2023-10-12 08:35:14 ET
Summary
- Edison International is investing heavily in transmission line upgrades to greatly lessen the likelihood of recurrence of past wildfire events attributed to sparks from transmission lines.
- These capital expenditures are able to be included in Edison International tariff calculations and therefore will contribute an increase in future revenues.
- The company is mostly financing these capital expenditures with increased net debt, increasing financial risk, offset by reduced exposure to catastrophic risks, and increased revenues from an increased rate base.
Investment Thesis:
Previous assessments - I previously published articles on Vistra Corp. (VST) and Edison International (EIX) back in July 2021, both with a Buy rating. Since publication of those articles, for " Edison International : Bullish Case Short And Long Term", the share price has increased by 8.58% and total return per SA Premium is 19.84%, and, for " Vistra Corp : Potential High Returns Tempered By Risk", the share price has increased by 65.2% and total return per SA Premium is 76.94% (note share price increases and returns do not take into account duration held so are not annualized results).
Current assessments - I recently published article, " Vistra : Regulatory Nightmares Compounded By A Weak Balance Sheet (Rating Downgrade)". The downgrade was from Buy to Strong Sell, mainly due to the risks associated with a greatly weakened balance sheet, due largely to discretionary decisions of management. In preparing this current article on Edison International, I perceive a somewhat weakened balance sheet, also due largely to discretionary decisions of management. Despite this, I am holding my Buy rating on Edison International and that likely requires an explanation why the different conclusion, as outlined below.
- Vistra common stock equity has reduced from $6,597 million (62.9% of Net Operating Assets "NOA") at end of 2016 to $3,359 million (19.6% of NOA) at end of Q2 2023.
- Edison International common stock equity has increased from $11,996 million (49.2% of Net Operating Assets "NOA") at end of 2016 to $13,815 million (28.1% of NOA) at end of Q2 2023.
Vistra's reduction in common stockholders' equity, both in absolute dollars and in percentage of NOA can be attributed to Management's decisions to leverage by expending $4,401 million on share repurchases over the last 6.5 years. These repurchases have continued into the first half of 2023.
Edison International's common stockholders' equity has not reduced in absolute dollar terms, it has increased. The reduction as a percentage of NOA derives from financing capital expenditures primarily with debt and preferred equity.
Vistra management's repurchasing of shares, using borrowings, appears to have no benefit for future revenues, and increases interest expense. EPS might increase due to reduced share count. The company was conservatively financed coming out of bankruptcy, and this has been completely turned around with a highly leveraged balance sheet and remaining common stock equity funds of $3,359 million are little more than the cost of past single catastrophic events.
Edison International have made investments in regulatory assets that will add to future revenues, and mitigate against future catastrophic events and their associated costs. While these investments have been mostly financed with debt and preference share issues, part has been financed through an increase in common stock equity capital. Remaining increased common stock equity funds of $13,815 million are many multiples of the cost of past single catastrophic events.
In the final analysis, the differences in the approaches of Management toward growing the earnings and EPS of the companies, and the degree of risk they are prepared to take on, and have taken on, is what colors my opinion, and thus my very diverse ratings for Edison International as a Buy, and Vistra as a Strong Sell. Of course, Vistra might survive the higher risks I perceive, and provide the higher return appropriate for higher risk. Opinions of readers will likely vary on these conclusions depending on individual risk tolerance. A detailed financial analysis for Edison International follows.
Financial Analysis and Comment
Looking for market mispricing of stocks -
What I'm primarily looking for here are instances of market mispricing of stocks due to distortions to many of the usual statistics used for screening stocks for buy/hold/sell decisions. I believe the answer is to compare projections, based on analysts' estimates out to the end of 2024 or later, to past performance. Summarized in Tables 1 and 2 below are the results of compiling and analyzing the data on this basis.
Table 1 - Detailed Financial History And Projections
Table 1 documents historical data from 2016 to 2022, including share prices, P/E ratios, EPS and DPS, and EPS and DPS growth rates. The table shows EPS grew at an average rate of 2.72% per year, between 2016 and 2022, while the share price declined at a rate of 2.04% per year over the same period. The table also includes estimates out to 2026 for share prices, P/E ratios, EPS and DPS, and EPS and DPS growth rates. (Note - while estimates are shown for analysts' EPS estimates out to 2023 to 2026 where available, estimates do tend to become less reliable, the further out the estimates go. These estimates are only considered sufficiently reliable if there are at least three analysts' contributing estimates for the year in question). Based on analysts' consensus EPS estimates, EPS is projected to continue to grow at low to mid single-digit percentages through end of 2025. Table 1 allows modeling for target total rates of return. In the case shown above, the target set for total rate of return is 7.5% per year through the end of 2025 (see line 12), based on buying at the Oct. 11, 2023, closing share price level. As noted above, estimates become less reliable in the later years. I decided to input a target return based on the 2025 year, which has EPS estimates from fourteen analysts because it allows for the impact of the projected EPS growth rates to be taken into account in the assessment of the value of Edison International shares. The table shows to achieve the 7.5% return, the required average yearly share price growth rate from Oct 11, 2023 through Dec. 31, 2025, is 2.56% (line 51). Dividends and dividend growth account for the balance of the target 7.5% total return.
Edison International's Projected Returns Based On Selected Historical P/E Ratios Through The End Of 2025
Table 2 below provides scenarios projecting potential returns based on select historical P/E ratios and analysts' consensus, low, and high EPS estimates per Seeking Alpha Premium through the end of 2025.
Table 2 - Summary of relevant projections Edison International
Table 2 provides comparative data for buying at closing share price on Oct. 11, 2023, and holding through the end of years 2023 through 2026. There's a total of twelve valuation scenarios for each year, comprised of three EPS estimates (SA Premium analysts' consensus, low and high) across three different P/E ratio estimates, based on historical data, plus a fourth P/E ratio selected to provide an alternative scenario. Edison International's P/E ratio is presently 13.73, which is below the historical average P/E ratio of 14.40. Table 2 shows potential returns from an investment in shares of the company across the range of P/E ratios This analysis, from hereon, assumes an investor buying Edison International shares today would be prepared to hold through 2025, if necessary, to achieve their return objectives. Comments on contents of Table 2, for the period to 2025 column follow.
Consensus, low and high EPS estimates
All EPS estimates are based on analysts' consensus, low and high estimates per SA Premium. This is designed to provide a range of valuation estimates - from low to most likely to high - based on analysts' assessments. I could generate my own estimates, but these would likely fall within the same range and would not add to the value of the exercise. This is particularly so in respect of well-established businesses such as Edison International. I believe the "low" estimates should be considered important. It's prudent to manage risk by knowing the potential worst-case scenarios from whatever cause.
Alternative P/E ratios utilized in scenarios
- The actual P/E ratios at the share buy date are based on actual non-GAAP EPS for Q2-2023 TTM.
- A modified average P/E ratio based on 29 quarter-end P/E ratios from Q4 2016 to Q3 2023 and current P/E ratio in Q4 2023. The Q3 and Q4 2023 P/E ratios are based on share price at the end of Q3 2023 and the current share price in Q4 divided by TTM EPS for latest reported earnings through end of Q2 2023. The average of these P/E ratios has been modified to exclude the three highest and three lowest to remove outliers that might otherwise distort the result.
- A modified low P/E ratio was calculated using the same data set used for calculating the modified average P/E ratio, and calculated on a similar basis, with the three highest and lowest P/E ratios excluded.
- A median P/E ratio is calculated using the same data set used for calculating the modified average P/E ratio. Of course, the median is the same whether or not the three highest and lowest P/E ratios are excluded. In the case of Edison International, I have chosen to use an assumed P/E ratio of 15.0 in place of the historical median of 14.31 (similar to the average). I have done this to provide an idea of the impact on returns of the multiple increasing above the present level and the historical average. The selected P/E multiple of 15.0 compares to the sector median of 15.67 for PE Non-GAAP [FWD], per Seeking Alpha Premium metrics.
Reliability of EPS estimates (line 18)
Line 18 shows the range between high and low EPS estimates. The wider the range, the greater disagreement there is between the most optimistic and the most pessimistic analysts, which tends to suggest greater uncertainty in the estimates. There are fourteen analysts covering Edison International through the end of 2025. In my experience, a range of 3.5 percentage points difference in EPS growth estimates among analysts is relatively low and suggests a degree of certainty, and thus increased reliability.
Projected Returns (lines 19 to 45)
Lines 25, 35, and 45 show at a range of historical P/E ratio levels, Edison International is conservatively indicated to return between 5.8% and 10.2% average per year through the end of 2025. The 5.8% return is based on analysts' low EPS estimates and the 10.2% on their high EPS estimates, with a 7.3% return based on consensus estimates. Those are the lowest of the returns under the consensus, low, and high EPS scenarios and assume a P/E multiple at Edison International's modified historical low multiple of 12.17. At Edison International's historical average P/E multiple of 14.40, the indicative returns range from 15.5% to 20.4%, with consensus of 17.2%. Edison International's present multiple of 13.73 is below its historical average of 14.40. But indicative returns if the multiple remained unchanged through end of 2025 range from 11.3% to 16.0%, with consensus 12.9%.
Checking Edison International's "Equity Bucket"
Table 3.1 Edison International Balance Sheet - Summary Format
Seeking Alpha Premium and SEC filings
Over the 6.5 years from end-December 2016 to the end of Q2-2021, Edison International has increased Net Assets Used In Operations by $24,715 million. The increase was funded by $1,819 million in common stock shareholders' equity, $1,978 million in preferred stock shareholders' equity, and $20,918 million in debt net of cash. Net debt as a percentage of net debt plus equity increased from 50.8% at end of December 2016 to 67.8% at end of Q2-2023, due to the high proportion of debt used to fund increases in net operating assets. Outstanding shares increased by 57.4 million from 325.8 million to 383.2 million, over the period, due primarily to capital raisings and also for shares issued for employee and stockholder share purchase plans. The $1,819 million increase in common stock shareholders' equity over the last 6.5 years is analyzed in Table 3.2 below.
Table 3.2 Edison International Balance Sheet - Equity Section
Seeking Alpha Premium and Sec filings
I often find companies report earnings that should flow into and increase shareholders' equity. But often the increase in shareholders' equity does not materialize. Also, there can be distributions out of equity that do not benefit shareholders. Hence, the term "leaky equity bucket." I see this happening to some extent with Edison International.
Explanatory comments on Table 3.2 for the period end FY-2016 to end Q2-2023.
- Reported net income (non-GAAP) over the 4.5-year period totals $10,427 million, equivalent to diluted net income per common stock share of $29.13.
- Non-GAAP EPS growth averaged 2.72% per year from 2016 to the end of 2022 (see Table 1, line 24).
- Over the 4.5-year period, the non-GAAP net income excludes $6,227 million of GAAP losses (EPS effect $17.64) of items regarded as unusual or of a non-recurring nature in order to better show the underlying profitability of Edison International. These excluded losses primarily relate to costs associated with wildfires and mudslides for which the company has been found legally responsible.
- Other comprehensive income includes such things as foreign exchange translation adjustments in respect to buildings, plant, and other facilities located overseas and changes in valuation of assets in the pension fund - these are not passed through net income as they fluctuate without affecting operations and can easily reverse in the following period. Nevertheless, they do impact the value of shareholders' equity at any point in time. For Edison International, these items amounted to positive $81 million (EPS effect $0.21) over the 6.5-year period.
- The company has a stock compensation scheme under which shares are purchased to settle equity awards. Amount recorded in the income statement for stock compensation is less than the amount paid to purchase shares to settle equity awards. The effect is a reduction of $32 million (EPS effect negative $0.15) compared to reported income.
- By the time we take the above-mentioned items into account, we find, over the 6.5-year period, the reported non-GAAP EPS of $29.13 ($10,427 million) has decreased to $11.69 ($4,249 million), added to funds from operations available for distribution to shareholders.
- Dividends of $6,001 million were greater than the $4,249 million generated from operations, resulting in a decrease of $1,752 million in equity.
- This net $1,752 million decrease in equity from operations is more than offset by $3,571 million from public offerings and stockholder and employee share plan purchases, resulting in the $1,819 million net increase in shareholders' funds per Table 5.1 above.
Balance Sheet Risk
The Board and Management of Edison International are undertaking a major program to replace bare wires on their transmission lines with covered wires. This is expected to cost billions, but the company is allowed to earn a capital return on this capital expenditure, with regulatory approved increases to tariffs. This expenditure has three effects, less risk of incurring the potentially huge costs of transmission caused fires for which the company is held responsible, an increase in income and earnings from regulated operations based on the increased capital base, and some weakening of balance sheet strength, with associated increased financial risk for common stock shareholders. In 2016, Net assets used in operations of $24,363 million was funded 49.2% ($11,996 million) by Common Stock shareholders equity and 50.8% ($12,463 million) by debt net of cash. By June 30, 2023, net assets used in operations increased to $49,078 million of which $33,285 million (67.8%) was committed to supporting net debt, $1,978 million (4.0%) committed to Preference shareholders, and $13,815 million (28.1%) in which common stock shareholders have an equity claim. So common stock shareholders equity in the net assets of the business has declined from 49.2% to 28.1% over the space of the past 6.5 years. The danger this creates for common stock shareholders is another catastrophic fire event could reduce the value of the Net assets used in operations and further reduce their equity share, leaving them with reduced downside reserves to meet a series of catastrophic events. On the other hand, if the current and ongoing expenditure on transmission lines eliminates or substantially reduces costs from this source, the underlying earnings should more than fully cover dividends, leaving a surplus to grow the common stock equity capital base. Driven by capital expenditure on transmission line protection, a return on which is recoverable in tariffs, analysts' estimates are for EPS growth in high single digits from 2024 onwards.
Edison International: Summary and Conclusions
The underlying results for Edison International have been consistently positive, but have been offset in part by costs of catastrophic wildfires. Edison International is spending on actions to mitigate against these catastrophes recurring and these expenditures are allowable in calculating the cost base for future tariffs, creating a win-win for the company. Indicative returns for buying now and holding through the end of 2025 are in the double digits range, based on the current P/E multiple which is below historical P/E ratio levels. Even if the P/E ratio were to fall significantly to historical low, provided EPS falls within the range of analysts' estimates, returns from holding through the end of 2025 should remain positive. At historical average P/E multiple, returns from ~13% to 18% are indicated.
For further details see:
Edison International: Similarities To Vistra, With Important Differences (Buy Rating Maintained)