PPL: Investors Seem Unconvinced By Business Transformation
PPL Corporation (NYSE:PPL) could be set to deliver peer-leading growth in the regulated utility sector following its business transformation. Investors, however, appear to still need convincing, following the sacrifice to its near-term earnings and dividends, which resulted from the company’s strategic repositioning.
First, let’s take a look at its recent quarterly earnings release. On February 17, 2023, PPL reported adjusted earnings from ongoing operations of $0.28 per share for the fourth quarter of 2022. This fell short of the consensus forecast for non-GAAP earnings of $0.29 per share.
Nevertheless, investors reacted positively to the fact that earnings exceeded the company’s earlier guidance. The company delivered adjusted EPS of $1.41 from ongoing operations for the 2022 full year, beating management’s forecast midpoint of $1.40. Shares in PPL closed 1.3% higher on February 17, 2023.
PPL also increased its quarterly dividend by 7%, from $0.225 per share to $0.24 per share, beginning with the payment due on April 3, 2023. This reflects its recently announced policy to grow dividends in line with projected earnings growth, while maintaining a dividend payout range of 60-65%.
Looking forward to the current fiscal year, management expects to achieve ongoing earnings of between $1.50 to $1.65 per share, with a midpoint of $1.58 per share for 2023. This is just slightly below the consensus analysts’ forecast of $1.59 per share.
As part of its strategy to improve shareholder value and focus on its core business of energy generation and supply in the US, PPL sold its UK regulated electricity distribution business, Western Power Distribution (WPD) to National Grid (NGG), in June 2021. The UK unit was valued at £7.8 billion, and this resulted in net cash proceeds of $10.4 billion for the group.
In a concurrent acquisition, PPL acquired National Grid’s Rhode Island regulated electric business, The Narragansett Electric Company, for $3.8 billion. The strategic repositioning drastically transformed PPL into a US regulated utility pure-play, and more importantly, freed up financial resources to capitalize on new opportunities to invest in renewable energy and grid modernization.
The transactions also enabled PPL to tackle its high leverage ratios, and the improvement in its balance sheet has been reflected by a recent credit ratings upgrade. Moody’s Investors Service upgraded the group’s rating to Baa1 from Baa2, in June 2022, while S&P has maintained an A- rating.
With the improved financial flexibility, PPL in January announced an updated business plan to deliver top-tier earnings and dividend growth for shareholders. The company intends to significantly increase investments in its Kentucky electricity network – with a more than 20% increase from its capital spending plan last year. That’s an additional $2.5 billion, which would bring its total capex to $14.3 billion between 2022 and 2026.
The planned generation and transmission investments are expected to increase PPL’s projected growth rate in its average annual rate base to 5.6% through 2026, up from 3.5% previously.
Elsewhere, the company is looking to raise its operating and maintenance cost savings target by at least $175 million by 2026, from the centralization of shared services, efficiency investments, and digital transformation.
Management expects these changes would enable PPL to generate 6-8% earnings growth through to at least 2026. This would put PPL in line with some of the fastest-growing names in the sector, including NextEra Energy (NEE), which is expecting a similar level of earnings growth through to 2026. In contrast, Duke Energy (DUK), Southern Company (SO), and Consolidated Edison (ED) expect slightly lower earnings growth, of between 5-7% over the same period.
It’s clear that PPL’s improved growth prospects have come at the cost of its near-term profitability. After all, something has had to give way in the pursuit of growth and lower debt levels. WPD had once generated a majority of PPL’s profits; but high leverage at the group prevented it from taking advantage of new opportunities arising from rising EV adoption and the decarbonization of its electricity networks.
As such, PPL’s adjusted ongoing earnings had been stagnating for the past decade or so. Between 2011 and 2020, PPL’s adjusted annual EPS came in between $2.21-2.72. Moreover, the last full year that WPD was treated as an ongoing concern saw PPL generate adjusted EPS of $2.40 in 2020.
This compares to an estimated $1.48 in ongoing EPS for 2022 on a pro forma basis – Rhode Island Energy was acquired in May 2022. From here, this indicates a 38.3% decrease in adjusted EPS following the asset swaps with National Grid.
Meanwhile, its quarterly dividend had been cut by 51.8% to $0.20 per share in early 2022. It has since been increased to $0.225 per share – and will rise further to $0.24, beginning with the April 2023 payment.
Has The Strategy Paid Off?
From PPL’s stock price performance, it seems that investors are still undecided over whether the strategic repositioning is worth the sacrifice to earnings and dividends in the short to medium term. Since the decision to sell WPD in August 2020, PPL’s total return has lagged behind many of its peers in the regulated electric sector – although NextEra Energy is a notable exception.
Yet, valuation multiples suggest that investors may not fully appreciate PPL’s improved growth outlook. The stock trades at around 17.9 times its expected earnings in 2023, compared to the sector median forward PE of 19.0.