| | | | | | LNG Cameron Delay Weighing on SharesMgmt disclosed on the call they're experiencing delays with Cameron LNG. Cameron's EPC contractor indicated Trains 1-3 in-service dates are facing delays stemming from flooding at the EPC contractors fabrication facility. Trains 1, 2 and 3 are now delayed to mid-2018, late 2018 and mid-2019 respectively. Sempra's base plan called for all three trains to be in-service by FY2019. In turn, the delay will likely cause 2018 and 2019 Cameron earnings to be lower than anticipated, but we emphasize mgmt. noted these earnings will be made up over time, given the IRR has a tariff established in order to adjust to any costs associated with the delay, preserving the project NPV. The terms of the agreement with the EPC contractor allow for adjustments that are designed to substantially maintain the expected NPV for the project. We have previously noted that investors have immense focus on the LNG story, and careful communication around LNG are parallel given the LNG prospects will aid SRE in exceeding its 2020 EPS guidance. How could discussions between SRE and its EPC contractor play out?We note that based off commentary from the call mgmt. still is grasping the scope of delays at Cameron LNG, and after examining the conference call from Cameron's LNGs EPC provider, we ask why the timeline was not disclosed at the EPC. We find the disconnect intriguing given SRE noted on the call that they have received a detailed schedule. We emphasize the EPC contractor, Chicago Bridge & Iron Co. NV (CBI), noted on its Oct 27 conference call that the recent floods in Louisiana caused a schedule impact, though they did not provide any color as to how long the delays would be. Below we lay out different scenarios that could play out as SRE and CBI discuss project timeline:. See additional thoughts from our colleague Steve Fisher on Cameron LNG here from the CBI perspective on this issue. • Contractor claims force majeure citing the State of Emergency declared in Louisiana as a result of the torrential rain and flooding. In lump sum turn-key projects like this, there usually is not much cushion for error for EPC contracts. This may be one way for CBI to recover costs, while pushing out the projects. That said, SRE noted that rain does not qualify for force majeure. A situation like this would most likely result in a settlement, in our view, albeit this very well could push the timeline out further. • Contractor is still assessing the impacts of the delays, and did not disclose any timeline before speaking with SRE. While there could be risk to the delivery date, the contractor could still very easily catch up with the delayed work. • Contractor is developing an unapproved change order. • Contractor is working with SRE for an approved change order. We see this as unlikely based of the current deal that SRE struck, which is tailored to keep them whole on both sides between the customer and the contractor. Earnings Shift – Still Many Unknowns, but Sell-Off UnwarrantedThe length of delays are clearly still yet to be known, given management has just learned about the issues and will be meeting with the contractor soon for a clearer picture on the potential impacts. Mgmt. additionally has very little color on the exact issues that are driving the delays. We expect further updates from management following their discussions with the EPC contractor. Bearish investors may point out CBI's work with the SCG and SO nuclear facilities, using past history to assume continued delays with Cameron LNG. We emphasize though the characteristics of a nuclear project and LNG project differ greatly, and CBI has many successful projects outside of its nuclear work. We believe the markets concern lies with the shift in earnings if there is a delay in the Cameron project but note at the end of the day SRE will still be making its original NPV on the project, and this is now more of a timing issue rather than lost earnings. Mgmt expects the NPV to not be materially different, with only a shift to increased earnings from 2018 to outer years. We understand why the market reacted to LNG news so negatively (SRE underperformed the XLU by ~4% on the announcement), and note the Cameron LNG project currently represents ~$20/share on our SOP. However, given there is only a shift in earnings vs a loss, we believe there seems to be a doubt in the market that SRE can fully recover the full project NPV. The Cameron LNG baseline project value within our SOP analysis is based on 2020E EBITDA of $815m. We note that while the project was pushed out, we continue to see the in-service dates of all three trains before 2020, and thus our SOP value remains in-tact. Figure 1: Cameron LNG Export Project | 
| Source: Company Filings, UBSe |
Peru Opportunity – Expectations Tapered but Expect Resolution by YE The goal remains to keep International at ~35% through the forecast period Management confirmed recent reports that they are in continued discussions to acquire Odebrechts 50% stake in the $6.5Bn Gasoducto Sur Peroano (GSP) natural gas pipeline project in Peru. However, SRE indicated the need to resolve several significant issues before an agreement could be reached, dampening hopes for those who were looking for a deal. Mgmt has repeatedly looked at expanding its existing utility investments in Peru, given the likely high-return proposition. We emphasize mgmt. seems hopeful that an agreement can be reached but they're providing no assurance. We expect further details to emerge in the near team and emphasize our expectations for final announcement before year end. 3Q Takeaways SRE reported EPS of $1.02 vs UBSe $0.92 and $0.95 Consensus driven by higher earnings at its California utilities, offset by lower earnings at Sempra international due to unfavourable FX and inflation in Q316. Mgmt continues to execute on the international side including a successful $1.6Bn equity raise at Ienova that was multiple times oversubscribed. We note SRE participated in the offering, purchasing $351Mn of stock. SRE ownership due to the secondary has now been diluted to ~66% share of the company. Ienova Continues to Deliver Ienova delivered results in line with Street expectations (see UBS takeaways here) but we highlight is adding more renewables with the pending 242MW Ventika wind acquisition, expected to close Q416 as well as awards (141MW) in recent greenfield auctions for 15yr US contracts. We continue to see SRE positioned well in Mexico, especially in the context of transmission as there are bids expected to be out in 2017 for ~$1.2Bn of transmission projects (Oaxaca) in the country. Oaxaca specifically will be connecting windfarms to electricity demand in the center of the country. See our note here for Ventika project economics. We continue look for additional developments on the Baja Sur gas pipeline, though we note given the connection in Cabo San Lucas may not be as attractive because of the small industrial footprint. SoCalGas Updates Management noted on the call SoCalGas has made significant infrastructure technology and safety enhancements to the Aliso Canyon facility, and recently requested authority from DOGGR and the CPUC which could be approved by year-end. Root cause analysis report is due in the 1H17 with timing dictated by DOGGR, but we note mgmt can receive approval before the root cause analysis finding due to the SB380 rule, which requires satisfaction of a comprehensive safety review as an independent path from root cause analysis. Additionally, mgmt. released that their insurance coverage for Aliso Canyon ranges from $1.2B – 1.4B, giving investors additional comfort for the costs associated with claims (currently stands at $763Mn). SDG&E Adding Renewables We note a fairly quiet quarter at SDG&E with earnings primarily driven by $10Mn higher CPUC base margin. Additionally, SDG&E recently was approved to own and operate 37.5MW of battery storage, expected to be placed into service 1Q17. Mgmt sees an increased opportunity for batteries citing a 200MW opportunity on the call stemming from a new bill 2868 which calls for 500MW of new batteries to be installed. We continue to see upside to the plan at both utilities on the back of Storage, EV, and Otay Mesa acquisition among more tangible developments. PT Unchanged at $116Our price target remains unchanged at $116 and is predicated on a SOP analysis. We see upside to the current shares given the recent dislocation in the stock and the potential future deployment of capital across a variety of avenues that SRE has to execute on in the outer years. Figure 2: Updated EPS Estimates | 
| Source: FactSet, UBSe, Company Filings |
Full ValuationFigure 3: SRE Updated SOP : Unchanged | 
| Source: FactSet, UBSe, Company Filings |
Figure 4: Full SOP Part 1 | 
| Source: FactSet, UBSe, Company Filings |
Figure 5: Full SOP Part 2 | 
| Source: FactSet, UBSe, Company Filings |
| | | | | | | Forecast returns | Forecast price appreciation+16.7% | Forecast dividend yield3.3% | Forecast stock return+20.0% | Market return assumption5.8% | Forecast excess return+14.2% |
| Valuation Method and Risk Statement Risks for Sempra Energy (SRE) include but are not limited to: 1) declines in electric and demand consumption; 2) unfavorable movements in commodity prices; 3) adverse legal/regulatory/legislative outcomes; 4) potential inability to execute on base and/or upset capital expenditure programs; 5) decline in the demand for new wind and solar projects; 6) operational and construction risks; 7) inability to access the capital markets on attractive terms; 8) changes in foreign exchange rates; 9) failure to close pending or prospective M&A transactions; 10) natural disasters; 11) changes in macroeconomics; 12) loss and/or failure to renew key long-term contracts; and 13) other unforeseen changes.
Valuation is based on a sum-of-the-parts analysis. Required Disclosures This report has been prepared by UBS Securities LLC, an affiliate of UBS AG. UBS AG, its subsidiaries, branches and affiliates are referred to herein as UBS. For information on the ways in which UBS manages conflicts and maintains independence of its research product; historical performance information; and certain additional disclosures concerning UBS research recommendations, please visit www.ubs.com/disclosures. The figures contained in performance charts refer to the past; past performance is not a reliable indicator of future results. Additional information will be made available upon request. UBS Securities Co. Limited is licensed to conduct securities investment consultancy businesses by the China Securities Regulatory Commission. UBS acts or may act as principal in the debt securities (or in related derivatives) that may be the subject of this report. This recommendation was finalized on: 03 November 2016 11:28 AM GMT. Analyst Certification: Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers and were prepared in an independent manner, including with respect to UBS, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report. UBS Investment Research: Global Equity Rating Definitions 12-Month Rating | Definition | Coverage | IB Services | Buy | FSR is > 6% above the MRA. | 45% | 28% | Neutral | FSR is between -6% and 6% of the MRA. | 39% | 25% | Sell | FSR is > 6% below the MRA. | 15% | 17% | Short-Term Rating | Definition | Coverage | IB Services | Buy | Stock price expected to rise within three months from the time the rating was assigned because of a specific catalyst or event. | <1% | <1% | Sell | Stock price expected to fall within three months from the time the rating was assigned because of a specific catalyst or event. | <1% | <1% |
Source: UBS. Rating allocations are as of 30 September 2016.
1:Percentage of companies under coverage globally within the 12-month rating category.
2:Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided within the past 12 months.
3:Percentage of companies under coverage globally within the Short-Term rating category.
4:Percentage of companies within the Short-Term rating category for which investment banking (IB) services were provided within the past 12 months. KEY DEFINITIONS: Forecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12 months. Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not a forecast of, the equity risk premium). Under Review (UR) Stocks may be flagged as UR by the analyst, indicating that the stock's price target and/or rating are subject to possible change in the near term, usually in response to an event that may affect the investment case or valuation. Short-Term Ratings reflect the expected near-term (up to three months) performance of the stock and do not reflect any change in the fundamental view or investment case. Equity Price Targets have an investment horizon of 12 months. EXCEPTIONS AND SPECIAL CASES: UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell: Negative on factors such as structure, management, performance record, discount. Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment Review Committee (IRC). Factors considered by the IRC include the stock's volatility and the credit spread of the respective company's debt. As a result, stocks deemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating. When such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece. Research analysts contributing to this report who are employed by any non-US affiliate of UBS Securities LLC are not registered/qualified as research analysts with FINRA. Such analysts may not be associated persons of UBS Securities LLC and therefore are not subject to the FINRA restrictions on communications with a subject company, public appearances, and trading securities held by a research analyst account. The name of each affiliate and analyst employed by that affiliate contributing to this report, if any, follows. UBS Securities LLC: Julien Dumoulin-Smith; Jerimiah Booream, CFA. Company Disclosures Company Name | Reuters | 12-month rating | Short-term rating | Price | Price date | Sempra Energy | SRE.N | Buy | N/A | US$99.36 | 02 Nov 2016 |
Source: UBS. All prices as of local market close.
Ratings in this table are the most current published ratings prior to this report. They may be more recent than the stock pricing date 2.UBS AG, its affiliates or subsidiaries has acted as manager/co-manager in the underwriting or placement of securities of this company/entity or one of its affiliates within the past 12 months. 4.Within the past 12 months, UBS AG, its affiliates or subsidiaries has received compensation for investment banking services from this company/entity or one of its affiliates. 6a.This company/entity is, or within the past 12 months has been, a client of UBS Securities LLC, and investment banking services are being, or have been, provided. 6b.This company/entity is, or within the past 12 months has been, a client of UBS Securities LLC, and non-securities services are being, or have been, provided. 7.Within the past 12 months, UBS Securities LLC and/or its affiliates have received compensation for products and services other than investment banking services from this company/entity. 16.UBS Securities LLC makes a market in the securities and/or ADRs of this company. 18.A U.S.-based global equity strategist, a member of his team, or one of their household members has a long common stock position in Sempra Energy. Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report. For a complete set of disclosure statements associated with the companies discussed in this report, including information on valuation and risk, please contact UBS Securities LLC, 1285 Avenue of Americas, New York, NY 10019, USA, Attention: Investment Research. Sempra Energy (US$) 
Source: UBS; as of 02 Nov 2016 |
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