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Is PG&E Corporation Worth the Risk?

Tuesday, January 9th, 2018

Overall, I have been quite skeptical of the utility sector. The debt heavy sector typically does not fare well as rising interest rates increase borrowing costs and negatively impact utility companies bottom lines. Speaking of rising interest rates, we have seen the 10-year treasury pass 2.5% and I believe interest rates will continue to rise. That is the reason I am cautious with interest rate investments such as bonds, REITs, and utilities.

Looking at the utility space broadly, many companies have become very expensive compared to historical measures. With the recent California fires, PG&E has seen a large cut in its stock price. With that cut, is the company worth consideration to electrify your portfolio?

PG&E currently delivers and sells natural gas and electricity to customers primarily in Northern and Central California. Customers include residential, commercial, industrial, and agricultural. The stock price currently trades at $44.93 which is well below its 52-week high of $71.57 and close to its 52-week low of $41.61. The stock price has seen a large decline after liability concerns in the harsh California fires. In the state of California, if a utility’s equipment is found to have been a substantial cause of damage in an event such as a wildfire, the company could be liable for property damages and attorneys’ fees associated with the event. This occurs even if the company has followed the established inspection and safety rules. California is one of the only states to place this high burden onto utility companies.

If we turn to the valuation ratios, I am impressed by the numbers. The current P/E of 10.2 is below the industry average of 14.3; Price/Sales of 1.3 is attractive compared to the industry average of 1.8; Price/Tangible Book Value of 1.2 is favorable to the industry average of 2.1; and Price/Cash Flow of 4.5 is also below the industry average of 6.9. It is important to recognize these numbers look at results from the prior 12 months, which means they would not include any potential damages from lawsuits against the company.

Another story that sent the stock price spiraling was the suspension of the company’s dividends for both common and preferred shareholders. Based on the prior dividends, the company would have a dividend yield of 4.7%. With the potential liabilities for the company, they felt it prudent to conserve cash and suspend the dividend. If the company can overcome these problems, investors could receive a nice stable dividend once it is resumed. In normal business operations I believe the dividend is stable as the company only uses 47% of earnings to pay out that dividend. This is a very manageable payout ratio as it still leaves the company with enough room to invest in future growth.

Sales have increased 3.7% over the last 12 months which slightly lags an industry average of 4.6%. Earnings per share over the same time frame increased 160.6%, while the industry average increased 127.4%. As an investor, I would be interested in knowing why EPS growth grew at such a rapid rate compared to the sales growth.

The balance sheet is key for a company that is going through turmoil. With a current ratio of just 0.85, I can see why the company suspended its dividend. There is not much liquidity and if the company has a large liability from the lawsuits, I am concerned they do not have the cash and cash flow to cover them in the short term. They may need to turn to long term debt to finance those needs and raise cash. Fortunately, the company does not have a burdensome Debt/Equity as it is 95.6%. This is substantially below the industry average of 128.4% and shows me that they have the capability to take on more debt if needed.

If I look out to December 2018, estimated EPS of $3.43 would give me a target sell price of $56.60. This is currently 25% away from the current price. We like to buy companies when there is a 30% margin of safety as it allows for fluctuation in the stock price and the analyst estimates. Even if there was a slight pullback in the stock price or an increase in the target sell price, I would want to do deep research into the company’s potential liability from lawsuits related to the California fires. If the liability hinders the company’s operations it could have a substantial impact on the stock price.

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