Should We Take a Chance on Now Bankrupt PG&E?
California’s Pacific Gas and Electric, or PG&E, is the nation’s largest utility. It went bankrupt in January over massive potential lawsuits. Is it worth a gamble now?
For whatever reason, California’s wildfires have been particularly brutal over the last couple of seasons. Many believe that global warming is to blame, and if that is the case, then we’re in for a lot more of this in the future, because global warming is supposed to get worse over time.
PG&E, the largest utility company in both California and the United States, was particularly hard hit by the wildfires of 2017 and 2018, and filed for bankruptcy on January 19, 2019.
The interesting part about this filing is that companies usually wait until they are insolvent to file for bankruptcy protection, but in PG&E’s case, it was the fear of insolvency that brought this on. With the specter of billions of dollars’ worth of legal settlements on the horizon, the wall of flames from these claims that was heading toward the company ended up just giving off too much heat.
Utility companies have a certain duty to maintain their lands and equipment and, like everything else, the decisions about how much money to allocate to this becomes a matter of economics. When wildfires get as fierce as they have been in California lately, this has upped the ante and exposed the utility to a lot more risk than they envisioned, and with another wildfire season underway, the tally just keeps growing.
It’s not only the wildfires that they need to be worried about, as other natural disasters such as flooding and hurricanes can also cost the company a lot of money. Utilities are granted monopolies and with that comes tight regulation and they can’t always just raise prices to compensate for these things.
The utility scene in California overall has heated up so much that the state government rushed through a bill in preparation for the current season to lighten the load on these companies. California not only has the largest utility company in the country in terms of customers but the second largest as well, and these companies are essential to the state’s infrastructure and aren’t the sort of companies that anyone wants to see fail.
California now has new statutory limitations on claims against utility companies, as well as a better structure for the companies to pass along these expenses to their customers. Both of these provisions were sorely needed to help these companies manage the much greater risk that changing weather patterns have brought lately.
In order for PG&E to benefit from this as well, they need to get out of bankruptcy soon, and they have a year to do this now. That’s far from a sure thing and adds to the uncertainty surrounding the company.
To Say PG&E Stock Has Question Marks Beside It is an Understatement
There are a lot of question marks out there about PG&E that shareholders and potential shareholders need to be aware of, starting from the fact that holding shares of a company in bankruptcy of any sort is not an ideal or even a good situation by any means.
There are some good things that the company may have going for it, starting with the fact that their stock bottomed two days before the bankruptcy announcement, and within a week of the announcement, their share prices more than doubled. This is in spite of many complaining about this filing, feeling that it wasn’t necessary, but this did attract the attention of hedge funds who stepped in and propped the stock up quite a bit.
Hedge funds started picking up a lot of PG&E stock back in February 2018, and have been adding since. The 4% they held back then grew to 19% at the time of the bankruptcy announcement and just kept growing, and they now own about half of the company’s stock.
It’s not that the stock has taken off or anything over this time but it certainly has stabilized, and has settled into a range of $17-$23 per share. While this isn’t exactly a tight range, it’s pretty tight compared to the several falls of a cliff it took over the last 2 years where it lost 90% of its value at the worst of this.
This does not mean that the bad news is necessarily over as there is a lot that could go down to change things. One of the questions among many out there is how much PG&E will dilute its shares to raise more capital, and it’s not if we will see this, it’s how much we will see.
A lot of people are familiar with a company buying back its stock, which is done with the express intent of raising their stock price, but the other side of this, selling stock, does the opposite. This is not a thought that shareholders who have gotten slammed so much already are going to be looking forward to.
The projection is currently at 60%, which is a lot of dilution indeed. PG&E doesn’t just need to worry about claims, they also need to spend money on improvements which will help minimize future liability, adding up to billions of dollars more for the utility. The state’s three major utilities are being ordered by the legislature to spend a total of $5 billion on this plus contribute an additional $7.5 billion to an insurance fund.
There is an existing insurance arrangement to protect the utilities, funded by rate payers, but at the rate we’re going, there is much fear that this will dry up and leave the companies hung out to dry as well.
This is not the first time PG&E has declared bankruptcy, as they went through one from 2001-2004 due in part to the Enron scandal where they had to buy electricity at inflated prices and were not permitted to pass these extra costs along. The ordeal ended up costing PG&E and the state $45 billion, but they were able to keep things together enough to survive the bankruptcy.
This is a Risky Investment Indeed Here, But May Present Good Trading Opportunities
This stock has recently been promoted by Morgan Stanley as a potential investment right now, with an upside of 20%. We do need to ask ourselves whether all the baggage that PG&E has, all the risk that is, would make such a potential return worth pursuing.
From an investment perspective, it is very hard to make sense out of this, as we’d need a lot more upside to make these additional risks palatable. It’s not hard at all to find stocks with more upside than this without all these extra risks and uncertainties.
While hedge funds may have been eager to jump on, this is what some hedge funds do, buy distressed companies like this, but big funds need to put their money somewhere, and their choices are a lot more limited than ours are. We can invest in whatever we want because we are not this saturated.
PG&E is also particularly not suited to your typical investor, as plays like this require very skilled management, and investors just don’t have those skills. We’re not talking about your average investor here either, and this is even well out of Warren Buffett’s league, at least in terms of managing it properly. When risk comes home to roost, investors are more likely to just freeze like deer in headlights than to act wisely. Most people do not even have any exit plan whatsoever, and are especially not equipped to deal with the complexities involved in managing a position such as this or anything close to it.
If we are thinking that these things are best left to hedge funds, we share the same thinking that has had so many regular investors bail and sell to the hedge funds, which is what has been going on over the last year and a half.
If we really want to take advantage of this play, and are up for it, we can shoot for this 20% gain by just trading the range, and there may even be several opportunities to do this as the money keeps changing hands in a way that has been fairly predictable so far. If we buy near the bottom of this range, where the stock is now, and look to set our stops a little below this, we can look to ride the next wave up to the $23 area and make this much in a pretty short period of time.
This is not even a trade that takes very much skill, although it does take real discipline to get out quickly if this trend breaks down and to also get out if we get to the top and start to move down. This would even be a play where it wouldn’t be such a bad idea to just take our profits there regardless, even though this strategy is generally not a very good one as we normally want to see the move fail a bit first.
Other than that, if you are investing not just for a few weeks but for a few years or longer, it’s just too hard to say where the stock will be then, although it’s not unreasonable at all that it would be at least 20% higher if not more. The road to there will be a bumpy one though, and these aren’t the kind of bumps that investors want to be riding, especially given they let others do the driving and just ride on the back of the truck and hope that they won’t be thrown onto the pavement.
The destination does matter a lot, but so does the smoothness of the ride.
Editor, MarketReview.com
Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.
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