Hawaiian Electric Industries

Hawaiian Electric Industries reported second-quarter core operating earnings per share of $0.13, down from $0.20 in the year-ago period.

Why it matters: Hawaiian Electric's core electric utility supported operating earnings, more than offset by higher operating costs and higher interest expense.

The bottom line: We are lowering our fair value estimate to $12 per share from $13.50. Our no-moat rating and High Morningstar Uncertainty Rating are unchanged. We have increased our operating costs outlook. We think Hawaiian will have difficulty recovering the full amount. An increase to our cost of capital also lowered our fair value estimate. HEI's stock is down 33% since its peak in mid-February, significantly trailing the Morningstar US Utilities Index. It trades in line with our revised fair value estimate and our sector valuation as of Aug. 10.

Long view: Hawaiian is on track to invest $700 million-$750 million this year, a significant increase from $368 million invested last year. Wildfire mitigation investments are the main reason for the step-up in capital investments. The company plans to invest $2.15 billion-$2.4 billion during 2026-28, up slightly from the previous expectations. Financing will be crucial, given the company's wildfire settlement obligations in addition to its investment plan. Management will seek recovery of $350 million of wildfire expenses this year through securitization, which would help the balance sheet and mitigate customer bill increases.

Coming up: Management is working to rebase rates outside of a typical rate base application. Regulatory risk is significant, where a constructive outcome is important to improving core earned return on equity, which was just 5.7% at the end of the quarter. The rate rebase outcome will set rates for the next five years. A final decision is expected in April 2027, with an interim decision possible by year-end.

Our fair value estimate is $12 per share after incorporating year-to-date financial results, regulatory outcomes, and an updated cost of capital methodology.

We assume that the utility invests $2.15 billion during 2026-28 and receives constructive regulatory recovery for those investments.

We no longer incorporate an additional liability amount above the $1.99 billion settlement fund.

We expect management to operate within the performance-based regulatory ratemaking construct, though we expect it will take time for the company to increase its allowed returns on equity to be more in line with its regulatory-allowed returns.

We do not think Hawaiian Electric has an economic moat, as we think the regulatory and political challenges surrounding the Maui wildfires will make it difficult for the company to earn its allowed returns on equity.

Service territory monopolies and efficient scale advantages are the primary sources of economic moats for regulated utilities. State and federal regulators typically grant regulated utilities exclusive rights to charge customers rates that allow the utilities to earn a fair return on and return of the capital they invest to build, operate, and maintain their distribution networks. In exchange for regulated utilities’ service territory, monopolies, state and federal regulators set returns at levels that aim to minimize customer costs while offering fair returns for capital providers.

This implicit contract between regulators and capital providers should, on balance, allow regulated utilities to earn more than their costs of capital in the long run, though observable returns might vary in the short run based on demand trends, investment cycles, operating costs, and access to financing.

Intuitively, utilities should have an economic moat based on efficient scale, but in some cases regulation offsets this advantage, preventing excess returns on capital. The risk of adverse regulatory decisions precludes regulated utilities from earning wide economic moat ratings. However, the threat of material value destruction is low, and normalized returns exceed costs of capital in most cases, leaving us comfortable assigning narrow moats to many regulated utilities.

Regulation in Hawaii has improved. Performance-based ratemaking reduces earnings volatility while offering opportunities for management to earn incentives.

Hawaii's aggressive renewable energy standards and wildfire investments support HEI's plan to invest $2.15 billion-$2.4 billion in 2026-28.

Hawaiian has taken several strategic steps to fund its wildfire liability, and the wildfire settlement has withstood numerous court challenges.

Wildfires in Hawaiian Electric's service territory have significantly increased investor risk.

Relationships with key stakeholders are likely to remain strained for years, pressuring regulatory returns.

The wildfire settlement agreement will require significant access to capital markets over the next four years.