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Prepare for the Worst, Hope for the Best

By Ari Charney on October 7, 2016

With Hurricane Matthew brushing along the Florida coast, it looks like the Sunshine State may end up avoiding the worst of what had been feared. The rest of the Southeast could be similarly spared the hurricane’s full fury, if the storm continues to follow its projected path just offshore.

Nevertheless, as the National Hurricane Center likes to remind us, hurricane-force winds and other damaging weather can still occur well outside the cone of probability.

Indeed, while many Floridians are breathing a sigh of relief today, others are contending with serious property damage, in addition, of course, to power outages.

Likewise, executives at NextEra Energy Inc. (NYSE: NEE) may also be breathing a sigh of relief. The utility holding company, whose Florida Power & Light (FPL) subsidiary provides power to 4.8 million customers across nearly half the state (and accounts for nearly two-thirds of NextEra’s operating profits), had expected that as many as 2.5 million customers could lose power during the hurricane.

However, if Matthew continues to scrape along Florida’s coast without making landfall, then the final tally could end up being far less. This morning, for instance, the utility reported that 475,000 customers were without power, while crews assisted by linemen from neighboring states worked through the night to restore power to 230,000 customers.

FPL said it expects to restore power to the majority of its customers in South Florida by the end of the day, though it noted that another 1 million customers remain in harm’s way as the storm rotates north.

Interestingly, the market has already given NextEra the all-clear signal, even though the hurricane is still lashing the state’s coastline. Shares of the utility holding company were up as much as 4.4% in this morning’s market session, compared to a 0.3% rise for the rest of the sector, though the stock has since given back some of its gain.

Electric utilities that operate in adjacent states along the East Coast, such as Southern Company (NYSE: SO), Scana Corp. (NYSE: SCG), and Duke Energy Corp. (NYSE: DUK), will likely also see some action before Matthew heads out to sea.

The main threat such storms pose to utility infrastructure is against the transmission and distribution systems (i.e., the wires) that deliver electricity from generating stations to homes and businesses. High sustained winds and gusts can knock down trees onto power lines, while storm surges can flood substations.

Fortunately, NextEra has invested more than $2 billion in hardening FPL’s infrastructure over the past 10 years and has a workforce of about 15,000 that can be mobilized once the immediate threat has passed.

But even if NextEra suffers significant damage to crucial infrastructure, it should ultimately be able to recoup the costs of repairing such systems from ratepayers. That’s because regulatory law typically considers storm damages as part of the cost of doing business, so recovery is usually allowed.

It also helps that the Florida utility has a good relationship with state regulators. The same holds true for its peers in nearby states, all of whom enjoy largely constructive relationships with their regulators.

Of course, such cost recovery isn’t automatically a given. Since regulators are appointed in some states and elected in others, they are ultimately political animals.

And that means if a utility mismanages its response to a disaster, regulators will get an earful from ratepayers and consumer advocates. That could lead to a long lag in cost recovery or even the possibility that investors will have to shoulder some of the cost, as has been the case for utilities in other states after weather-related disasters.

So it’s absolutely critical for utilities to have the scale, resources, and expertise to respond swiftly and thoroughly in the wake of such disasters. The good news is that the aforementioned utilities have a record of successfully rising to the challenge.

In the immediate aftermath, utilities will often finance the initial cost via insurance, federal block grants and the issuance of specialized bonds, since rate recovery via the regulatory process takes time.

Utilities’ fourth-quarter financial performances could also take a hit due to lower revenue resulting from outages.

For example, the consensus forecast for NextEra’s fourth-quarter adjusted earnings per share has dropped by 5.9% over the past 10 days, according to Bloomberg, though most of that decline appears to be due to an analyst whose forecasts appear to be outliers. Three other analysts have reaffirmed their prior forecasts for the final quarter of the year.

Odds are that many of the 17 other Wall Street analysts who track the stock will be revisiting their estimates in the days to come, once NextEra offers an initial assessment of the damage.

Thankfully, some or all of any near-term loss could later be recaptured via cost recovery and the further hardening of infrastructure.

But any concerns about how the hurricane will affect fourth-quarter numbers haven’t dampened sentiment over the medium term, at least so far. Of the eight analysts who have weighed in on NextEra’s prospects over the past two days, all have reiterated their “buy” ratings, while two bumped their 12-month target prices by an average of 2.1%.

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