PG&E Corp

PG&E management announced a strategic review on Sept. 2 but made no substantial changes to its long-term outlook, including its five-year $73 billion investment plan, 9% earnings growth target, and dividend policy.

Why it matters: PG&E had hoped legislators would cap utility wildfire liabilities and enlarge the state's Wildfire Fund, but neither of those made it into legislation before the state's congressional session ended Aug. 31. PG&E management announced it will delay $2 billion of capital investment planned for 2027 primarily related to customer growth. Interest cost savings should offset any earnings impact. Management initiated 2027 EPS guidance at $1.78-$1.82, in line with our estimate and implying 9% growth. Management announced no change to the 2026 dividend and said the board will review the 2027 dividend in December, as usual. Management did not change its target 20% payout ratio by 2028, up from 12% this year.

The bottom line: We are reaffirming our $20.50 per share fair value estimate for PG&E. We are also reaffirming our no-moat rating, which reflects the company's long-term wildfire-related financial exposure. PG&E's stock is down 29% since Aug. 28 when talks between Gov. Gavin Newsom and state legislators related to wildfire legislation began to fall apart. It is now the cheapest US utilities stock we cover. We think the market is overestimating its wildfire risk given existing legislation and the company's operational improvements.

Big picture: Wildfire legislation from 2019 and 2025 effectively eliminates any shareholder exposure to wildfire liabilities if PG&E meets certain safety and operating standards. State utility regulators and politicians likely will reject any significant corporate changes typically associated with a strategic review. PG&E plans no changes to its general rate case filing, which will set customer rates and investments for 2027-30.

Coming up: The California general election is Nov. 3.

Our fair value estimate is $20.50 per share after incorporating management's strategic review plans and regulatory updates.

We forecast 9% average annual earnings growth through 2029 based primarily on the 2023-26 general rate case decision and future capital investment plans. PG&E has secured regulatory approval for most of its $73 billion capital investment plan in 2026-30. Management's plan to defer some of its 2027 investment has no material impact on our valuation or long-term outlook.

We think it's likely regulators will sign off on the bulk of PG&E's capital investment plan during the 2027-30 general rate case, given the need to strengthen and expand the electric distribution system to serve demand growth.

We incorporate an average 10.5% allowed return on equity in 2029 and beyond to reflect higher interest rates in California's cost of capital ratemaking methodology. We also assume PG&E can keep operating costs mostly flat.

Our projections and valuation assume PG&E will be able to recover the bulk of any future wildfire liabilities and costs through its insurance policies, customer rates, the AB 1054 wildfire insurance fund, and the SB 254 continuation fund. If any of those backstops fail, new equity needs to pay for future wildfire liabilities could have a significant negative impact on our fair value estimate.

We assume PG&E's gas utility investments begin to tail off beyond 2029.

We assume a 9% cost of equity in our discounted cash flow valuation, higher than our assumptions for other regulated utilities, given the operational, regulatory, and legal risks PG&E faces.

We do not believe PG&E has an economic moat. Although PG&E has efficient scale advantages due to its rate-regulated service territory monopoly, we do not have enough confidence that PG&E will maintain a sufficiently wide spread between its cost of capital and returns on capital for more than 10 years to justify a narrow moat rating.

PG&E is often subject to more public scrutiny than most other utilities, and we expect that to continue. Wildfire safety expenses, postbankruptcy regulatory restrictions, and unrecovered investments likely will depress returns on capital for several more years.

State legislation in 2019 and 2025 reduced the wildfire-related financial risk for investor-owned utilities in California. The centerpiece 2019 legislation, AB 1054, authorized a $21 billion state wildfire insurance fund that utilities can use to pay fire-related liabilities over $1 billion and not covered by insurance if utilities meet certain wildfire management standards. This includes obtaining a wildfire safety certification from regulators every year. PG&E maintains a valid certification. An $18 billion continuation fund established in 2025 as part of SB 245 further reduces wildfire-related financial risk.

Despite the legislative changes, the state's inverse condemnation strict liability standard remains in place. In December 2017, California regulators denied San Diego Gas & Electric recovery of wildfire costs, setting the precedent that led PG&E into bankruptcy in January 2019. The US Supreme Court declined to hear SDG&E's appeal in October 2019. Reforms to the inverse condemnation standard will take new legislation in California. That doesn't seem likely anytime soon.

California's core ratemaking regulation is highly constructive, including allowed returns on equity that are above the sector average, usage-decoupled rates, and multiyear capital investment budgets. This constructive regulation typically would support an economic moat for a regulated utility, like peers Edison International and Sempra. But the San Bruno pipeline explosion in 2010, allegations of gas pipeline mismanagement, and 2017-18 wildfire liabilities have kept PG&E's earned returns on capital below its cost of capital.

The San Bruno incident resulted in $1.6 billion of penalties and $558 million of third-party claims. Wildfire victims and insurers received $25.5 billion out of PG&E's bankruptcy, and shareholders suffered several billion dollars in additional fines and unrecovered costs.

Regulators will have to tread lightly if they want PG&E to be able to raise the capital required to decarbonize the state's economy. PG&E's last three major rate cases, including the 2023-26 case, have ended with constructive outcomes that supported most of PG&E's proposed capital investments. Regulators have focused more on ensuring PG&E is being efficient with its operating costs to limit customer bill increases.

PG&E hasn't always achieved constructive regulatory outcomes. PG&E for many years struggled with California regulators. The California Public Utilities Commission granted PG&E just 55% of its requested revenue increase in its 2014-16 general rate case and just half of its requested rate increases in its 2011-13 general rate case. We need more proof that PG&E can maintain regulatory and political goodwill before considering a Narrow Economic Moat Rating.

California's core utility ratemaking structures are constructive, with usage-decoupled revenue, annual rate true-up adjustments, and forward-looking rate-setting.

State regulators and politicians support the company's investments in grid modernization, electric vehicles, and renewable energy to meet the state's progressive energy policies.

State legislation passed in 2018, 2019, and 2025 limits shareholder losses if PG&E faces another round of wildfire liabilities.

PG&E depends almost entirely on regulators to approve rate hikes to ensure its large investment plan results in earnings growth.

It could take many years for PG&E's dividend payout ratio to reach the utilities sector average near 50%.

Future safety lapses almost certainly will lead to another round of large losses for shareholders.