Why Merrill Lynch Thinks PG&E Is Starting to Heat Up

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PG&E Corp. (NYSE: PCG) shares made a handy gain on Tuesday after a key analyst upgraded the stock. Most of this report has to do with California wildfire liabilities from 2017, and there seems to be a clear path ahead. Overall the firm believes the worst is likely over.

Merrill Lynch upgraded PG&E to a Buy rating from Neutral with a $56 price objective, up from $48, implying upside of 21.3% from the most recent closing price of $46.18. This upgrade came after the firm saw that 2017 wildfire liabilities substantially de-risked following the passage of SB 901 by the California legislature last Friday.

The brokerage firm noted that the inclusion of maximum disallowance language (“stress test”) for the 2017 wildfire liability provides essentially a cap on the exposure to shareholders. While the true level of the cap may not be known until the second half of 2019, Merrill Lynch sees worse case scenarios as now off the table, given securitization of costs would be allowed above the cap.

While reinstatement of the dividend looks to be prolonged, an equity raise may be too. Prospects in drawing a clear limit on 2017 wildfire liabilities gives the firm further confidence after engaging with stakeholders. Merrill Lynch believes total claims are likely to settle below the $10 billion insured loss figure and management likely will tap short-/medium-term debt to bridge claims in the interim, limiting initial equity dilution.

Merrill Lynch gave its investment rationale as follows:

Our Buy rating is predicated on PCG’s ability to limit equity dilution as 2017 wildfire claims due to inverse condemnation are settled through the next few years. The passage of SB 901 via the CA legislature limits shareholders exposure to a certain cap. While the cost cap is currently unknown, we believe both claims and the associated cap are likely to be below the $10Bn+ discount implied in shares today. We model $6Bn of equity dilution and assume shares remains at a discount to peers.

Shares of PG&E were last seen up about 4% at $48.08 on Tuesday, with a consensus analyst price target of $50.57 and a 52-week range of $37.30 to $71.57.