2023-08-02 17:25:51 ET
Summary
- Public Service Enterprise Group is a large utility that provides electric and natural gas service to customers throughout the state of New Jersey.
- The company delivered moderate revenue and earnings growth over the past year, and it is likely to be able to continue to deliver on this trend going forward.
- The company should be able to deliver a 9% to 11% average annual total return over the next five years.
- The company has a very strong balance sheet relative to its peers and a limited amount of debt.
- The stock looks a lot more expensive than some of its peers, so it could be a good idea to wait for the price to drop a bit.
On Tuesday, August 1, 2023, New Jersey-based electric and natural gas utility Public Service Enterprise Group Incorporated ( PEG ) announced its second-quarter 2023 earnings results. At first glance, these earnings results were quite positive, as the company managed to beat the expectations of its analysts in terms of both top-line revenue and bottom-line earnings. The stock market also seemed to appreciate these results, as the company's price shot up when the market opened following the announcement. The stock has since given back all of its gains, though:
For the most part, these results showed relatively modest growth from the prior-year quarter, which fits well with the general thesis that investors have when purchasing any utility company. In general, utilities typically deliver relatively stable through any economic conditions and slowly grow their revenues and earnings over time. This is exactly what we see in Public Service Enterprise Group's most recent results. The company also paid out a larger dividend than it did in the prior-year quarter, although it was in line with the ones paid in both of the previous two quarters. At the current price, Public Service Enterprise yields 3.61% on an annualized basis, which is very reasonable for a company in this sector.
Earnings Results Analysis
As regular readers are no doubt well aware, it is my usual practice to share the highlights from a company's earnings report before delving into an analysis of its results. This is because these highlights provide a background for the remainder of the article as well as serve as a framework for the resultant analysis.
Therefore, here are the highlights from Public Service Enterprise Group's second quarter 2023 earnings results:
- Public Service Enterprise Group brought in total revenues of $2.4210 billion during the second quarter of 2023. This represents a 16.62% increase over the $2.0760 billion that the company brought in during the prior-year quarter.
- The company reported an operating income of $823.0 million in the current quarter. That represents a substantial ____________% increase over the $385.0 million that the company reported in the year-ago quarter.
- Public Service Enterprise Group reported that its customer base increased by approximately 1% over the twelve-month period that ended on June 30, 2023.
- The company invested $900 million into green energy initiatives during the quarter, in line with regulators' demands for driving the energy transition process.
- Public Service Enterprise Group reported a net income of $591.0 million during the second quarter of 2023. This represents a substantial ____________% increase over the $131.0 million net income that the company reported in the second quarter of 2022.
In the introduction to this article, I stated that Public Service Enterprise Group typically enjoys relatively stable finances along with slow growth over time. We can certainly see that here as the company's revenues increased by 16.62% relative to the prior-year quarter. This also represents an increase over the $1.874 billion that the company brought in during the corresponding quarter of 2021. However, the company's revenues on a quarter-by-quarter basis do tend to be a bit more variable:
In particular, we do see that the company's revenues usually are much higher during the cold winter months than during the summer. This comes from the fact that Public Service Enterprise Group is both an electric and a natural gas utility. The company did not actually break down its revenues or income by product in either its press release or earnings conference call, which is unfortunate. In a presentation that the company gave to its shareholders in early June, it stated that it had 2.3 million electric and 1.9 million natural gas customers:
Public Service Enterprise Group
As such, the scope of the company's two businesses are about equal, although the electric utility appears to account for somewhere between 50% and 70% of the company's revenue depending on the year. We can draw this conclusion by looking at the difference in revenue between the summer and winter seasons. After all, the primary use of utility-supplied natural gas is in space heating and there is little need for that in the summer months. Indeed, during the summer, the only thing that most residential users have for natural gas is cooking food and hot water, assuming that their home uses natural gas for these purposes. These two items consume much less natural gas than a whole-house furnace. As such, we will always expect to see the company's revenue go up during the winter months due to the increased consumption of natural gas for space heating, while electric consumption tends to remain at least somewhat more level over the course of a year. This does not change our thesis about overall stability though, since Public Service Enterprise Group's revenues do exhibit this stability over time when you compare its revenues in a given quarter to the same quarter in a previous year.
The reason for the overall stability of Public Service Enterprise Group's revenue over time should be fairly obvious. After all, the company provides electric and natural gas service to more than two million homes and businesses in New Jersey. These things are generally considered to be necessities for our modern way of life. After all, nobody wants to have their heat cut off in the middle of winter or be forced to read books by candlelight because they have no electricity. As such, most people will prioritize paying their utility bills ahead of discretionary spending during periods in which money gets tight. That is something that could be a major concern today as there are numerous indicators pointing to the likelihood of a near-term recession and the high inflation rate has strained the budgets of many average households.
When we combine this with the fact that most people tend to not vary their electric or natural gas consumption very much over time, it results in relatively stable revenue for Public Service Enterprise Group. This is, to put it mildly, exactly the kind of company that you want to be holding in your portfolio during times of economic uncertainty.
Growth Prospects
Naturally, as investors, we are unlikely to be satisfied with mere stability. It is very important to us that any company in which we are invested grows and prospers with the passage of time. Fortunately, Public Service Enterprise Group is well positioned to deliver this to its shareholders going forward.
In the highlights, I pointed out that Public Service Enterprise Group specifically stated in its earnings report that its customer base increased by approximately 1% over the trailing twelve-month period. This is curious because New Jersey's population actually declined by 0.7% year-over-year:
As we can see above, the state of New Jersey is estimated to have had a population of 9,261,699 in 2022 but the population is estimated at 9,255.437 today in 2023. This directly opposes Public Service Enterprise Group's statement that it increased its customer count over the past twelve months. With that said, there are a lot of possible explanations for this discrepancy:
- Children moving out of their parents' home and purchasing or renting their own home. These children would represent new customers for the company as it would mean that two bills are being paid instead of one.
- Residential customers renting a commercial space to open a store, restaurant, or other business. Once again, there would be an additional entity being billed by Public Service Enterprise Group.
- People moving within the state from an area that is outside of the company's service territory to an area within it. That would have no impact on the state's population, but would add a customer for the company.
- A customer that formerly had propane or oil heat switching to the company's natural gas utility service due to an expansion of its service territory.
As we can clearly see, there are a lot of potential explanations for the discrepancy between what the company is reporting in terms of its customer base and the population trends of the state in which it operates. The fact that the company is adding more customers is a net positive for growth, as it represents more people or businesses paying their monthly utility bills. All else being equal, this should equate to more revenue for Public Service Enterprise Group.
As anyone reading this will likely point out, a 1% year-over-year growth rate will not excite any investor. Thus, the company needs to have a way to grow its revenue and profits more rapidly than its customer base. One way that it can do this is by growing its rate base. The rate base is the value of the company's assets upon which regulators allow it to earn a specified rate of return. As this rate of return is a percentage, any increase to the rate base allows the company to increase the prices that it charges its customers so that it can earn that allowed rate of return. The usual way for a utility to increase the size of its rate base is by investing money into upgrading, modernizing, and possibly even expanding its utility-grade infrastructure. Public Service Enterprise Group is planning to do this exact thing. The company recent outlined a plan to invest between $15.5 billion and $18 billion into its infrastructure over the 2023 to 2027 period:
This is only a small part of the company's overall investment plan, as it is only the company's near-term ambition. Public Service Enterprise Group further stated that it will be investing approximately between $34 billion and $40 billion into its infrastructure through the end of 2032. This is an enormous amount of money, but it is admittedly only a small proportion of the investments that will be needed all across the country if the United States is to have anywhere close to the electrical infrastructure that is needed to support a complete transition to electric vehicles by the end of the decade. For a variety of reasons, I do not expect that electric cars will fully replace gasoline-powered ones anytime soon, and certainly not by the end of the decade. Public Service Enterprise Group does not expect that its service territory alone will not be ready for electrification that quickly.
The company still expects its natural gas utility business to be in operation on that date. The company's investment plan does allow for the company to completely replace all of the remaining cast iron and steel mains by 2032 though, which will help it greatly reduce methane leaks. That is something that "green" investors can take comfort in, even if it is highly unlikely that their more ambitious goals will come to pass.
Public Service Enterprise Group stated in its earnings conference call that the growth program as discussed should allow it to grow its rate base at a 6% to 7.5% compound annual growth rate over the next five years. This should translate into a 5% to 7% earnings per share growth rate over the 2023 to 2027 period. When we combine that with the company's current 3.61% dividend yield, we can see that it is positioned to deliver a 9% to 11% total average annual return over the period. This is an acceptable annual return for a conservative utility company like Public Service Enterprise Group.
Financial Considerations
It is always important to investigate the way that a company finances its operations before making an investment in it. This is because debt is a riskier way to finance a company than equity because debt must be repaid at maturity. That is normally accomplished by issuing new debt and using the proceeds to repay the existing debt as very few companies have the ability to pay off their debts with cash as they mature. Since new debt is issued with an interest rate that corresponds to the interest rate in the market at the time of issuance, this process can cause a company's interest expenses to increase following the debt rollover. This is an especially big concern today due to the fact that interest rates in the United States are currently at the highest levels that we have seen since 2007. In addition to interest-rate risk, though, there is also the fact that a company will need to make regular payments on its debt if it is to remain solvent. As such, an event that causes a company's cash flow to decline could push it into financial distress if it has too much debt. Although utilities like Public Service Enterprise Group tend to have remarkably stable finances over time, there have been bankruptcies in the sector before so this is not a risk that we can ignore.
One metric that we can use to analyze a company's financial structure is the net debt-to-equity ratio. This ratio tells us the degree to which a company is financing its operations with debt as opposed to wholly-owned funds. It also tells us how well a company's equity can cover its debt obligations in the event of a bankruptcy or liquidation, which is arguably more important.
As of June 30, 2023, Public Service Enterprise Group had a net debt of $19.069 billion compared to $15.053 billion in shareholders' equity. This gives the company a net debt-to-equity ratio of 1.27 today. Here is how that compares to the company's peers:
Company | Net Debt-to-Equity Ratio |
Public Service Enterprise Group | 1.27 |
DTE Energy ( DTE ) | 1.89 |
Edison International ( EIX ) | 1.95 |
CMS Energy ( CMS ) | 1.91 |
FirstEnergy Corp. ( FE ) | 2.17 |
As we can clearly see, Public Service Enterprise Group appears to be maintaining a very conservative financial structure compared to many of its peers. The company is considerably less reliant on debt to fund its operations than most of the other companies in this list. This is a positive sign for risk-averse investors as it should mean that the company has somewhat lower risks than many of its peers. As such, we should not have to worry too much about its leverage.
Dividend Analysis
One of the biggest reasons why investors purchase shares of utility companies is because of the high yields that these companies usually possess. Public Service Enterprise Group is certainly no exception to this as the company yields 3.61% at the current stock price. Admittedly, this is not particularly impressive right now considering that money market yields are at 5% but it is still a lot better than the 1.43% yield of the S&P 500 Index (SP500) right now. Public Service Enterprise Group also has a long history of raising its dividend on an annual basis:
This is something that is very nice to see during inflationary periods, such as the one that we are in right now. This is because inflation is constantly reducing the number of goods and services that we can purchase with the dividend that the company pays out. This can make it feel as though we are getting poorer and poorer with the passage of time, and is an especially big problem for anyone that is relying on their portfolio for income. That is a category of people that includes most retirees. The fact that Public Service Enterprise Group raises its dividend every year helps to offset this effect and ensures that the company's dividend maintains its purchasing power over time.
As is always the case though, it is critical that we ensure that the company can actually afford the dividend that it pays out. After all, we do not want to be the victims of a dividend cut since such an event will reduce our incomes and almost certainly cause the company's stock price to decline.
The usual way that we judge a company's ability to pay its dividend is by looking at its free cash flow. The free cash flow is the amount of money that was generated by a company's ordinary operations and is left over after it pays all of its bills and makes all capital expenditures. This is therefore the money that can be used for purposes that benefit the shareholders such as reducing debt, buying back stock, or paying a dividend. During the second quarter of 2023, Public Service Enterprise Group reported a negative free cash flow of $45 million. This was obviously not enough to pay any dividends, let alone the $285 million that the company actually paid out during the quarter. At first glance, this is almost certain to be concerning as the company did not earn sufficient free cash flow to cover its payouts.
However, it is not uncommon for a utility like Public Service Enterprise Group to finance its operations through the issuance of debt and equity. The company will then pay its dividends out of operating cash flow. The reason why this is done is that it is extremely expensive to construct and maintain utility-grade infrastructure over a wide geographic area. If the company were to attempt to finance everything out of free cash flow, utility service would either be much more limited or most of these companies could never provide investors with any sort of a return. During the second quarter of 2023, Public Service Enterprise Group reported an operating cash flow of $572.0 million, which was more than enough to cover the $285 million that the company paid out in dividends with quite a bit of money left over for other purposes. Thus, it appears that the company should not have any real difficulty maintaining its dividend at the current level.
Valuation
It is always critical that we do not overpay for any assets in our portfolios. This is because overpaying for any asset is a surefire way to earn a suboptimal return on that asset. In the case of a utility like Public Service Enterprise Group, one way that we can value it is by looking at the price-to-earnings growth ratio. This is a modified version of the familiar price-to-earnings ratio that takes a company's growth into account. A price-to-earnings growth ratio of less than 1.0 is a sign that the market may be undervalued relative to a company's forward earnings growth and vice versa. However, there are very few companies that have such a low ratio in today's richly-valued market. As such, the best way to use this ratio today is to compare Public Service Enterprise Group's valuation to that of its peers in order to determine which company has the most attractive relative valuation.
According to Zacks Investment Research , Public Service Enterprise Group will grow its earnings per share at a 4.85% rate over the next three to five years. This is actually quite a bit less than the earnings growth rate that we can project based on the company's rate base growth over the same period so may be too low. Nevertheless, this earnings growth rate gives the company a price-to-earnings growth ratio of 3.78 at the current stock price. Here is how that compares to the company's peers:
Company | PEG Ratio |
Public Service Enterprise Group | 3.78 |
DTE Energy | 3.05 |
Edison International | 4.08 |
CMS Energy | 2.50 |
FirstEnergy Corp. | 2.39 |
Here we can see that Public Service Enterprise Group looks pretty expensive compared to its utility peers. However, this calculation was also performed using the Zacks' earnings per share growth estimate, which as I already mentioned, could be a bit low based on the company's rate base growth. The company's management has projected a 5% to 7% growth rate over the period, the midpoint of which gives the company a price-to-earnings growth ratio of 3.05. That still looks a bit expensive, but it is not ridiculously out of line with the peer companies shown here. The conclusion here is that it might make some sense to wait for the price to come down a bit, and admittedly that would also give buyers of the stock a higher yield than can be obtained today.
Conclusion
In conclusion, Public Service Enterprise Group delivered reasonably decent results that were in line with what we have come to expect from this company. In particular, it managed to deliver a relatively moderate amount of revenue growth year-over-year, which also translated to improved earnings. The company is well-positioned to continue this trend going forward due to its large capital spending program and business model. The only real downside here is that the Public Service Enterprise Group Incorporated stock price may be a bit high at the current level, so it may make some sense to wait for it to come down before purchasing shares.
For further details see:
Public Service Enterprise: Slow And Steady Revenue Growth, But A High Valuation