Ingus Kruklitis
Shares of Consolidated Edison, Inc. (NYSE:ED) have seen a free fall in recent weeks, as higher interest rates hit the shares of this dividend play as well. With the company announcing a large divestment recently, it is an opportune time to update the investment thesis. This thesis goes back a long way, as my last coverage on the company dates back nearly a decade ago.
Back To 2013
Shares of Edison traded in the mid-fifties in 2013, when I was a bit cautious. While the company is a respected local utility provider which provides more than 3 million households with gas and electricity, the results and valuation were a bit underwhelming.
The company posted sales around $12 billion at the time, on which it reported net earnings of around 10%. Net debt was substantial at the time, reported around $12 billion, as equity of the business was valued at $16 billion, for a $28 billion enterprise value. Modest – or a lack of – growth was offset by a 4.5% dividend yield, which looked compelling, yet the 70% payout ratio was quite high.
What Happened?
The company is taking climate change, and notably rising sea levels, very seriously after super-storm Sandy. Con Ed has been a front-runner in the adoption of renewable energy production.
Fast forwarding to 2021, the company has grown sales to $13.7 billion, translating into very modest growth since 2013. Most of the business is derived from the utility business, yet the company has a clean energy segment and transmission business as well.
Operating revenues have mostly derived from electricity sales, accompanied by natural gas and steam. Non-utility sales have grown rapidly, but remain modest at around a billion. The company remains incredibly profitable with operating earnings reported at $2.8 billion, yet after significant interest expenses and investment expenses, net earnings came in around $1.2 billion.
Following some dilution, earnings were stuck around $3.85 per share as the company reported a share count of 350 million shares with continued dilution seen amidst a high dividend payout, as we see substantial net capital spending requirements, while a roughly $4 billion annual capital spending budget is about two times the annual depreciation charge.
These shares were awarded an $85 per share equity valuation at the start of this year, translating into a $30 billion equity valuation. If one includes $25 billion in net debt, the enterprise value of $55 billion is essentially about double that of Consolidated Edison in 2013, albeit that sales are largely flattish. Low interest rates have attracted investors to the dividend, yet the business has become a lot less efficient in terms of capital efficiency and asset usage.
2022 – So Far
At the start of the year, the company guided for 2022 earnings between $4.40 and $4.60 per share, with the dividend being hiked for 48 years in a row to an annual payout of $3.10 per share, still translating into an elevated payout ratio, given that net capital spending is so high.
Amidst uncertainty in the global economy and higher utility rates, shares of Edison actually rose and hit a high around the $100 mark as recently as September. In the time frame of about a month, shares have now plunged to $81, as a 20% pullback in this short period of time is a huge move, of course.
In August, when shares were still trading near their peak, Edison posted second quarter results. Higher rates meant that revenues for the first half of the year rose to $7.5 billion, trending at $15 billion a year here, up 12% on the year before.
Higher costs across the expense base meant that operating earnings are down 7% to $1.18 billion. The company posted GAAP earnings of $2.41 per share for the six-month period thanks to some one-time positive incidentals, as net debt was stable around $22 billion. The 355 million shares outstanding, following continued dilution, resulted in an equity valuation of $36 billion at the peak, or about $29 billion at $81 per share, for a more than $50 billion enterprise valuation.
A Big Deal
On the first day of October, Consolidated Edison announced that it has reached a deal to sell its Clean Energy business to RWE Renewable America in a $6.8 billion deal. The deal allows the company to forego equity issuance, planned at $850 million this year, and further issuance in 2023 and 2024. This comes as capital spending is set to rise to a combined $15 billion in the years 2022-2024.
Shares hardly reacted to the deal, suggesting the price is about fair, yet shares have been falling recently amidst the rapid rise in the federal funds rate, which creates headaches as costs of debt will go up. Part of this rate risk is mitigated as Consolidated Edison is now cutting its debt load in a major way.
While shares have sold off some 20% in the time frame of a month, leaving shares flat for this year, it is easy to understand why investors are cautious. Despite the recent pullback, the dividend yield of 3.9% is not very competitive in this interest rate market, as Consolidated Edison is still facing large capital requirements to transform the business.
For me, utility companies, including Consolidated Edison, are too risky. The high debt commitment, high earnings multiples, and large net capital expenditures required by the business make this a very tricky proposition in many environments, certainly in the current one. Consequently, I am quite cautious here, as I do not see a reason to get involved, certainly not as Con Edison is selling the renewable part of the business, leaving real long-term strategic questions.
Be the first to comment