Between 1993 and 2014, David Tepper (Trades, Portfolio)'s Appaloosa Management was one of the most successful funds in America, with an average annual return of 26.70%, according to the Gurufocus Scoreboard. In 2019, he converted his fund to a family office, but he remains an active investor.
In the third quarter of 2020, Tepper made a 803.15% addition to his holding in Pacific Gas & Electric Co (PCG, Financial). With 80,775,057 shares, it is now his largest single holding, making up 13.41% of his portfolio.
Tepper was not the only guru who began buying the stock this summer - Daniel Loeb (Trades, Portfolio) of Third Point LLC was another. In the third quarter, Loeb invested in 84,935,257 shares of PG&E. In a subsequent investor letter, he noted he first bought the troubled electricity and gas distribution company's bonds in late 2018, after they were forced to distress levels when the company's neglect of its aging equipment caused the Camp Fire in California .
In early 2020, PG&E finalized a deal to restructure its "bad capital structure," and Loeb observed:
"The bankruptcy addressed the company's outstanding legacy liabilities and repositioned the balance sheet for investment and growth. PG&E's fundamentals position it at the high end of the utility industry, with equity rate base growth of approximately 8% and EPS growth of 8‐12% driven by strong investments in infrastructure to serve customers safely and reliably while also reducing the company's carbon footprint and providing customers with energy choice."
Given those metrics, Loeb felt the share price was too low:
"PG&E's valuation is a fraction of its peers: it trades at under 8x 2022 earnings versus the regulated utility peer set at 18x. The shares have traded poorly (down ~5%) since exiting bankruptcy due primarily to technical factors that are extremely common in these situations."
Further, he expected the price discount to shrink as PG&E finds a new institutional shareholder base, hires a permanent CEO and takes care of its prior operational deficiencies."
The latter included wildfire safety shortfalls, which Loeb believed the company has been addressing. In addition, there is a new Wildfire Fund; it offers insurance for future catastrophic wildfire claims to all investor-owned utilities.
Summing up, Loeb believes PG&E is a strong and profitable company that reached a low point because of its poor capital structure and failure to keep its equipment updated. Going forward, he seems to think that the company can resolve these issues.
Fundamentals
While some gurus may be rushing in due to the company's distressed condition, a quick scan of the fundamentals suggests this might not be a stock for those with low risk appetite, even after its restructuring:
But, of course, both great value investments (and investments that are not so great) often begin with troubled companies that have good assets and good prospects, which is the point that Loeb is making. Often, they represent companies that have the potential to improve from bottom-tier conditions.
Looking at the financial strength and profitability tables above, they may look weak, but this is fairly common for utilities. For example, among the 10 companies in the GuruFocus Competitive Comparison table for this stock, PG&E receives a financial strength rating of 3 out of 10, while the industry group averages 3.9 out of 10.
Profitability looks similar within an industry context. PG&E has a profitability rating of 5 out of 10, while the industry average is 6.1 out of 10. In both cases, it trails the industry average, but not significantly. It also has a decent operating margin.
Valuation
Let's look at a 10-year view of PG&E's share price. What this likely suggests to investors like Tepper and Loeb is potentially big capital gains in the future as they expect the stock to return to previous levels after the plunge.
Before falling from grace, the share price hit $70.00. If it recovers to that level, it would provide significant capital gains. PG&E has not paid a dividend since 2017, and at that time the dividend yield was 3.1%, which is not the kind of yield that might attract a fund manager on its own merit.
The forward price-earnings ratio stands at 12.44 according to earnings estimates from Morningstar analysts, which is below the industry's 10-year median of 16.03. This suggests the market continues to underestimate PG&E's ability to get back to a pre-2017 normal.
Gurus
At the end of the third quarter, Daniel Loeb (Trades, Portfolio) held the largest position among the gurus, with 84,935,257 shares. That represented 4.28% of PG&E's shares outstanding and 8.01% of Third Point's total assets.
Tepper held the second-largest position, with 80,775,057 shares, representing 13.41% of his firm's assets.
Ten other gurus also held shares of PG&E, including Seth Klarman (Trades, Portfolio) of The Baupost Group, David Abrams (Trades, Portfolio) of Abrams Capital Management and Howard Marks (Trades, Portfolio) of Oaktree Capital Management.
Conclusion
Two gurus bought massive numbers of shares in Pacific Gas & Electric in the third quarter of 2020, which is a major vote of confidence in a stock.
For value investors who agree with their analysis, this looks like an opportunity to buy into a near-monopoly at a deeply discounted price. Yes, the company is deeply indebted, but that's not unusual among utilities. More cautious value investors will likely be ready to give up a bit of the upside to ensure that the share price will go up before committing their capital. Similarly, growth investors will want to see the rebound begin before buying.
Disclosure: I do not own shares in any of the companies named in this article and do expect to buy any in the next 72 hours.
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