Sempra (SRE)

Executive Summary / Key Takeaways

• The Texas Transformation Is Sempra's Primary Value Driver: Sempra is executing a decisive pivot from its California roots to become a Texas-dominated utility, with Oncor's capital opportunity reaching $55-60 billion through 2030 and management targeting Texas to produce half of company earnings by decade-end—this geographic reweighting fundamentally alters the company's growth profile and risk/reward calculus.

• Capital Recycling as Financial Engineering Masterstroke: The pending $10 billion sale of a 45% stake in Sempra Infrastructure Partners to KKR (KKR) unlocks three simultaneous benefits: it eliminates 100% of planned equity issuance from the 2025-2029 financing plan, deconsolidates infrastructure debt to fortify the balance sheet, and adds an estimated $0.20 annual EPS accretion starting in 2027—this transaction transforms Sempra from a capital-hungry conglomerate into a self-funding regulated utility pure-play.

• California Operations Have Been Derisked, Not Disregarded: SB 254 legislation caps SDG&E's wildfire fund contributions at a modest 4.3% share (under $13 million annually through 2045), while the utility has hardened 100% of its highest-threat transmission lines and cut undergrounding costs by 40%—these developments matter because they stabilize a previously volatile earnings stream while management simultaneously targets $300 million in additional customer savings.

• Massive Capex Creates Both Opportunity and Execution Risk: Sempra's $13.3 billion 2025 capital deployment, concentrated in Oncor's Texas grid expansion, positions the company at the center of the utility super-cycle driven by data centers, electrification, and reshoring—yet this spending has pushed free cash flow to -$3.3 billion TTM, making execution and regulatory recovery critical to avoiding balance sheet strain.

• Valuation Reflects Quality but Requires Flawless Execution: Trading at 29.1x trailing earnings and 18.4x forward earnings with a 2.7% dividend yield, Sempra commands a premium to traditional utilities that hinges entirely on delivering 9%+ EPS growth through 2029 while managing California wildfire exposure and completing the SI Partners transaction by mid-2026.

Setting the Scene: A 28-Year-Old Utility Reinventing Itself

Sempra, incorporated in 1996 and headquartered in San Diego, California, has spent nearly three decades building one of America's most strategically positioned energy infrastructure platforms. The company makes money through two distinct but complementary models: regulated electric and gas utilities that earn predictable returns on capital deployed, and energy infrastructure assets that generate cash from long-term contracts. This dual structure historically provided diversification, but management's recent actions reveal a stark strategic judgment—that the regulated utility business, particularly in Texas, offers superior risk-adjusted returns than the more volatile infrastructure segment.

The industry structure has shifted dramatically. Utilities are entering what management calls a "super-cycle" with over $200 billion in sector investment anticipated for 2025 alone, driven by three secular forces: the electrification of everything from vehicles to industrial processes, the explosive growth of AI and data centers creating unprecedented power demand, and the reshoring of manufacturing requiring new grid infrastructure. Texas sits at the epicenter of all three trends, with ERCOT projecting power demand to jump 62% by 2030 and Oncor's interconnection queue swelling to 186 gigawatts—more than double the state's current peak demand.

Sempra's competitive positioning reflects this geographic advantage. Through Oncor Electric Delivery, Sempra owns the largest regulated transmission and distribution utility in Texas, serving 3.8 million customers across 140,000 miles of lines. In California, SoCalGas is the largest natural gas utility in the Western Hemisphere, serving 22 million people across 24,000 square miles, while SDG&E provides electric service to 3.6 million customers in San Diego. This scale creates cost efficiencies and regulatory influence that smaller peers cannot replicate. The strategic differentiation lies not in technology but in operational excellence and regulatory relationships—SDG&E's 17-year record without a utility-caused wildfire and Oncor's ability to secure the Unified Tracker Mechanism (UTM) demonstrate management's skill in navigating complex regulatory environments to earn superior returns.

Strategic Differentiation: The Art of Regulatory Arbitrage

Sempra's core competitive advantage is its ability to extract favorable regulatory treatment in two of America's most important energy markets. In Texas, House Bill 5247 established the UTM, allowing Oncor to record eligible capital investments to a regulatory asset and apply for interim rate adjustments annually. The significance of this is that it reduces regulatory lag—the delay between spending capital and earning returns—from years to months, improving earned return on equity by 50 to 100 basis points over time. For a utility deploying $36 billion in base capital plus $12 billion in incremental projects through 2029, this mechanism translates into hundreds of millions in additional earnings that competitors without UTM protection cannot capture.

In California, the passage of SB 254 represents a material derisking event. The legislation strengthens the state's wildfire fund and caps SDG&E's contribution share at just 4.3%, or under $13 million annually through 2045, with additional payments only if needed. Crucially, this replaces a potentially unlimited liability with a predictable, manageable expense. Simultaneously, SDG&E has hardened 100% of its transmission system in the highest fire-threat areas with steel structures and reduced undergrounding costs by 40% over 24 months. These operational improvements aren't just safety measures—they're direct reductions in future regulatory disallowances and a demonstration of prudence that strengthens future rate case outcomes.

The capital recycling strategy represents financial engineering at its most sophisticated. By selling 45% of Sempra Infrastructure Partners for $9.99 billion, management achieves four objectives simultaneously: it unlocks capital to fund the Texas growth plan without issuing dilutive equity, deconsolidates approximately $4 billion of infrastructure debt from GAAP financials to improve credit metrics, increases the regulated earnings mix above 90%, and generates $0.20 annual EPS accretion from 2027 onward. This transaction is pivotal as it transforms Sempra from a capital markets-dependent conglomerate into a self-funding regulated utility, fundamentally reducing the cost of capital and increasing financial flexibility.

Financial Performance: Evidence of Strategic Execution

Third-quarter 2025 results provide clear evidence that the strategy is working. Adjusted EPS of $1.11 beat prior year by 25% and reflects the earnings power of the restructured portfolio. The segment breakdown reveals the transformation in real-time: Sempra California earnings surged $123 million (50%) in Q3, with higher income tax benefits ($92 million) and base operating margin improvements ($47 million) contributing to this growth. This demonstrates that even the mature California business can generate earnings growth through operational efficiency and favorable regulatory outcomes.

Sempra Texas Utilities posted a $56 million (17%) earnings increase, with Oncor's net income rising to $380 million from $324 million year-over-year. The driver—higher revenues from rate updates reflecting increased invested capital, the System Resiliency Plan, and the UTM—validates the thesis that Texas capital deployment translates directly into earnings. With Oncor's rate base more than doubling from $12 billion in 2018 to $26 billion in 2025, and projected to reach $55-60 billion by 2030, the earnings trajectory is both visible and compounding.

The infrastructure segment's $580 million loss in Q3 appears alarming but is purely an accounting artifact. The loss stems from a $705 million income tax expense to adjust deferred tax liabilities related to classifying SI Partners as held-for-sale. This accounting treatment obscures the underlying operational performance—Port Arthur LNG Phase 1 is over 50% complete with Train 1 expected in 2027, Phase 2 reached FID in September 2025, and ECA LNG Phase 1 is 95% complete with first production expected spring 2026. The transaction's structure ensures these assets will contribute to earnings without burdening the balance sheet.

The balance sheet reflects the pre-transaction state but shows manageable leverage. Debt-to-equity of 0.81 and interest coverage ratios remain within investment-grade parameters, with credit ratings of Baa2/BBB/BBB. The $8.6 billion in available credit facilities and $131 million in unrestricted cash provide liquidity to fund the $13.3 billion 2025 capital plan. However, negative free cash flow of -$3.3 billion TTM highlights the critical importance of completing the SI Partners sale to avoid incremental debt issuance that could pressure credit metrics.

Outlook and Execution: The Path to 9%+ Growth

Management's guidance tells a story of accelerating earnings power. The affirmed 2025 adjusted EPS range of $4.30-$4.70, with expectation to finish in the upper half, provides near-term confidence. More importantly, the 2026 guidance of $4.80-$5.30 and long-term growth rate of 7-9% are underpinned by tangible catalysts. Management explicitly stated they "could have maintained a 6% to 8% growth rate" but chose to reset higher because they "fundamentally raised our expectation of the earnings power of this business," now targeting "conservatively 9% or higher through 2029."

The key assumptions behind this outlook are audacious but achievable. Oncor's capital plan is expected to reach $55-60 billion by 2030, a substantial increase from the prior $36 billion base for 2026-2030. This implies rate base growth far exceeding the 10% compound annual target, with each dollar of capital deployed in Texas earning 9.7-10.55% ROE under the new rate case. The 29 gigawatts of high-confidence C&I load seeking interconnection through 2031—equivalent to adding 36 gigawatts to Oncor's current 31-gigawatt system peak—provides demand visibility that no other utility can match.

Critical execution milestones cluster in the next 18 months. The SI Partners sale must close by mid-2026 to fund the capital plan without equity issuance. Oncor's comprehensive base rate review, filed in June 2025 requesting a 45% equity layer and 10.55% ROE, expects a final order in Q1 2026. ECA LNG Phase 1 must achieve commercial operations in summer 2026 to begin contributing cash flows. The Texas 765 kV transmission expansion, with Oncor's portion exceeding 50% of the $32-35 billion total, requires regulatory approval and successful project execution. Each milestone represents a potential inflection point for earnings acceleration or deceleration.

Risks: What Can Break the Thesis

The California wildfire fund depletion risk remains the most material threat to the investment case. As management explicitly warned, "if the Wildfire Fund and the Continuation Account are materially diminished, exhausted or terminated, SDG&E would lose the protection afforded by these funds, and as a consequence, a fire in any California electric IOU's service territory could have a material adverse effect." This represents a binary risk—while SB 254 capped contributions, a catastrophic fire by another utility could drain the fund and expose Sempra to uncapped liability, potentially wiping out years of California earnings in a single event.

Mexican regulatory changes pose a direct threat to infrastructure value realization. Recent constitutional amendments and energy laws "increase government control and participation in the energy sector," creating challenges for ECA LNG Phase 2 development and potentially impairing the $391 million net book value of the Sonora pipeline if the company cannot resume operations. The SI Partners valuation assumes successful operation and expansion of Mexican assets; adverse regulatory changes could reduce the $10 billion transaction value or delay closing.

Execution risk on the massive capital program scales with its size. Oncor's plan to double its peak load through new interconnections requires not just capital but operational excellence in project management, supply chain coordination, and regulatory compliance. The April 2025 Port Arthur LNG incident that resulted in three deaths demonstrates that even experienced management faces execution hazards. With $13.3 billion in annual capex and negative free cash flow, any significant project delays or cost overruns could pressure liquidity before the SI Partners sale closes.

The Oncor rate case outcome presents a critical regulatory risk. While the UTM mechanism reduces lag, the base rate review's requested 10.55% ROE and 45% equity layer face regulatory scrutiny. A final order below these levels would compress earnings growth, while approval would validate the Texas growth thesis. The decision expected in Q1 2026 will set the return foundation for the entire $55-60 billion capital program.

Competitive Context: Winning Through Scale and Regulatory Skill

Sempra's competitive positioning is best understood through regional comparisons. Against California peers PG&E (PCG) and Edison International (EIX), Sempra's advantage is geographic diversification. While PCG and EIX face pure-play California wildfire exposure, Sempra's Texas operations provide earnings growth that offsets regulatory headwinds in California. PCG's debt-to-equity of 1.86 and EIX's 2.04 both exceed Sempra's 0.81, reflecting the balance sheet benefits of the capital recycling strategy. Sempra's Q3 revenue growth of 14% year-over-year outpaced PCG's modest increase, while its forward P/E of 18.4x sits between PCG's 10.9x (distressed) and EIX's 10.3x (value trap), reflecting its superior growth profile.

In Texas, CenterPoint Energy (CNP) is the direct competitor but at a material scale disadvantage. Oncor's 3.8 million customers and 140,000 miles of lines dwarf CNP's 2.9 million customers, while Oncor's $26 billion rate base (doubling since 2018) versus CNP's smaller footprint creates cost efficiencies that improve regulatory outcomes. CNP's debt-to-equity of 2.02 and lower ROE reflect less favorable regulatory treatment. Sempra's ability to secure UTM protection while CNP operates without such mechanisms demonstrates superior regulatory skill that translates directly into 50-100 basis points of additional ROE.

Dominion Energy (D) represents the national diversified utility model, but Sempra's focused Texas/California footprint generates superior growth. Dominion's 5-7% long-term EPS growth target lags Sempra's 9%+ aspiration, while its exposure to slower-growing East Coast markets lacks the Texas demand catalyst. Sempra's operating margin of 14.5% trails Dominion's 34.5%, but this reflects the higher growth investment phase rather than structural inferiority.

The competitive moats are clear: regulated franchise monopolies in the two largest U.S. energy markets, operational scale that creates cost advantages, and regulatory relationships that produce favorable mechanisms like UTM and SB 254. These advantages manifest in the ability to deploy $55-60 billion in capital with high confidence of earning allowed returns, a privilege no competitor can replicate at this scale.

Valuation Context: Paying for Quality and Growth

At $94.69 per share, Sempra trades at 29.1x trailing earnings and 18.4x forward earnings, a premium to the utility sector average of approximately 16-18x forward P/E. This valuation prices in the successful execution of the Texas transformation and SI Partners sale. The EV/EBITDA multiple of 17.1x sits above PCG's 9.9x and EIX's 8.5x, reflecting Sempra's superior growth trajectory, but below the 20x+ multiples commanded by pure-play growth utilities.

The dividend yield of 2.72% with a 78.6% payout ratio provides income while retaining capital for growth, a balanced approach that differs from EIX's 5.6% yield (indicating market skepticism) or CNP's 2.2% yield (lower growth). The price-to-operating cash flow ratio of 22.8x appears elevated but must be viewed in context of the -$3.3 billion free cash flow, which is temporarily negative due to the capex super-cycle. Post-SI Partners sale, management expects improved cash generation and reduced capital intensity.

Key valuation drivers are binary: successful SI Partners closure by mid-2026 would validate the premium multiple by eliminating equity issuance risk and deconsolidating debt, while any California wildfire event or Mexican regulatory setback could compress the multiple toward peer levels. The market is essentially paying for execution certainty on a strategy that is still in transition.

Conclusion: A Utility at an Inflection Point

Sempra stands at the intersection of two powerful forces: the utility sector's capex super-cycle and management's strategic decision to concentrate capital in America's most attractive growth market. The $10 billion SI Partners sale is not merely a divestiture but the financial catalyst that enables a fundamental transformation from a bicoastal conglomerate to a Texas-focused regulated utility powerhouse. This creates a rare combination of visible earnings growth—9%+ through 2029, driven by Oncor's $55-60 billion capital opportunity—and reduced risk from improved regulatory treatment in California and balance sheet fortification.

The investment thesis hinges on three critical variables over the next 18 months: the successful closing of the SI Partners transaction by mid-2026, the outcome of Oncor's rate case in Q1 2026 that will set returns on the massive capital program, and continued operational excellence in California to avoid wildfire liabilities. If management executes on these fronts, Sempra's premium valuation will be justified by earnings growth that far exceeds traditional utility peers. If any leg of this stool falters—particularly the SI Partners sale or a California wildfire event—the stock's premium multiple will compress rapidly.

What makes this story compelling is not just the numbers but the strategic clarity. Management has identified the best market, secured the capital to dominate it, and is derisking the legacy business simultaneously. For investors willing to accept execution risk during this transformation, Sempra offers exposure to the utility sector's most powerful growth driver with a management team that has demonstrated the financial sophistication to fund it without diluting shareholders. The Texas two-step—selling infrastructure to build a Texas powerhouse—may prove to be the defining strategic move of this utility cycle.