Resources Group, Inc. (MDU- NYSE; BUY, $24 price target) -We are lowering our 2012 EPS estimate to $1.20 from $1.25
as we see slower recovery than anticipated in construction.
TECO Energy, Inc. (TE- NYSE; HOLD) - We are lowering our 2012 EPS estimate to $1.30 from $1.35 for lower coal sales volumes
and unfavorable year- to- date weather.
Otter Tail Corporation (OTTR- NASDAQ; HOLD) - We are lowering our 2013 EPS estimate to $1.25 from $1.40 in assessing our
view of a slow- down in the Wind Energy tower manufacturing business due to possible U.S. wind production tax credit expiration at
year- end and the lack of 2013 orders in backlog.
Valuation Table for Companies in This Report with Changed Annual Estimates
2013E 2013 Price Tgt Price
Company TKR Rating EPS i PIE PIE Target
Ameren Corp._____ AEE Hold $1.95 17.3x N/A N/A
Consolidated Inc. _Edison, ED Hold $3.85 16.5x N/A N/A
Duke Energy Corp. DUK Hold $4.50 14.7x NIA N/A
MDU_Resources Group, Inc. MDU Buy $1.40 16.3x 17.1x
OtterTail Corp. OTTF Hold $1.25 19 Ix N/A N/A
Pinnacle West Capital Corp. PNW Hold $3.55 I 5.Ox N/A J N/A
TECO Energy, Inc. TE Hold $1.35 13.5x N/A N/A
KBCM Utility Peer Group Average Multiple 15.2x
Source: KeyBanc Capital Markets Inc. estimates
INVESTMENT OPINION
The following tables outline our 2Q12 operating earnings estimates and 2Q12 weather data with estimated EPS impacts for electric
utility companies under coverage:
3
Company Note July 20, 2012 2Q12 EPS Estimates I il I! 1111.11 1 1' I it 'It JE' ill ;!
'tIIb IhtlT jiIj 1111! !
iii; tt1 11 !I1H H1 j!
;'1 i i fl1i IL ga
II 1! II1I 11111 }fl IIII'I I'iii I' 1. ?fL I11I4 lUll li ! —
*! !
lift ---- • -
4 r1Mc4 --
L
ag g,gw a, ; g
log
3aU
- a .
***3
.f_... -p__i-.
**Si
-_+-- 41 *&$$ 1 1 -
Os: fe 14
w rx 4_ F1t Hiu
hn tdi1 dI 11111 dIll Idli!
f t
Source: KeyBanc Capital Markets Inc. estimates
Company Note
July 20, 2012
2Q12 Cooling Degree Days Deviation and Estimated EPS Impact
Estimated
2Q12 vs 2Q12 vs Same Qtr YOY
Company Ticker Normal 2Q11 EPS Impact
Ameren Corp. AEE 53.6% 17.6% $0.04
American Electric Power, Inc. AEP 46.3% 4.7% $0.02
CMS Energy Corp. CMS 80.5% 117.8% $0.05
Cleco Corp. CNL 22.5% (13.3)% ($0.03)
DIE Energy Co. DIE 75.1% 38.0% $0.05
Dominion Resources, Inc. D 15.7% (26.1)% ($0.04)
Duke Energy, Inc. DUK 28.9% (0.3)% $0.00
Exelon Corp. EXC 75.1 % 46.6% $0.02
First Energy FE 53.0% (14.4)% ($0.02)
Great Plains Energy GXP 60.5% 29.3% $0.03
Northwestern C orp .* NWE (15.3)% (28.8)% ($0.02)
Pepco Holdings, Inc. POM 49.6% (13.3)% ($0.01)
Pinnacle West Capital Corp. PNW 30.6% 17.7% $0.23
Southern Company SO 27.1 % (9.7)% $0.04
TECO Energy, Inc. TE 16.2% (5.8)% ($0.01)
Wisconsin Energy Corp. WEC 112.0% 169.5%1 $0.03
Xcel Energy, Inc. XEL 74.7%1 70.7%1 $0.03
* Data is Heating Degree Days
Source: National Oceanic and Atmospheric Administration (NOAA), KeyBanc Capital Markets Inc. estimates
ABOUT WEATHER DATA
Most companies give their earnings guidance using the assumption of normal weather in their territories. Temperature is an
uncontrollable variable for utility companies and can have a material impact on earnings when the deviation from normal is significant.
Our intention in developing this research product is to give investors a look at potential earnings variability so that they can adjust
their expectations. We believe that this incremental information will allow investors to capture value by responding to potential market
overreaction to earnings surprises induced by a factor beyond management control. Favorable weather in a peak month can materially
raise a company's earnings for a quarter, inflating the Company's perceived performance and presenting a sell opportunity. The reverse
is true for poor weather, which can make an otherwise successful quarter end with lower earnings than expected. Year- over- year
weather comparisons are also useful for noting where an earnings shortfall or uptick may take place for a utility
Our data is presented as a percentage differential between normal and the previous year's heating or cooling degree- days. The
magnitude of the numbers can be misleading, in our opinion, depending on the normal temperature of the territory. A 10% increase
in cooling degree- days in a historically warm climate may be significant, while a 100% increase in heating degree- days in the same
climate can, in fact, be very small.
The data included in this report is an approximation, based on heating and cooling degree- day totals taken from cities within each
company's service territory The weighting of the territories is based upon our assumptions of customer distribution within each
company's service territory and may differ from actual company data. The per share impact of weather is an estimate based on previous
year impacts given by the Company and our estimates on weather deviation from normal and prior- year periods. We continuously
fine- tune and calibrate our models in an effort to maintain and improve the accuracy of our forecasts.
BACKGROUND ON DEGREE DAYS
A degree day is the variation of the daily average temperature from 65 degrees Fahrenheit. Heating degree days relate to temperatures
below 65 degrees, while cooling degree days are for average temperatures above this temperature. As an example, if the average
temperature over the course of a 24- hour day were 70 degrees, this would equate to five cooling degree days. Conversely, an average
60- degree temperature day would be five heating degree days.
5
Company Note
July 20, 2012
AEE HOLD HOLD NA NA $2.32 $1.90 $2.56 $2.40 $1.95 $2.56 $2.35 $1.95
AEP BUY BUY $42.00 $42.00 $3.05 $3.13 $3.12 $3.05 $3.10 $3.12 $3.05 $3.10
AVA HOLD HOLD NA NA $1.76 $1.85 $1.72 $1.75 $1.85 $1.72 $1.75 $1.85
CMS BUY BUY $2550 $2550 1 $1.54 $164 $145 $155 $165 $145 5
CNL BUY BUY $44.00 $44.00 $2.39 $2.55 $2.53 $2.40 $2.55 $2.53 $2.40 $2.55
0 HOLD
-
HOLD NA - NA $320 $343 $305 $320 $340 $I 40
. ....L
OTE
-
HOLD HOLD NA NA $3.77 $3.99 $3.73 $3.75 $4.00 $3.73 $3.75 $4.00
DUK HOLD HOLD NA NA $4.28 $445 $438 $425 $450 $43 040
ED HOLD HOLD NA NA $3.74 $3.84 $3.61 $3.75 $3.85 $3.61 $3.70 $3.85
ETR HOLD NA NA $530 $539 $762 $525 $530 $762 $569 $O
EXC HOLD HOLD NA NA $2.78 $2.81 $4.16 $2.85 $2.80 $4.16 $2.85 $2.80
FE HOLD HOLD NA NA $340 $3 22 $3 64 '$3 40 $325 $364 $3 40f
GXP HOLD HOLD NA NA $1.28 $1.63 $1.25 $1.25 $1.60 $1.25 $1.25 $1.60
IDA BUY BUY $4400 400 r$3 1$31O 2o$336 rso
MDU BUY BUY $24.00 $24.00 $1.14 $1.35 $1.19 $1.20 $1.40 $1.19 $1.25 $1.40
NEE HOLD HOLD NAINA 4$45 $494 39 450 $495 $439 $4 $45
NI BUY BUY $26.50 $26.50 $1.45 $1.53 $1.31 $1.45 $1.55 $1.31 $1.45 $1.55
NVE HOLD HOLD NA NA $120 $1.25 $059 $120 $1.25 $0.69 $10.$1.25
NWE HOLD HOLD - NA NA $2.44 $2.57 $2.53 $2.45 $2.55 $2.53 $2.45 $2.55
OUR HOLD HOLD - NA NA - $1.15 $1.40 $054 $120 $125 $054 $120 $1 40
PNW HOLD HOLD NA NA $3.37 $3.52 $2.99 $3.40 $3.55 $2.99 $3.35 $350
POM HOLD HOLD NA NA $1.22 $1.29 $1.25 $1.25 $1.25 $1.25 $125 $1.25
PPL HOLD HOLD NA NA $2.31 $2.40 $2.73 $2.35 $2.35 $2.73 $2.35 $2.35
SO HOLD HOLD NA NA $2.66 $2.52 $2.55 $2.70 $2.80 $2.55 $2.0 4 $2.80
TE HOLD HOLD NA NA $1.34 $1.39 $1.27 $1.30 $1.35 $1.27 - $1.35 $1.35
WEC HOLD HOLD NA NA $2.2& .$2.40 $2.18 $2.30 $2.40 $2.18 $2.30 $2.40
XEL HOLD HOLD NA NA $1.77 $1.89 $1.72 $1.75 $1.85 $1.72 $1.75 $1.85
Company Note
July 20, 2012
KeyBanc Capital Markets Inc. Disclosures and Certifications
Important disclosures for the companies mentioned in this report can be found at https://key2.bluematrix.com/sellside/
Disclosures.action.
Please refer to the analysts' recently published reports for company- specific valuation and risks.
Reg A/C Certification
The research analyst(s) responsible for the preparation of this research report certifies that:(1) all the views expressed in
this research report accurately reflect the research analyst's personal views about any and all of the subject securities or
issuers; and (2) no part of the research analyst's compensation was, is, or will be directly or indirectly related to the specific
recommendations or views expressed by the research analyst(s) in this research report.
Rating Disclosures
Distribution of RatingsllB Services Firmwide and by Sector
KeyBanc Capital Markets ENERGY
lB ServiPast 12 Mos. lB Sep,/Past 12 Mos.
Rating Count Percent Count Percent Rating Count Percent Count Percent
BUY [BUY] 232 4402 43 1853 BUY [BUY] 38 48.10 14 36.84
HOLD [HOLD] 284 53.89 46 16.20 HOLD [HOLD] 41 51.90 16 39.02
SELL [UND] II 2.09 4 36.36 SELL (UND] 0 0.00
1
0 0.00
Rating System
BUY - The security is expected to outperform the market over the next six to 12 months; investors should consider adding the
security to their holdings opportunistically, subject to their overall diversification requirements.
HOLD - The security is expected to perform in line with general market indices over the next six to 12 months; no buy or sell
action is recommended at this time.
UNDERWEIGHT - The security is expected to underperform the market over the next six to 12 months; investors should
reduce their holdings opportunistically.
The information contained in this report is based on sources considered to be reliable but is not represented to be
complete and its accuracy is not guaranteed. The opinions expressed reflect the judgment of the author as of the
date of publication and are subject to change without notice. This report does not constitute an offer to sell or a
solicitation of an offer to buy any securities. Our company policy prohibits research analysts and members of their
families from owning securities of any company followed by that analyst, unless otherwise disclosed. Our officers,
directors, shareholders and other employees, and members of their families may have positions in these securities and
may, as principal or agent, buy and sell such securities before, after or concurrently with the publication of this report.
In some instances, such investments may be inconsistent with the opinions expressed herein. One or more of our
employees, other than the research analyst responsible for the preparation of this report, may be a member of the Board
of Directors of any company referred to in this report. The research analyst responsible for the preparation of this report is
compensated based on various factors, including the analyst's productivity, the quality of the analyst's research and stock
recommendations, ratings from investor clients, competitive factors and overall Firm revenues, which include revenues
derived from, among other business activities, the Firm's performance of investment banking services. In accordance with
industry practices, our analysts are prohibited from soliciting investment banking business for our Firm.
Investors should assume that we are seeking or will seek investment banking or other business relationships with the
company described in this report.
7