Sempra's (SRE) $471M After-Tax Earnings Hit from SDG&E's Track 2 Regulatory Decision: Assessing Long-Term Resilience in a High-Interest-Rate Environment

The recent $471 million after-tax charge to Sempra Energy (SRE) and its subsidiary San Diego Gas & Electric (SDG&E) from California's Track 2 regulatory decision has sparked scrutiny over the company's earnings resilience and valuation in a high-interest-rate environment. While this one-time hit to 2025 GAAP earnings underscores the vulnerability of regulated utilities to regulatory shifts, Sempra's updated guidance and strategic initiatives suggest a nuanced picture of long-term stability. This analysis evaluates the interplay of regulatory risk, interest rate dynamics, and Sempra's operational strategies to determine whether the company remains a compelling investment.

The Immediate Impact of the Track 2 Decision

The California Public Utilities Commission's (CPUC) December 2025 ruling on SDG&E's 2024 General Rate Case (GRC) Track 2 request imposed a $471 million after-tax charge, split into $34 million for the first three quarters of 2025 and $437 million for the 2019–2024 period. This decision directly reduced Sempra's GAAP earnings per share (EPS) guidance for 2025 to $2.38–$2.78, while adjusted EPS guidance remained at the high end of its $4.30–$4.70 range. The charge reflects the CPUC's rejection of certain cost recovery mechanisms, highlighting the sector's exposure to regulatory discretion.

However, the CPUC's authorization of a 5 basis point increase in SDG&E's return on equity (ROE) offers partial mitigation. This adjustment, though modest, signals regulatory recognition of the need to balance investor returns with affordability for ratepayers. For Sempra, this ROE boost could help offset some of the earnings drag from the Track 2 decision, particularly as the company reaffirmed its 2026 adjusted EPS guidance of $4.80–$5.30.

High-Interest-Rate Environments and Utility Valuation

The broader utility sector faces a dual challenge in high-interest-rate environments. On one hand, utilities typically rely on long-term debt to fund capital-intensive infrastructure, making them sensitive to rising borrowing costs. As noted by S&P Global, traditional electric and gas utilities exhibit the highest negative correlation to interest rate movements, as higher rates increase financing costs and reduce the present value of future cash flows. Additionally, conservative investors may shift capital to bonds, which offer more predictable yields in a rising rate environment, potentially depressing utility stock valuations.

Conversely, regulated utilities often have mechanisms to recover increased costs through rate base adjustments or inflation pass-through provisions. For example, Sempra's regulated operations in California and Texas could leverage these provisions to partially offset higher financing costs, provided regulators approve such adjustments. This regulatory flexibility is critical for maintaining earnings resilience, as demonstrated by Sempra's ability to maintain adjusted EPS guidance despite the Track 2 charge.

Sempra's Financial Health and Strategic Resilience

Sempra's financial profile presents a mixed picture. The company's Altman Z-Score of 1.1 places it in the distress zone, and its debt-to-equity ratio of 1.05 indicates significant leverage according to financial analysis. These metrics raise concerns about its ability to withstand prolonged earnings shocks. However, Sempra's strategic focus on capital recycling and infrastructure development has bolstered its long-term prospects.

For instance, Sempra's planned sales of equity interests in Sempra Infrastructure and Ecogas México are expected to strengthen its balance sheet and generate proceeds for shareholder returns or reinvestment. Additionally, its subsidiary Oncor has ramped up transmission and distribution investments in 2025, aligning with industry trends toward grid modernization and electrification. These initiatives not only enhance operational efficiency but also position Sempra to benefit from structural growth drivers such as renewable energy integration and AI-driven energy demand.

Regulatory Risk-Adjusted Valuation Models

Sempra's valuation appears to reflect both its regulatory risks and growth potential. As of January 2026, the company's P/E ratio stood at 27.62, significantly above its 12-month average of 20.43. This premium suggests investor confidence in Sempra's ability to navigate regulatory challenges and deliver long-term earnings growth. However, a discounted cash flow analysis indicates the stock may be slightly overvalued, trading at a 2.5% premium above its estimated fair value using a 6.8% discount rate.

Comparative analysis with peers like Centerpoint Energy and Dominion Energy reveals Sempra's competitive edge. While Sempra's revenue declined by 0.37% in Q2 2025 compared to a 14.71% increase for peers, its 17.3% net margin outperformed industry averages. This operational efficiency, coupled with its focus on regulated utility operations, positions Sempra to maintain earnings resilience even as interest rates remain elevated.

Conclusion: Balancing Risks and Opportunities

Sempra's $471 million earnings hit from the Track 2 decision is a stark reminder of the sector's regulatory risks. However, the company's updated guidance, ROE adjustment, and strategic initiatives demonstrate its capacity to adapt. In a high-interest-rate environment, Sempra's ability to leverage regulatory flexibility, optimize capital structure, and invest in infrastructure will be critical to sustaining long-term earnings growth. While its valuation suggests optimism, investors must remain vigilant about its leverage and regulatory exposure. For those willing to navigate these risks, Sempra's position in a sector poised for electrification and grid modernization offers compelling long-term potential.