EUR 850.00 For Business Accounts Only

Morningstar | Increased Confidence Entergy Can Decommission Merchant Nukes Using NDTs; Increasing Moat and FVE. See Updated Analyst Note from 30 Nov 2018

We are increasing our fair value estimate for Entergy to $96 per share from $83, driven by changing our uncertainty rating to low, increasing our moat rating to narrow from none, and lowering our cost of equity to 7.5% from 9%. The change in our cost of equity reduced our weighted average cost of capital to 6.1% from 6.6% and was the primary driver of our fair value estimate increase.

We increased our moat rating to narrow from none due to the anticipated retirement of Entergy's four remaining no-moat merchant nuclear power plants. Merchant power generation is usually a no-moat business because of its sensitivity to commodity prices and the resulting variability in returns on invested capital. Entergy plans to retire Pilgrim in 2019, Indian Point Unit 2 in 2020, Indian Point Unit 3 in 2021, and Palisades in 2022. By 2023, Entergy, which once owned six merchant nuclear reactors, will have completely exited that business. We estimate the remaining nonregulated businesses will represent less than 1% of net income in 2023.

Our cost of equity assumption is lower than the 9% rate of return we expect investors will demand of a diversified equity portfolio. We believe Entergy’s new COE reflects the risk associated with an integrated regulated utility operating in states that have average to above-average regulatory frameworks.

We assume that the remaining four operating merchant nuclear reactors can be decommissioned without a material impact on cash flow. This assumption is based on the currently adequate funding of the nuclear decommissioning trust funds for each reactor and comments from management earlier this year that the funds have been derisked after achieving the required level of funding.

There are several companies competing for the business of acquiring retired reactors and assuming the responsibility for decommissioning. The sale of Vermont Yankee (shut down in 2014) and the transfer of the NDT to a decommissioning company was approved by the Nuclear Regulatory Commission in October and is awaiting state approval. Pilgrim and Palisades have sale contracts that need regulatory approval following their planned shutdowns.

On Nov. 16, Entergy announced a joint NRC filing with Pilgrim’s buyer that the total cost for decommissioning is estimated at $1.13 billion. The balance in Pilgrim’s NDT as of Oct. 31 was $1.05 billion but will probably grow as the project will not be completed until the end of 2027.

We have a high level of confidence that Entergy’s remaining three reactors at Indian Point (Unit 1 was shut down in 1974 and some decommissioning work has been done) will also be sold to a third-party contractor that will take responsibility for decommissioning at close to zero cost to Entergy by the transfer of the NDTs. The balance of Indian Point's three NDTs total $1.99 billion at Sept. 30 with an estimated asset retirement obligation of $1.72 billion.