Hawaiian Electric – Massive Uncertainties in Wake of Maui Wildfire - 2Q23 Credit Report

Report 18 September

Hawaiian Electric – Massive Uncertainties in Wake of Maui Wildfire - 2Q23 Credit Report

By John Sinna, Sara Tapinekis and Greg Clark

Before we get into things, we want to send our well-wishes out to all of those impacted by the devastating wildfires in Maui. Writing a report like this can feel a little like grave dancing and reading it may also feel the same. Nothing herein is intended to make light of this very sad situation and we hope those of you reading this analysis will take the time to donate to help those in need. Our friends at Good Morning America put together what appears to be a helpful list of charities that could use your support.

Overview

Hawaiian Electric Industries, Inc. (NYSE: HE) is a holding company with operations in the State of Hawaii that conducts business within three reportable segments.

1. Electric Utility. The segment includes business of Hawaiian Electric Company, Inc. (Hawaiian Electric or HECO) and its two main operating subsidiaries: (i) Hawaii Electric Light Company, Inc. (Hawaii Electric Light or HELCO), acquired in 1970; and (ii) Maui Electric Company, Limited (Maui Electric or MECO), acquired in 1968. These operations are essentially a monopoly and are regulated by the Public Utilities Commission of the State of Hawaii. The Electric Utility operations provide essential electric service to ~95% of Hawaii’s population through the operation of five separate electrical grids serving Oahu, Hawaii, Maui, Lanai and Molokai. This segment comprised ~91% of HE’s total revenue for FY2022. The following tables highlight the generation statistics for this segment and generating assets as of 31 December 2022.

2. Bank. HE’s wholly owned subsidiary, American Savings Bank, F.S.B. (ASB) is one of the largest financial institutions in the State of Hawaii. HE acquired ASB in 1988 as part of an effort to diversify away from dependence on the Electric Utility segment. As of 31 December 2022, ASB operated 38 branches consisting of the following: (i) 27 on Oahu; (ii) 5 on Maui; (iii) 3 on Hawaii; (iv) 2 on Kauai; and (v) 1 on Molokai (two of the Oahu locations were closed in early 2023) along with 122 automatic teller machines. This segment comprised ~9% of HE’s total revenue for FY2022.

3. Other. This segment consists of HE’s corporate-level operations and Pacific Current, LLC (Pacific Current). Pacific Current was formed in 2017 and focuses on investments in non-regulated clean energy and sustainable infrastructure projects in the State of Hawaii.

On 3 December 2014 HE and NextEra Energy Inc. agreed to a transaction wherein NextEra would acquire HE for approximately USD 4.3bn. The transaction was terminated on 18 July 2016 after the PUC denied approval. The transaction also contemplated a spin-off of ASB.

Recent Events

On 7 August 2023, HE released 2Q23 results after market close. Revenue of USD 896m beat estimates of USD 749m. EPS of USD 0.50 per share missed estimates for USD 0.53 per share. Management pointed to elevated operations and maintenance costs in the quarter and also forecast slowing demand for loan products across the board, and most specifically mortgages, in the wake of higher interest rates. HE equity was down as much as ~5.6% in the 8 August 2023 session and closed down ~4%.

On 8 August, 2023, wildfire ravaged parts of Maui, and more specifically Lahaina.

On 16 August 2023, Debtwire reported that HE was in discussions with restructuring advisors following the deadly Maui wildfire.

On 18 August 2023, HE provided an update on the Maui fires. On the same day Moody’s downgraded HE’s issuer rating to Ba3 from Baa1.

On 21 August 2023, Fitch downgraded HE’s long-term issuer default rating to B from BBB+ and Hawaiian Electric’s long-term issuer default rating to B from A-.

On 22 August 2023, Debtwire reported that HE had engaged Guggenheim Securities.

On 24 August 2023:

S&P cut HE’s rating to B- from BB- with a negative outlook.
HE announced the suspension of the common stock dividend and also that the company and certain subsidiaries had drawn on revolving credit facilities.
Debtwire reported that certain HE investors had retained legal counsel relating to an investigation into possible violations of federal securities laws following the Maui wildfires and reported that certain HE private placement noteholders had retained Davis Polk.
Debtwire reported on the County of Maui lawsuit against HE relating to the wildfire.

On 25 August 2023, Debtwire published commentary around current views as to HE’s financial situation and the legal liabilities it might face relating to the wildfires.

On 27 August 2023, HE provided another update on the situation in Maui.

On 28 August 2023, Xtract issued a special report covering the revolver draw downs.

On 30 August 2023, Debtwire reported that HE is set to receive USD 95m from the U.S. Bipartisan Infrastructure Law and that a U.S. House committee is set to investigate the response to the Maui wildfire.

Financials

HE reported revenue of USD 896m for 2Q23, versus USD 896m for 2Q22, flat YoY. Slight declines in the Electrical Utility segment (~3% YoY) were made up for by growth in the Bank (~29%), which was primarily driven by 30% growth in YoY total interest and dividend income. The Other segment also posted healthy revenue growth (USD 5m in 2Q23 versus 1m in 2Q22).

Operating margin for 2Q23 was 10.5%, up from 9.7% in 2Q22. Electrical Utility segment margin grew to 9.3% in 2Q23 from 8.7% a year ago. Declines in fuel oil and purchased power as a percentage of sales more than made up for increases in other operation and maintenance expenses as a percent of revenue in 2Q23. Bank segment margin declined from 41.6% to 35.8% in 2Q23. Declines in provisions and growth in non-interest income were eaten up by growth in non-interest expense in the quarter.

Adjusted EBITDA for 2Q23 was USD 172m, up from USD 160m a year ago, driven by higher operating income levels in the Electrical Utility (USD 74m for 2Q23 versus USD 71m for 2Q22) and Bank (USD 26m for 2Q23 versus USD 22m for 2Q22) segments and flat YoY operating income in the Other segment. D&A was also marginally higher (USD 78m for 2Q23 versus USD 73m for 2Q22).

Our NTM revenue estimates are consistent with consensus FactSet estimates. Despite the current situation, HE’s monopoly on the power markets it serves remains. We have also assumed FactSet estimates for Adjusted EBITDA. We have assumed Operating Cash Flow is 100% of Adjusted EBITDA, somewhat lower than recent trends, and perhaps conservative, and have also added USD 43.75m in advisor fees per quarter for the NTM period resulting in a total fee burden related to the wildfire consistent with the PG&E Corp case. We expect total fees of USD 350m, paced out over two-years. We have also assumed NTM CapEx levels are 1.25x LTM levels, based on spending increases by PG&E Corp in the wake of the California fires from 2018.

Valuation

HE is currently trading at an NTM EBITDA multiple of 12.0x, versus a utility peer average of 10.6x. Total leverage is 10.0x, and Net leverage is 8.5x versus a utility peer average of 5.9x and 5.8x. We have assumed ~USD 2.75bn in damages claims (unsecured debt) in our analysis.

HE lends itself well to a sum-of-the-parts valuation analysis.

HE’s capital structure is made up of municipal offerings, revolving facilities, and a number of smaller private placement offerings. The municipal bonds have traded as of late and are now at distressed levels for municipal paper. As the security interest for these instruments is tied to revenue, they should be nicely covered no matter what happens in the wake of the wildfires. As holders of this flavor of paper are usually playing for cash flow, it then makes sense to see some nervous selling in the wake of headlines and discussions around credit risk and restructuring. We imagine the dollar trading levels are drawing attention from distressed investors. A few private placement senior notes are also quoted and are starting to reflect the view that they could face impairment in any potential restructuring. Various cumulative preferred issuances also seem to trade, and recent pricing does not reflect a distressed view as the paper is subject to duration price risk (no maturity and relatively low coupons).

The elephant in the room for HE is damages. Market cap lost by HE since the wildfire implies total damages of ~USD 2.75bn. HE will face significant challenges should it be found responsible for damages. The company’s borrowing capacity is limited under current facilities and also the PUC. The latter also regulates HE’s pricing power, and HE cannot unilaterally decide to pass through expenses to customers. Finally, HE partners with the State of Hawaii in terms of muni borrowing. The State will certainly need to be involved in a solution in this respect. Finally, HE is a key offtake partner (purchaser of power) for a number if IPPs in Hawaii. If the State of HI wants to continue to grow green generation, HE will need to remain a buyer in order to incentize private capital to develop solar, wind and other facilities.

While the situation is still fresh and very dynamic, our early view is that all parties will eventually see the benefit in keeping HE and its electrical utilities operational. One way of accomplishing this would be through the establishment of one or more trusts similar to those created in the PG&E Corp situation. In that case, the holding company and the operating subsidiary utility commenced a Chapter 11 case and emerged from bankruptcy with a plan that created a fire victim trust. Created for the exclusive benefit of fire victims, the trust was funded with approximately USD 13.5bn in assets, including a mix of cash, a minimum of 20.9% of common stock in the reorganized PG&E, and an assignment of rights under certain relevant insurance policies. In addition to individual wildfire claimants, the claims of federal and state agencies such as Federal Emergency Management Agency (with an agreed-upon, allowed USD 1bn claim) and the California Department of Forestry and Fire Prevention (with an agreed-upon, allowed USD 115.3m claim) were also channeled into the trust. PG&E’s plan also dealt with holders of subrogation claims. The company ultimately reached a deal with an ad hoc group of subrogation claimants giving the claimants an allowed USD 11bn claim and up to USD 55m in payment of the group’s professionals’ fees and expenses. PG&E also created a trust for holders of such subrogation claims. Another significant creditor group constituency with whom PG&E reached a settlement was holders of claims by various cities and counties. For these creditors, PG&E agreed to pay USD 1bn in cash and to fund a USD 10m defense fund for those entities. PG&E also provided for the restructuring of its prepetition funded debt. We would expect that HE and/or HELCO, MECO and HECO would need to address similar categories of claimants as part of its any restructuring.

As part of its strategy, any required bankruptcy filing likely would include the utilities entities – ie – HELCO, MECO and HECO, each of which has been named as a defendant in litigation arising from the fires. ASB likely would be ineligible for relief under Chapter 11 because section 109(b) of the Bankruptcy Code provides that banks that are insured under section 3(h) of the Federal Deposit Insurance Act cannot liquidate or reorganize under Chapter 11. As exemplified by the Chapter 11 filing of SVB Financial Group, however, relief under Chapter 11 is available to a non-bank entity that owns and/or controls a bank, such as HE, which is also a named defendant in pending litigation. We believe the bank has significant value and imagine parties are discussing a wide range of potential alternatives to both maximize value and minimize concerns. HE contemplated a spin-off as part of the NextEra transaction, and we believe either a spin-off or similar distribution to HE shareholders is the best plan to remove ASB from the situation before any required bankruptcy filings by the utility entities and perhaps HE. S&P points out similar views in a recent report.

HE's secured debt is covered under our scenarios. The following valuation tables then focus on unsecured and damages claims as well as HE’s common equity.

Debtwire estimated EV for HE: