PG&E Dividend Cut an Ominous Sign

We are reaffirming our $52 fair value estimate and no-moat and stable moat trend ratings for

Dividend policy does not impact our discounted cash flow valuation, but potential future liabilities would have a negative impact on our fair value estimate. For now we continue to incorporate a $5 billion gross pretax estimate for potential fire-related liabilities, resulting in a $4.50 per share reduction in our fair value estimate. This represents a 50% probability that PG&E could be liable for worst-case damages that could top $10 billion.

The key question is how California courts and regulators treat the concept of inverse condemnation. This legal standard could leave PG&E strictly liable for all fire-related losses if investigators find PG&E's equipment caused the fire, regardless of fault. Utilities are subject to inverse condemnation with the understanding that they should be able to recover those costs by raising customer rates. However, regulators who determine rates are not legally obligated to approve all cost recovery. This adds considerable uncertainty.

The other complication is Section 501 of the California corporations code, which restricts companies from paying dividends if they might be unable to pay a future actual or probable liability. It appears PG&E's board took a conservative approach by assuming PG&E could face a large fire-related liability. Thus, we think there is a good chance the board might suspend the dividend for at least a few more quarters. A key decision point could come after the California Department of Forestry and Fire Protection, known as Cal Fire, finishes its investigation, likely in mid-2018. However, that will only kick off what could be a multi-year legal and regulatory battle.

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