Ever since I graduated business school – which was a long time ago – I’ve been having discussions and arguments as to whether or not share buybacks (SBB) create value. Despite the fact that many impartial studies have demonstrated and many mathematical proofs have been proffered that SBB don’t create value, astonishingly people continue to emphatically argue that SBB create value. This is not to say that SBB cannot be used to return truly unused capital back to shareholders, but we believe that SBB should be an action of last resort. Regardless, the conclusion: SBB cannot and, therefore, do not create shareholder value.
Even CEOs and CFOs of many companies can’t seem to bring themselves to stop SBB despite all of the evidence that companies cannot create value by buying back their own shares. And, even when it is demonstrated to these managements that there are far better ways to utilize the cash, managements still have reservations about ending their SBB program.
Therefore, I’m hoping that I can end this resistance to ending SBB through this editorial tutorial. The following lists arguments that we’ve encountered for why SBB create value for shareholders:
1) The P/E argument: SBB reduce share count, which increases EPS, and given the same multiple, the stock price must go up;
2) Investing in the company’s own stock creates value for shareholders: Companies can buy their stock at a low price and sell it at a higher price, which creates value;
3) Higher ROE means higher valuation: By reducing the amount of equity on the balance sheet, this raises the ROE on the returns from company projects, for which investors give the stock a higher valuation; and
4) Excess cash returned: This point is about returning excess cash to investors not about shareholder value.
Soft winter weather (warmer than normal) has not helped natural gas prices currently, nor the prospect for strong natural gas prices in 2H2017
However, due to declining production, storage levels have continued to remain below record levels seen last year
LNG IN KOREA
There was an article in the Central Daily News Agency (CDNA) of South Korea that predicted a large shortage of global LNG supply by some 2024 that would have a strong impact on pricing
In a related article, the CDNA is contending that India is set to renegotiate its contract with Cheniere Energy (LNG), also due to high pricing
Given our natural gas outlook, it is natural that investors may think that our view on the power sector is negative; however, it is not, particularly given the developments at NRG Energy
We believe that the power sector is at the cusp of another paradigm shift in which unprofitable assets finally exit stage left (or right, we don’t care which as long as they do)
UTILITY AND INFRASTRUCTURE SECTORS
We believe that the flight to safety is over and a general migration towards a “risk-on” portfolio started in 1Q2017, which we expect to continue into 2018
Also, we expect interest rates to continue rising, which isn’t going to do any favors for the utility and infrastructure sectors in terms funding costs and comparative investment profile relative to fixed income instruments
2016 GRC PD was negative surprise amid positive quarter ||
2016 GRC final decision (FD) was better than the preliminary decision, but still puzzlingly disappointing. Implementation began Oct. 1 2016. The FD is expected to be appealed to NM Supreme Court with final adjudication expected in 1Q2018. We’re particularly puzzled by disallowance of balance draft technology at San Juan, which we believe is necessary part of keeping San Juan operational, and book-value transfer-pricing for PV 2. In view of more modest demographic growth assumptions going forward, PNM reduced expectations for its CAGR in rate base for 2015-2019 to about 5%-6% (was 5%-7%) and lowered its expectations for CAGR in earnings for 2015-2019 to roughly 7%-8% (was 7%-9%). Regardless, we maintain our outlook for CAGR in AEPS through 2019 of about 7%. Total capital spending estimate was increased to some $1.9B (was $1.7B; some $1,019MM after depreciation) through 2019. Much of the increase spending comes from PNM T&D and at TNMP, partially offset by deferment of the now 40MW (was 80MW) peaking unit to 2020 from 2018. The next important development is the IRP to be file mid-2017. We expect surprises, particularly on the renewable energy front.
Cheniere Energy Inc. to rollup Cheniere Energy Holdings (CQH) ||
In a stock exchange transaction, Cheniere Energy Inc. (Cheniere) is proposing to buyback all of CQH
For each share of CQH, Cheniere is offering 0.5049 of Cheniere stock, which calculates to about a 3% premium as of the closing prices of Cheniere/CQH on September 29, 2016, and some 6% premium to the 30-day average trading price of both Cheniere/CQH as of September 29, 2016.
If this transaction is concluded then, based on our data and calculations, Cheniere would increase its economic ownership of CQH from 80.1% to 100.0%, which in turn would increase Cheniere’s economic interest in CQP to about 52% from some 42% currently. More importantly, this would increase Cheniere’s share of CQP distributions to about 32% from some 28% at present.
Although the timing is a bit of a surprise, it is no surprise that Cheniere is attempting to consolidate CQH, something that which we expected.
Unsurprisingly, Hunt has withdrawn its current offer for Oncor
Equally predictable was that much of Hunt’s decision to withdraw its offer had to do with PUCT’s determination to share tax savings more equitably between investors and Oncor customers
It seems that Hunt is willing to resubmit its bid for Oncor that would be viewed by all as a more fair and just sharing of the tax benefits
We would assume that if the new bid includes more sharing of tax benefits, by definition, the price offered would be lower
Regardless, we believe that this opens up an opportunity for CNP to enter the fray
If market’s valuing NRG at such ridiculous levels, it should go private ||
Moving ST-Target to $17 and NIV goes to $52 from $19 and $58, respectively. Retail margins weren’t as robust as expected for 3Q16 causing us to re-evaluate future margins. We feel that there is upside coming for commodity fundamentals. We are less than thrilled about the potential for headline risk surrounding the potential financial distress of GenOn, but we look for a positive outcome. We like that NRG is paying down debt and refinanced some $5.8B of debt due in 2018 to later maturities. Given strong potential for upside, we’re opposed to high level of hedging, especially in 2018 & 2019, so we were pleasantly surprised at the liquidation of some GenOn hedges. And, NRG has yet to disavow share buybacks, and we’d still like NRG to officially and separately reestablish a customer-based marketing and trading business through a bankruptcy-remote sub with strong, consistent and vigorously enforced risk-management policies. NRG needs to roll-up NYLD, in our minds, before NRG runs out of drop-down options. SunEdison renewable portfolio acquisition looks reasonable. 2016E AEBITDA guidance increased, but 2017E AEBITDA guidance lower due to hedge liquidation.
At precipice of demonstrating its LT potential || Our previous AEPS CAGR estimate thru 2021 was 9%; guidance thru 2020 is 8%-10%. But, 2017E AEPS guidance of $1.00-$1.10 seems light. Regardless of forward expectations, AES is trading as if its growth prospects are next to none. As expected, 2016 appears to be bottom and forward prospects for AES look better; AES: 1) is out of many riskier or no-growth-prospect countries, 2) has sold or reduced its interests in non-performing plants, riskier businesses, or assets that have no growth potential, 3) has begun accelerating its investment program, 4) significantly and continues to reduced parent debt, 5) has businesses in stable countries/regulatory-regimes, 6) even troubled assets like Maritza in Bulgaria and Argentina seem to have turned corner, and 8) it’s seriously going green in US. This isn’t to say there aren’t issues, AES: 1) continues to pay more than a nominal dividend, 2) hasn’t disavowed share buybacks, and 3) stubbornly clings to an inexplicably high investment hurdle rate. Regardless, given its investment program we look for it to overshadow our reduced $19/share ST-Target and march towards our reduced NIV of $36/share in the MT-to-LT. We like acquisition of sPower for some $1.6B, which appears to be accretive by over $1/share to our NIV; no meaningful earnings accretion in ST.
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