Enbridge: Line 3 Receives Federal Water Permits; Two Permits Remain
by Joe Gemino, CPA | Morningstar Research Services LLC | 11-24-20

Wide-moat Enbridge received all the necessary federal permits from the U.S. Army Corps of Engineers, including the Section 404 water permit, on Nov. 23. With the federal permits secured, Enbridge still needs two additional permits before it can start construction. Enbridge previously applied to the Minnesota Pollution Control Agency for the construction stormwater permit and is waiting for the final permit. Now that Enbridge has received the federal water permits, it can apply to the Minnesota Public Utilities Commission for the final authorization to construct. We don't anticipate any difficulties in receiving the final construction permits based on the MPCA granting the stringent 401 permit and the MPUC voting to uphold Line 3's certificate of need multiple times. At this time, Enbridge is hopeful that it can receive the final two permits and start construction on the pipeline this year. We continue to expect construction to take six to nine months, and the end of 2021 still looks like an appropriate in-service date. We are maintaining our $43/CAD 56 fair value estimates, which include the probability that the pipeline is built and fully operational at 80% and that the pipeline is protected by its integrity replacement status at 20%.

Payment to Chairman of Ohio Commission Further Strains FirstEnergy's Regulatory Relationships
by Charles Fishman, CFA | Morningstar Research Services LLC | 11-20-20

We are lowering our fair value estimate to $43 per share from $44 after narrow-moat FirstEnergy filed its overdue 10-Q for the 2020 third quarter. The filing revealed a $4 million payment was made in early 2019 to terminate a consulting agreement that had been in place since 2013. The filing also stated that the counterparty of the consulting agreement later took a full-time role as an Ohio government official.

It became apparent that the government official was Sam Randazzo, chairman of the Ohio Public Utilities Commission, when he resigned the following day and following an FBI raid on his home the week before.

The reduction in our fair value estimate is due to our assumption that FirstEnergy will reduce planned investment in its Ohio distribution utilities from 2021-24 by approximately 30% below guidance. This would reduce our five-year estimated consolidated capital expenditures by roughly 5%, or $680 million, to about $14 billion. Lower Ohio investment reduces our average annual EPS growth in 2021-24 by 50 basis points, to 4.8%, modestly lower than FirstEnergy's 6%-8% target for 2021 and 5%-7% target in 2022-23.

Less capital investment in Ohio would reduce or eliminate any rate increase request when FirstEnergy's three Ohio utilities file for new base rates in 2023, effective in 2024. We believe this would help repair strained Ohio regulatory relationships. In addition, the lower capital expenditures would strengthen FirstEnergy's balance sheet and reduce the risk of credit agency downgrades.

We reiterate that Ohio distribution represents less than 20% of FirstEnergy's consolidated operating earnings. In our opinion, its other utility businesses remain solid and we continue to see strong growth at the company's Federal Energy Regulatory Commission-regulated interstate transmission, which we estimate will represent close to one third of earnings by 2024.

A Fair Value Increase for UPS
by Matthew Young, CFA | Morningstar Research Services LLC | 11-23-20

Upon revisiting our model assumptions, we are raising our fair value estimate for UPS to $123, from $121. The increase was mostly due to tweaking our operating margin assumptions modestly higher for the next several years to give UPS more credit for operating leverage from solid B2C volume gains.

In recent years, UPS' flagship parcel delivery operations have benefited from the surge in U.S. e-commerce trends (including rising demand for next-day air deliveries), new business wins from Amazon (now 11.5% of revenue), and new services catering to large and midsize e-commerce shippers. COVID-19 disruption and sluggish industrial end markets have hit UPS' commercial B2B shipment demand this year. However, B2C activity is seeing strong tailwinds from the spike in online fulfillment, and although this creates mix headwinds to margins, it's providing a nice offset to soft B2C activity. Additionally, B2B volumes are now posting sequential improvement off pandemic lows.

A Fair Value Increase for Ventas
by Kevin Brown, CFA | Morningstar Research Services LLC | 11-25-20

We are increasing our fair value estimate for Ventas to $57 per share from $55 per share after updating our model for third-quarter results and moderating the short-term impact of the coronavirus in our senior housing assumptions. Our fair value estimate implies a mid-5% cap rate on our forward four-quarter net operating income forecast, a 20-times multiple on our forward four-quarter funds from operations estimate, and 3.8% dividend yield, based on a $1.80 annualized payout.

The rent, occupancy and margin assumptions for each sector drive total company annual same-store NOI growth averaging 2.8% across our 10-year forecast. We expect continued acquisition and disposition activity as Ventas repositions its portfolio and improves the overall quality of its assets; we project $350 million-$450 million in acquisitions annually at an average cap rate of about 6.1% and $120 million of dispositions at 6.7% cap rates as the company looks to recycle lower-quality assets to partially fund the acquisition of higher-quality assets. We plan to incorporate significant announced external growth as they are announced. Additionally, we expect Ventas to invest roughly $360 million annually in new development and redevelopment projects at a 7.9% average yield.

Implementation of Trump's Recent Efforts to Affect Drug Pricing Seems Unlikely
by Damien Conover, CFA | Morningstar Research Services LLC | 11-23-20

President Donald Trump issued several orders on Nov. 20 designed to lower U.S. drug prices, but we don't expect implementation of the orders due to legal challenges, lack of support from the U.S. Congress and the new Biden administration, and unclear financial impacts. As a result, we don't expect any major impact on the U.S. pricing power of drugs, a core pillar of the moats and valuations in the drug industry.

One of the White House directives focused on pricing 50 of the largest Medicare B drugs (hospital-administered drugs) at the lowest levels paid by developed countries. While this would significantly affect U.S. prices, as we estimate drug pricing in the United States is close to double prices in developed markets, we expect valid industry legal challenges to stop this order. The order doesn't appear to have followed the normal legal process and instead was rushed out for Trump to enact the policy before leaving office. Additionally, we believe the rule is difficult to implement without legislative support from Congress. Further, we don't expect the Biden administration to focus initially on U.S. drug pricing, especially in the form of these recent proposals that lack full legal and congressional support.

A second White House directive targeted the elimination of pricing rebates in the U.S. drug system, an entrenched system that is very complex to undo through presidential order, especially without a clear analysis of financial implications. While we expect the drug industry to support the removal of rebates as drug firms only receive payments excluding rebates, we expect the payer groups will oppose the rule, given the importance of rebates in payer strategies. With a high degree of uncertainty regarding the impact on the federal budget, we expect the payer groups will be successful in stopping this effort to repeal drug price rebating.

Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. Analyst ratings are subjective in nature and should not be used as the sole basis for investment decisions. Analyst ratings are based on Morningstar’s analysts’ current expectations about future events and therefore involve unknown risks and uncertainties that may cause such expectations not to occur or to differ significantly from what was expected. Analyst ratings are not guarantees nor should they be viewed as an assessment of a stock's creditworthiness. Ratings, analysis, and other analyst thoughts are provided for informational purposes only; references to securities should not be considered an offer or solicitation to buy or sell the securities.