Bay Street analysts downgraded their views for Hydro One Ltd. and investors drove down the utility’s share price in response to the Ontario government’s extraordinary move to push out the board and chief executive officer Mayo Schmidt.
After markets closed Wednesday, Hydro One announced that its entire board of directors will resign by mid-August and the CEO would retire immediately. The move was in response to threats by Ontario Premier Doug Ford to displace the board and Mr. Schmidt, whom he derided in the June election campaign as the company’s “$6-million man,” a reference to his compensation last year.
The leadership shakeup at Hydro One, which runs much of the province’s electrical transmission network, fulfills one of Mr. Ford’s campaign promises. But the market reacted badly, causing Hydro One shares to fall 6.2 per cent to a record low in early trading on Thursday before paring losses late to end down 3.2 per cent.
The decline knocked nearly $390-million off Hydro One’s market capitalization, giving the provincial government – which owns 47 per cent of the company – a paper loss of about $180-million in one day.
While analysts remain largely upbeat about the long-term prospects of Hydro One – which the previous Liberal government partly divested through an initial public offering in 2015 – they have raised concerns about political uncertainty and further government moves that could cut the company’s profitability, which could weigh on the utility’s valuation.
Four analysts downgraded the stock. RBC Dominion Securities lowered its recommendation to “sector perform” from “outperform.” Similarly, Credit Suisse lowered its recommendation to “neutral” from “outperform” previously, arguing that political interference is going to be a drag on the stock’s perception by the market. Laurentian Bank Securities and Industrial Alliance Securities also lowered their ratings to the equivalent of a hold.
“In our view, we believe Hydro One’s shares will de-rate” – or begin to trade at a lower valuation relative to earnings – “and suffer from a potentially long-term ‘Ontario overhang,’ ” Credit Suisse analyst Andrew Kuske said in a note.
Robert Catellier, an analyst at CIBC World Markets, also raised concerns in a note that slashed the 12-month target price on the stock to $20.50 from $24 previously – a nearly 15-per-cent reduction.
“While the transition will occur through a more orderly process than we had feared, it indicates the government is willing to meddle. Just as worrisome is the possibility that the government meddles with the company’s rates [what it charges consumers for electricity] in some form, potentially impacting earnings and upside from incentive rate-making,” Mr. Catellier said in a note.
He also raised concerns about Hydro One’s planned acquisition of Avista, a U.S. energy utility that has not yet received all the necessary regulatory approvals.
Even filling the vacant CEO seat may be difficult, given that any prospective executive now faces possible intervention from the utility’s biggest stakeholder.
“While someone will be motivated to take the CEO role, we view this vacancy as one that may be difficult to fill under the confines implied by the Progressive Conservative rhetoric on executive compensation,” Mr. Catellier added.
Nonetheless, some analysts do see an upside.
“Investors will likely view the management changes as positive. But the enthusiasm will ultimately depend on the new makeup of the board of directors and who is chosen as the new CEO,” David Galison, an analyst at Canaccord Genuity, said in a note.
The company is about to get a new 11-member board of directors, which is to include four nominees from the government, six from a committee of large shareholders and the new chief executive.
Mr. Galison, who has a 12-month price target of $22 on the share price, added he was not surprised by the retirement of Mr. Schmidt following the planned acquisition of Avista Corp., a deal he blames for the weak share price in recent months. The addition of Avista – a midsized utility supplying natural gas and electricity to 740,000 customers in the Northwestern United States – was part of Mr. Schmidt’s long-term strategy to build a leading North American utility.
Mr. Galison added: “Despite other things, the impacts from the recent U.S. tax reform combined with the settlement agreements to complete the acquisition have eliminated the potential earnings accretion from the acquisition. Investors were also likely unhappy with the acquisition, seemingly reflected in the shares declining 16 per cent to a low of $18.93 from $22.53 on July 19, 2017,” the date the Avista deal was announced.
Frederic Bastien, an analyst at Raymond James, is more enthusiastic about Hydro One over the longer term, given its efforts at controlling costs and improving operational efficiency: He has an “outperform” recommendation on the stock, with a 12-month price target of $24. However, he believes investors should brace themselves for a challenging period.
“While we maintain our constructive stance on Hydro One, the uncertainty surrounding a new board and CEO will likely weigh on the stock in the near-term,” he said in a note.
But a sell-off, he believes, is ultimately a buying opportunity. “We advise investors to look beyond the noise and capitalize on the opportunity to add to positions near all-time lows in a company with solid long-term fundamentals,” Mr. Bastien said.
-With a file from Andrew Willis