Entergy: The Most Attractive Fully Regulated Utility (outside of California) After Agreement to Sell Final Merchant Nuclear Power Plant

Eric Selmon
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Eric Selmon                              Hugh Wynne

Office: +1-646-843-7200            Office: +1-917-999-8556

Email: eselmon@ssrllc.com       Email: hwynne@ssrllc.com

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

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April 17, 2019

Entergy: The Most Attractive Fully Regulated Utility (outside of California) After Agreement to Sell Final Merchant Nuclear Power Plant

Yesterday Entergy (ETR) announced an agreement to sell all three generating units at the Indian Point nuclear plant after the final unit retires in 2022. This completes Entergy’s plans to remove all merchant nuclear risk from their balance sheet once the generating units are retired. What remains is a rapidly growing large cap electric utility that trades at a meaningful discount to the sector even when adjusted for additional leverage at the parent company.

  • With the announcement of yesterday of the agreement to sell the Indian Point nuclear power plant to Holtec upon retirement of units 2 & 3, Entergy has successfully laid out a path to exit the merchant nuclear business and transform itself into a fully regulated electric utility.
  • We identified ETR as a preferred regulated utility investment about a year ago (see our note from April 3, 2018“Utility Portfolio Update: Adding ETR to our List of Preferred Utilities”) as we believed that it would be able to successfully exit their merchant nuclear business with little if any residual risk to shareholders, leaving investors with a rapidly growing group of electric utilities that trade at a discounted valuation.
    • Since then Entergy announced, in August 2018, an agreement to sell the Pilgrim and Palisades plants to Holtec for decommissioning upon their retirement, closed on the sale of the already retired Vermont Yankee plant in January 2019 and, yesterday, announced an agreement to sell the Indian Point nuclear plant to Holtec. (See Exhibit 1).
    • This means that upon retirement of the Palisades plant in 2022 Entergy will have eliminated all exposure to their ~3 GW merchant nuclear fleet leaving only their 6 regulated utilities and less than 400 MW of fossil fuel fired merchant generating assets.

Exhibit 1: Entergy’s Merchant Nuclear Generating Units and Their Post-Retirement Plans

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Source: Company reports

  • Importantly, the regulated utilities that now comprise Entergy are attractive ones, with above average rate base growth now and over the long term. In Exhibit 2 we show Entergy’s forecasted rate base growth over 2019-2022, 2022-2026 and beyond 2026 and compare these growth rates to our forecast for the industry median. In all periods we expect Entergy’s rate base to grow meaningfully faster than the industry. This should support Entergy’s 5-7% EPS growth guidance through 2021 and beyond.

Exhibit 2: Entergy and Industry Median                Exhibit 3: Entergy and Industry Median

Rate Base Growth, 2019-22, 2022-26 and              Rate Base Growth by Function, 2019-22

Long Term

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Source: FERC Form 1, company reports, SNL, SSR analysis

  • Interestingly, unlike the industry, the largest portion of Entergy’s rate base growth through 2022 is from generation and we believe that will likely continue to be the case for Entergy. (See Exhibit 3). We see this as a long term growth opportunity for Entergy: our forecast of U.S. power plant retirements shows that Entergy has one of the largest needs to invest in new regulated generation to replace retiring power plants over the next 20 years. (See our note from April 19, 2018, The Next Wave of Rate Base Growth – Half of U.S. Generating Capacity Will Retire by 2040: Who Wins and Who Loses?).
  • In spite of its attractive long term growth, Entergy trades at a ~10% discount to the utility sector on 2021 P/E, offering 11% upside were its valuation to align with the group’s. (See Exhibit 4).
    • We believe much of Entergy’s persistent discount to the sector has been due to concerns over the operating and residual risk from the merchant nuclear fleet. Although some risk remains until the plants are actually retired and sold, we expect the discount to shrink meaningfully as 2022 approaches and investors rethink their views on Entergy.

Exhibit 4: Relative PE                   Exhibit 5: Relative EV/EBITDA   Exhibit 6: Equity Upside

 

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Source: FERC Form 1, company reports, SNL, SSR analysis

  • Many investors, however, believe that Entergy deserves to continue to trade at a discount due to the large amount of debt at the holding company and non-regulated subsidiaries.
    • Entergy has ~$4.2 billion of debt outside of its regulated utility subsidiaries, comprised of ~$2.2 billion of long term debt and ~$1.9 billion of commercial paper. In addition, there is ~$220 million of preferred equity outside of the regulated utilities.
  • We disagree with this valuation assessment. First, we expect the debt at the holding company to decline over time as there are no longer non-utility operations to fund. In addition, the ratings agencies have already affirmed Entergy’s credit ratings even before the agreements to sell the nuclear plants had been announced.
  • More importantly, there is evidence from other metrics that Entergy is trading at a discount even after adjusting for leverage. In Exhibit 5, we also included a valuation analysis of Entergy based on EV/EBITDA, a valuation metric that takes leverage into account, as enterprise value sums the value of all debt, preferred and common equity outstanding and EBITDA represents the cash available for distribution to all these sources of capital.
    • Using consensus EBITDA for 2021, and adjusting it to remove Entergy’s guidance of $90 million of EBITDA from the merchant nuclear operations, Entergy still trades at an ~8.5% discount to the regulated utility median on EV/EBITDA and appears to offer over 19% equity upside were this gap to close.

Additional Insight: Nuclear decommissioning risk is less than most investors believe and is declining

  • More generally for the industry, the willingness of Holtec to take ownership of these nuclear plants strongly supports our view that the risk of nuclear decommissioning is much lower than many investors believe.
    • Holtec committed to commencing decommissioning immediately upon retirement, with only the current assets in the nuclear decommissioning trusts to cover all decommissioning costs and to compensate Holtec for the risks it has assumed.
    • Moreover, as more nuclear generating units have retired and begun decommissioning over the past several years, nuclear decommissioning service companies have been able to reduce costs due to increased experience and scale of operations. This suggests that actual decommissioning costs could come in below those used to estimate the required funding for nuclear decommissioning trusts.

Exhibit 7: Heat Map: Preferences Among Utilities, IPP and Clean Technology

©2018, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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