The U.S. utility sector is gearing up for what Wall Street expects to be a busy fourth-quarter 2020 earnings season, even if results themselves may take a hit.

"Oh, it is going to be an exciting [fourth-quarter] earnings season for sure," CreditSights analyst Andrew DeVries said in a Jan. 20 email.

Even before calls begin, one of the nation's largest utilities appears close to resolving what many view as a major earnings overhang.

Duke Energy Corp. on Jan. 25 announced it has agreed to forgo recovery of about $1.1 billion in coal ash management costs as part of a settlement agreement reached in the North Carolina electric rate cases for Duke Energy Carolinas LLC, and Duke Energy Progress LLC. As a result, the utilities are each expected to incur a pretax charge to earnings of about $500 million in the fourth quarter of 2020.

The companies, however, would retain the ability to earn a debt and equity return during a five-year amortization period.

"We believe ratings agencies should view the settlement and allowance for return on expenditures positively and the agreement clears the overhang for [Duke Energy] and other parties in the state to shift their attention to clean energy legislation in 2021 — a key focus," Guggenheim Securities LLC analyst Shahriar Pourreza wrote in a Jan. 25 research report.

During an August 2020 earnings call, Duke Energy management warned it faced a significant impact to cash flow and credit metrics absent a favorable ruling on the recovery of coal ash management costs in North Carolina. The settlement is still subject to commission approval.

Earnings beats/misses

When it comes to results, U.S. investor-owned utilities are expected to offer a mixed bag of earnings beats and misses for the fourth quarter of 2020.

The mean earnings per share estimate for 12 of the top 15 U.S. electric utilities is lower than actual third-quarter 2020 results, according to an S&P Global Market Intelligence analysis. Only PG&E Corp., PPL Corp. and Avangrid Inc. are expected to report higher quarter-over-quarter earnings.

The analysis shows that seven of the nation's top 15 electric utilities are expected to report an increase in year-over-year earnings per share, including NextEra Energy Inc., which reports on Jan. 26.

Dominion Energy Inc. leads a group of nine multiutilities expected to report a drop in fourth-quarter 2020 earnings compared to actual third-quarter 2020 results. Meanwhile, the S&P Global Market Intelligence mean earnings per share estimate for at least five of the top 15 U.S. multiutilities is higher than actual third-quarter 2020 results.

Eight of the nation's top 15 multiutilities are expected to report a year-over-year EPS increase, including Sempra Energy and Public Service Enterprise Group Inc.

The majority of the utilities subject to the analysis are expected to report an increase in revenue versus the prior quarter and actual fourth-quarter 2019 results.

Utilities, by and large, have been able to mitigate lower commercial and industrial demand tied to the COVID-19 pandemic through higher residential sales, cost controls and regulatory support.

"In our view, how utility stocks perform during [the fourth-quarter 2020] earnings season won't be a function of results, which should be broadly in line with or slightly better than expectations, we forecast," Scotia Capital (USA) Inc. analyst Andrew Weisel wrote in a Jan. 22 research report. "Instead, performance may be primarily driven by macro sentiment, which is unfortunately sour despite strong fundamentals and attractive valuations."

The analyst noted that investors are "pretty universally rotating from growth and defensives into value and cyclicals, leaving utilities behind."

"Overall, we're bullish on fundamentals and valuations, but recognize that 'good might not be good enough' in 2021," Weisel wrote.

New growth opportunities

Investors and analysts also will zero in on capital spending plans, as well as new renewable and battery storage investments for utilities throughout the sector.

"These are all positives for utility earnings growth and credit quality," CreditSights analyst DeVries said. "On the cautionary side of things, it will be interesting if any [management] team has, or thinks they have, insight into tax reform and the potential for higher corporate tax rates. This is a major issue since rates are going up to support all this capex, so boosting taxes on top of that can have a real impact."

Biden has proposed raising the top corporate income tax rate to 28% from 21%, reversing much of the reduction former President Trump enacted in the 2017 Republican tax bill.

Wall Street is also interested in how utilities are approaching hydrogen pilot projects on the gas and electric side and potential financing methods.

"We actually think that hydrogen reduces risk for the industry," S&P Global Ratings analyst Gabe Grosberg said in a Jan. 21 phone interview.

Grosberg noted that utilities can utilize hydrogen to transform existing fossil assets into clean energy producers.

"The technology, for the most part, is really there," Grosberg said, adding hydrogen should benefit from President Joe Biden's administration looking to further its development.

The sector also is expected to benefit under Biden's $2 trillion clean energy and green infrastructure plan.

Additionally, industry observers also will be looking at the progress of planned divestitures, including PSEG's sale of PSEG Power LLC's non-nuclear generation fleet as well as the PSEG Solar Source LLC portfolio.

PSEG, Dominion and Eversource Energy could also provide updates on offshore wind projects, including planned cost recovery and production tax credits.

Regulatory, legislative and legal updates for FirstEnergy Corp. and Exelon Corp. will likely be key given the fallout from bribery cases implicating the companies and their subsidiaries. This is further underscored by increased focus on environmental, social and governance practices.

"We think ESG is a real risk for the industry," Grosberg said. "After the incidents that have occurred in Illinois and Ohio, we have been reaching out to all the management teams, reviewing procedures, discussing the culture of the company and making sure that everybody else has the right procedures in place. ... There is a lot of sensitivity to even the perception of wrongdoing, which is so important."

2021 outlook

The outlook for 2021 also is beginning to come into view.

"If you look at how 2020 unfolded, one of the key drivers to weakening credit quality was actually weak financial measures," S&P Global Ratings analyst Grosberg said. "One of the expectations is because the Democrats now control the presidency and control Congress, to the extent that they decide to go forward with the higher corporate rate, that will provide cushion in the funds from operations-to-debt measure that we expect will improve for the industry by about 100 basis points. And that's very material."

The "offsetting measure" is ESG.

"ESG remains a very important focus of investors. I think it's only increasing," Grosberg said, noting the industry is facing more scrutiny especially on the environmental front despite reducing greenhouse gas emissions by about 25% during the past 10 years.

"I think that could also add some pressure to credit quality, near term," the analyst added.