|Shares Out. (in M):||232||P/E||14.5||13.8|
|Market Cap (in $M):||9,297||P/FCF||14.5||12.5|
|Net Debt (in $M):||15,211||EBIT||1||1|
|Borrow Cost:||General Collateral|
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Purchase November 18 and January 19 put options. Implied volatility on these strikes is ~12% - 15%, creating an opportunity to get fairly inexpensive exposure to a material negative equity event (either significant dilution and a dividend cut, or a downgrade to junk by Moody’s)
Emera is a Canadian utility that owns TECO Energy (Tampa Electric Company and New Mexico Gas Company), Nova Scotia Power Inc (vertically integrated electric utility), Emera Maine (electric T&D utility), Emera Caribbean (electric utility), various gas pipelines in Canada and power generation assets in Canada and New England. Approximately 90% of EMA earnings are from rate-regulated businesses, which enables forecasting cash flow within a relatively tight band.
EMA announced their acquisition of TECO at a 48% premium to TECO’s unaffected share price (total EV of $10.4B USD, and LTM EV/EBITDA of 11.6x) in September, 2015. This acquisition, combined with project delays and accompanying rate deferrals at the Muskrat Falls transmission lines, are the two primary contributors to EMA current credit situation.
Consolidated CFO pre-W/C <12%
Moody’s laid out the credit bogey for EMA to maintain consolidated CFO pre-W/C to debt of greater than 12% back in June of 2016. EMA’s performance on this credit metric was 6.1% for TTM ending 12/31/2016, and improved to 10.1% for LTM ending 09/30/2017. Moody’s placed a negative rating outlook (to junk) on 12/21/2017 after reviewing LTM ending 09/30/2017. I believe that EMA will fall materially short of the 12% bogey for the TTM ending 09/30/2018, potentially leading to a downgrade when Moody’s completes their annual review (likely due in December 2018). Furthermore, I don’t believe that EMA can reach the 12% bogey by even 2020, assuming that EMA is maintaining debt levels at Q22018 levels and funding a cumulative cash flow deficiency (CFO - CAPEX - dividends) or ~ negative $2.5B with common equity.
Credit Metric Calculation
The street equity research agree with this shortfall, but are ignoring the credit implications. Shown below is one example of a street model where cumulative equity & preferred issuances of $3.6B (excluding DRIP) through 2020 don’t get EMA to a 12% CFO pre-W/C. For the purposes of Moody’s calculation, this preferred issuance counts as 50% debt. I have made adjustments CFO to approximate the Moody’s calculation.
Example Street Model
Changes to Executive Compensation
Earlier this year in the Management Information Circular, EMA adjusted their performance metrics for long-term incentive compensation. These metrics directly impact compensation that represented ~63% of former CEO Huskilson’s 2017 compensation. The reasons for for the change are, “The Company’s long-term focus will be on cash generation, particularly in light of the impact the acquisition had on the Company’s balance sheet and the importance of de-leveraging.” Most importantly in this LTI compensation metric change is the removal of this clause, “In addition, dividends had to be maintained at or higher than the December 31, 2014 levels; if dividends were reduced, the second performance factor would be deemed to be zero regardless of EPS growth.” In short, a large portion of management compensation was previously tied to maintaining the dividend - now it isn’t.
Prior LTI Compensation Metrics
Current LTI Compensation Metrics
Comments on Dividend
Comments on Capital and Rating Agency
Moody’s Rating History & Detail
06/01/2016: Moody’s Assigns new Baa3 ratings to Emera Inc.
Emera's stable rating outlook incorporates a view that Emera will successfully execute on its permanent financing plans to finance the TECO Energy acquisition in a consistent manner with what has been stated publicly. The stable outlook also reflects our expectation that Emera's consolidated financial metrics improve, such that consolidated CFO pre-W/C to debt approaches 14% over the next 3 years.
Factors that Could Lead to a Downgrade
Emera's rating could be downgraded if regulatory support of its operating utilities deteriorates; or business risk profile increases through investments in its non-regulated activities; or holding company debt increases further; or if financial metrics do not improve as expected and consolidated CFO pre-W/C to debt remains below 12% on a sustained basis.
12/21/2017: Moody's changes the rating outlook of Emera Inc. and Emera US Finance LP to negative
Factors that Could Lead to a Downgrade
“Emera's rating could be downgraded if regulatory support of its operating utilities deteriorates; or business risk profile increases through investments in its non-regulated activities; or holding company debt increases further; or if financial metrics do not improve as expected and consolidated CFO pre-W/C to debt remains below 12% on a sustained basis.”
Commentary: Over the next 12-18 months, we expect Emera will continue to exhibit financial policies that emphasize holding company debt reduction and improving cash flow generation across its portfolio of subsidiaries. Our negative outlook will focus on the company’s execution to improve its financial metrics.
Over the 12-month period ending 30 September 2017, Emera generated approximately CAD1.3 billion in cash flow from operations, invested about CAD1.5 billion in capital investments and made CAD 388 million in dividend distributions resulting in negative free cash flow of about CAD560 million. Emera used asset sales, equity issuances and short-term borrowings to supplement the shortfall in cash flow. Going forward, we expect Emera’s cash flow from operations will approximately cover planned capital expenditures.
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