Rating Update: Stock Rating C-Neutral (10/17/19)-Pinnacle West Capital Corp (PNW).

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BUSINESS

Pinnacle West Capital Corporation, through its subsidiary, Arizona Public Service Company, provides retail and wholesale electric services primarily in the state of Arizona. It generates, transmits, and distributes electricity using coal, nuclear, gas, oil, and solar resources. The company serves approximately 1.2 million homes and businesses. It owns or leases approximately 6,236 megawatts of regulated generation capacity. The company was founded in 1920 and is headquartered in Phoenix, Arizona.
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INVESTMENT RATING

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PNW is expected to continue to be a modest Value Builder reflecting capital returns that are forecasted to be above the cost of capital.

PNW has a current Value Trend Rating of C (Neutral).
With this rating, PTR’s two proprietary measures of a stock’s current attractiveness are providing contradictory signals. PNW has a poor Appreciation Score of 29 but a slightly positive Power Rating of 68, resulting in the Neutral Value Trend Rating.

PNW’s stock is selling above targeted value. The current stock price of $93.69 compares to targeted value 12 months forward of $80.
This low appreciation potential results in an appreciation score of 29 (71% of the universe has greater appreciation potential.)
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PNW has a Power Rating of 68. (This slightly positive Power Rating indicates that PNW has a better chance of achieving attractive investment performance over the near to intermediate term than all but 32% of companies in the universe.)
Factors contributing to this slightly positive Power Rating include: is in a strong phase current; and recent price action has been slightly favorable. An offsetting factor is earnings estimate behavior for PNW has been slightly negative recently.

INVESTMENT PROFILE

PNW’s financial strength is below average. Financial strength rating is 38.
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Relative to the S&P 500 Composite, Pinnacle West Capital Corp has moderate Value characteristics; its appeal is likely to be to Income-oriented investors; the perception is that PNW is lower risk. Relative weaknesses include: low forecasted profitability, low financial strength, and low expected growth. PNW’s valuation is low: high dividend yield, moderate P/E ratio, and low price/book ratio. PNW has unusually low market capitalization.

CURRENT SIGNALS

PNW’s current operations are stable. Return on equity is falling, reflecting: falling asset utilization; declining pretax margin; and falling leverage.

PNW’s current technical position is very strong. The stock price is in a 12.1 month up move. The stock has appreciated 31.3% from its prior low. The stock price is above its 200 day moving average which is in an uptrend. The stock has just fallen below its 200 day moving average.

ALERTS

Pinnacle West Capital Corp (NYSE: PNW) has recently experienced meaningful negative changes in investment behavior: the stock’s recent price decline challenged its longer term uptrend.
The stock is currently rated C.
Pinnacle West Capital Corp (NYSE: PNW) stock suffered a major decline of -16.2% on 10/17/19. The shares closed at $0.24. However, trading volume in this decline was below average at 69% of normal. The stock has been strong relative to the market over the last nine months but has declined -1.8% during the last week.

CASH FLOW

In 2018, PNW experienced a very significant reduction in cash of -$8 million (-58%). Sources of cash were much lower than uses. Cash generated from 2018 EBITDA totalled +$1,356 million. Non-operating sources contributed +$115 million (+8% of EBITDA). Cash taxes consumed -$22 million (-2% of EBITDA). Re-investment in the business amounted to -$1,166 million (-86% of EBITDA). On a net basis, debt investors contributed +$4 million (+0% of EBITDA) while equity investors pulled out -$295 million (-22% of EBITDA).
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PNW’s Non-operating Income, %EBITDA has exhibited a minor overall uptrend over the period. This improvement was accompanied by stability for the Pinnacle West Capital Corp Peer Group. In most years, PNW was in the third quartile and lower quartile. Currently, PNW is substantially above median at +8% of EBITDA (+$115 million).

PNW’s Cash Taxes, %EBITDA experienced a volatile overall downtrend over the period. This downtrend was accompanied by a similar trend for the Pinnacle West Capital Corp Peer Group. In most years, PNW was in the third quartile and second quartile. Currently, PNW is slightly below median at -2% of EBITDA (-$22 million).

PNW’s Business Re-investment, %EBITDA has experienced a downtrend over the period. This downtrend was accompanied by an opposite trend for the Pinnacle West Capital Corp Peer Group. In most years, PNW was in the top quartile and second quartile. Currently, PNW is slightly above median at -86% of EBITDA (-$1,166 million).

PNW’s Debt Investors, %EBITDA has experienced a very strong overall uptrend over the period. This improvement was accompanied by a similar trend for the Pinnacle West Capital Corp Peer Group. In most years, PNW was in the third quartile and lower quartile. Currently, PNW is below median at +0% of EBITDA (+$4 million).

PNW’s Equity Investors, %EBITDA has experienced a downtrend over the period. This downtrend was accompanied by a similar trend for the Pinnacle West Capital Corp Peer Group. In most years, PNW was in the third quartile and second quartile. Currently, PNW is below median at -22% of EBITDA (-$295 million).

PNW’s Change in Cash, %EBITDA has exhibited little to no overall change over the period. This stability was accompanied by stability for the Pinnacle West Capital Corp Peer Group as well. In most years, PNW was in the third quartile and second quartile. Currently, PNW is lower quartile at -1% of EBITDA (-$8 million).
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PNW’s Cash, %Revenue has exhibited little to no overall change over the period. This stability was accompanied by stability for the Pinnacle West Capital Corp Peer Group as well. In most years, PNW was in the third quartile and lower quartile. Currently, PNW is lower quartile at +0%.

PROFITABILITY

PNW’s return on equity reached a new post-2009 low in 2019.
This was due to very strong positive trend in pretax operating return and very minor positive trend in non-operating factors.
The productivity of PNW’s assets declined over the full period 2009-2019: asset turnover has suffered a strong overall downtrend.
More than offsetting this trend, however, pretax margin enjoyed a very strong overall uptrend but it experienced a small decline after the 2012 high.
Non-operating factors (income taxes and financial leverage) had a very small positive influence on return on equity.
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PNW’s return on equity is slightly below median (9.6%) for the four quarters ended June, 2019.
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Operating performance (pretax return on assets) is at the upper quartile (3.5%) reflecting asset turnover that is lower quartile (0.20X) and pretax margin at the upper quartile (17.4%).
Tax “keep” rate (income tax management) is at the lower quartile (79.5%) resulting in after tax return on assets that is slightly below median.
Financial leverage (leverage) is at the upper quartile (3.47X).

GROWTH RATES

There are no significant differences between Pinnacle West Capital’s longer term growth and growth in recent years.
Pinnacle West Capital’s historical income statement growth and balance sheet growth have diverged. Revenue growth has paralleled asset growth; earnings growth has exceeded equity growth.

Annual revenue growth has been 0.6% per year.

Total asset growth has been 3.8% per year.

Annual E.P.S. growth has been 11.3% per year. (More recently it has been 5.1%.)

Equity growth has been 3.9% per year.

Pinnacle West Capital’s consensus growth rate forecast (average of Wall Street analysts) is 5.2% — in line with the average of the historical growth measures.
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Relative to the Pinnacle West Capital Corp Peer Group, PNW’s historical growth measures are erratic. E.P.S. growth (11.3%) has been upper quartile. Revenue growth (0.6%) has been substantially above median. Total asset growth (3.8%) has been at median. Equity growth (3.9%) has been slightly below median.

Consensus growth forecast (5.2%) is slightly below median.
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PRICE HISTORY

Over the full time period, Pinnacle West Capital’s stock price performance has been slightly below market. Between December, 2008 and October, 2019, Pinnacle West Capital’s stock price rose +192%; relative to the market, this was a -12% loss. Significant price moves during the period: 1) June, 2015 – March, 2019: +68%; and 2) February, 2009 – January, 2015: +167%.
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TOTAL INVESTMENT RETURNS

Current annual total return performance of 26.7% is upper quartile relative to the S&P 500 Composite.
In addition to being upper quartile relative to S&P 500 Composite, current annual total return performance through September, 2019 of 26.7% is at the lower quartile relative to Pinnacle West Capital Corp Peer Group.

Current 5-year total return performance of 16.1% is above median relative to the S&P 500 Composite.
Through September, 2019, with above median current 5-year total return of 16.1% relative to S&P 500 Composite, PNW’s total return performance is at median relative to Pinnacle West Capital Corp Peer Group.
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VALUATION BENCHMARKS

Relative to S&P 500 Composite, PNW’s overall valuation is normal. The highest factor, the ratio of enterprise value/revenue, is above median. Ratio of enterprise value/earnings before interest and taxes is above median. Price/earnings ratio is at median. Price/equity ratio is near the lower quartile. The lowest factor, the ratio of enterprise value/assets, is at the lower quartile.

Relative to Pinnacle West Capital Corp Peer Group, PNW’s overall valuation is quite low. The highest factor, the ratio of enterprise value/earnings before interest and taxes, is lower quartile. Ratio of enterprise value/revenue is at the lower quartile. Price/equity ratio is below median. Price/earnings ratio is at the lower quartile. The lowest factor, the ratio of enterprise value/assets, is lower quartile.
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PNW has a large value gap compared to the median. For PNW to hit median valuation, its current ratio of enterprise value/revenue would have to rise from the current level of 4.46X to 4.93X. If PNW’s ratio of enterprise value/revenue were to rise to 4.93X, its stock price would be higher by $15 to $109.
For PNW to achieve upper quartile valuation relative to the Pinnacle West Capital Corp Peer Group, its current ratio of enterprise value/revenue would have to rise from the current level of 4.46X to 5.28X. If PNW’s ratio of enterprise value/revenue were to rise to 5.28X, its stock price would increase by $27 from the current level of $94.

VALUE TARGETS

PNW is expected to continue to be a modest Value Builder reflecting capital returns that are forecasted to be above the cost of capital.
Pinnacle West Capital’s current Price Target of $81 represents a -13% change from the current price of $93.69.
This low appreciation potential results in an appreciation score of 29 (71% of the universe has greater appreciation potential.)
Notwithstanding this low Appreciation Score of 29, the moderately high Power Rating of 68 results in an Value Trend Rating of C.
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Pinnacle West Capital’s current Price Target is $81 (+10% from the 2018 Target of $74 but -13% from the 10/17/19 price of $93.69). This slight rise in the Target is the result of a +7% increase in the equity base and a +2% increase in the price/equity multiple. The forecasted increase in growth has a large positive impact on the price/equity multiple and the forecasted increase in return on equity has a slight positive impact as well. Partially offsetting these Drivers, the forecasted increase in cost of equity has a slight negative impact.
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PTR’s return on equity forecast is 10.2% — in line with our recent forecasts. Forecasted return on equity exhibited a slight, erratic increase between 2010 and 2018. The current forecast is steady at the 2010 low of 9%.

PTR’s growth forecast is 6.0% — slightly above our recent forecasts. Forecasted growth enjoyed a dramatic, variable increase between 2010 and 2018. The current forecast is above the 2013 low of 1%.

PTR’s cost of equity forecast is 7.9% — in line with recent levels. Forecasted cost of equity exhibited a modest, steady increase between 2010 and 2018. The current forecast is steady at the 2010 low of 6.7%.
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At Pinnacle West Capital’s current price of $93.69, investors are placing a positive value of $33 on its future investments. This view is consistent with the company’s most recent performance that reflected a growth rate of 3.0% per year, and a return on equity of 9.9% versus a cost of equity of 7.3%.
PTR’s 2020 Price Target of $81 is based on these forecasts and reflects an estimated value of existing assets of $63 and a value of future investments of $18.

About John Lafferty 52629 Articles
During his career, John has developed valuation and stock rating methodologies, managed institutional portfolios and mutual funds, and provided equity research to institutional investors on thousands of companies. He has been Director of Research at PTR since its inception in 2004.

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