PCG - Edison International: A Hot Investment Opportunity Or A Flaming Sell?

2023-12-24 21:54:27 ET

Summary

• Edison International's stock price has generated total returns of 112% over the past decade despite increasing risks from wildfires.
• The company demonstrated a strong financial performance in the third quarter of 2023, with a solid core EPS and guidance for future growth.
• Edison is investing heavily in grid infrastructure to support California's transition to a carbon-neutral economy, which could benefit investors.

Introduction

Edison International ( EIX ), a large player in the utility sector, provides indispensable services by ensuring the continuous delivery of electricity, a fundamental need in modern society. As a utility company, Edison International is considered by many a stable investment choice, owing to the consistent demand for its essential services.

However, the landscape of utility investments is evolving, with increasing risks highlighted by the prevalence of wildfires. Recent incidents, such as the PG&E Corporation ( PCG ) - related fires in California and those potentially linked to Hawaiian Electric ( HE ) in Hawaii, underscore these emerging challenges.

Despite those threats, Edison's stock price has charged ahead, generating total returns of 112% for investors over the past decade. But can it continue, and what has fueled the rise thus far?

In today's article, we delve into Edison International's operations within the ever-critical utility industry. We'll provide a comprehensive review of its latest quarterly earnings and offer a financial analysis in comparison to its industry peers, offering insights essential for informed investment decisions.

Brief Overview

The utility industry is pivotal in delivering essential services like electricity and gas. These companies engage in heavy capital investment, often backed by substantial debt, to develop and maintain their infrastructure. They typically function as monopolies in their designated areas, subject to strict regulation and oversight by public authorities. This ensures steady demand for their services but also puts them under close scrutiny, particularly during operational challenges or periods of inflation.

Based in California, Edison operates chiefly through its subsidiary Southern California Edison, a major utilities provider across SoCal. This significant presence makes Edison a key component in powering a region known for its economic strength, supplying electricity to numerous homes, businesses, and industries.

Edison Quarterly Update

Now that we've covered the basics of Edison's business and the industry at a high level, let's take a look at how their business has performed financially over the past quarter.

Financials

In Edison's third-quarter 2023 financial report, the company demonstrated a relatively strong performance, evidenced by a core EPS of $1.38 for the quarter and an aggregate of $3.48 for the first three quarters. This solid performance underpinned the company's reassurance of its 2023 core EPS guidance, which ranges from $4.55 to $4.85.

Management noted that this projection aligns with their strategic objective to achieve a 5 to 7% increase in core EPS through 2025, not accounting for additional potential benefits from other initiatives.

While core EPS growth looks positive, it appears as if there is more work to do to improve EPS once accounting for those "non-core" items, as its basic EPS of 3.22 has remained roughly flat over an entire decade.

Hopefully helping to improve those figures is the company's massive capital investment plan, which sports an anticipated spend of $38 to $43 billion from 2023 to 2028, aimed at supporting a rate base growth of 6 to 8%.

In its earnings call management noted that the investment is primarily directed toward enhancing the grid infrastructure, essential for California's transition to a carbon-neutral economy, a goal for the state. Regardless of the virtues of such a goal, the consumers will pay for it, and investors of Edison stand to benefit from it.

As far as the balance sheet goes, the company recently implemented a $750 million tender offer for the outstanding preferred stock which is designed to streamline the company's balance sheet and reduce vulnerability to interest rate fluctuations.

Clearly, based on its large debt load ($53B), it will need to pay close attention to managing the risks imposed by higher interest rates. Evidently Edison is already feeling the pinch of higher interest rates as interest expense has increased to nearly $1.3B per annum, whereas at the start of 2022, that figure was less than $1B.

Wildfire Risks

While wildfires will always pose a risk in California, Southern California Edison SCE is taking proactive steps to mitigate this threat wherever possible. Recognizing the inevitability of such natural events in the region, SCE recently increased its provisions for wildfire claim settlements by $475 million, largely in response to the Woolsey Fire. Simultaneously, SCE has implemented a comprehensive strategy to reduce wildfire risks, achieving an 85% reduction in losses from catastrophic wildfires since 2018.

This strategy, which includes grid reinforcement, extensive vegetation management, and the use of advanced meteorological monitoring, underscores SCE's commitment to proactively managing and reducing the impact of wildfires in California.

Regulatory Commentary

Regulatory engagement was a notable aspect of Edison International’s quarter. The filing of SCE’s $2.4 billion TKM cost recovery application exemplifies its responsible management of resources and operations. Furthermore, SCE’s proposal for the California Public Utilities Commission to approve the settlement on track 4 of its 2021 General Rate Case, which establishes the revenue requirements for 2024, along with the 70-basis point increase in its return on equity effective from January 1, 2024, help to fortify the company’s fiscal position.

Edison versus Peers

Returns on Invested Capital

Compared to other large utilities, Edison has consistently underperformed in terms of its returns on invested capital. Over the past 5 years, Edison has generated a mere 2.2% return on invested capital compared to this peer group high set by Sempra of 4.4%. Given the massive scale of capital, it is able to deploy and the regulated nature of the business, lower returns on capital are to be expected, but the sheer scale of that underperformance is remarkable and, in my view, indicates the company may be struggling to deploy capital effectively.

Unsurprisingly, those poor returns on invested capital have contributed to a moderately lower forward price-to-earnings ratio as compared to peers. At 14.66X forward earnings, Edison looks like a relative value among utility companies due to that greater margin of safety from the lower valuation.

One interesting observation based on the above is that while other utility companies have seen their valuation multiple compress, Edison's has held up, perhaps due to its lower starting point.

On a positive note, the company has a strong dividend growth track record, having increased its dividend by more than double over the past 10 years.

So, while the company may be slow to grow its earnings and under-delivers on returns on its invested capital at least it remains attractive for dividend-focused investors, a large cohort of utility investors.

Conclusion

To wrap it up, while the company's track record of deploying capital at high returns leaves much to be desired, its strong dividend growth history and low valuation compared to peers leave a fair margin of safety.

While I cannot recommend purchasing the stock, as I believe better utility stocks exist, I also cannot recommend selling either.

I rate Edison International a "Hold".

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