INVESTMENT THESIS
Consolidated Edison Inc. (NYSE: ED). Con Ed also continues to issue new equity, diluting EPS. We expect the company to grow earnings and dividends more slowly than peers, and believe that investors will favor companies with stronger growth.
Our long-term rating remains BUY, however, reflecting the company’s strong financial position and continued capital investments. Despite its below-peer-average growth, the dividend also appears secure, and the current yield of about 3.7% may be attractive for income-oriented investors. We expect shareholder returns to average 7%-8% annually over the next four to five years.
RECENT DEVELOPMENTS
The beta on ED is 0.16.
Con Ed recently reported third-quarter results that fell short of consensus estimates. Adjusted earnings came to $495 million or $1.48 per share. The consensus estimate called for adjusted 3Q earnings of $1.51 per share. Revenue fell 1% to $3.33 billion. The company’s results have fallen short of Street expectations in four of the last six quarters.
The company now expects 2020 non-GAAP EPS of $4.15-$4.30, down at the high end from its prior outlook of $4.15-$4.35. The guidance assumes capital investments of $4.1 billion.
CECONY will raise its 2020 electric rates by $113 million and its gas rates by $84 million. The increase allows for a return on equity of 8.8%.
Con Edison Gas Pipeline and Storage’s $5.3-$5.5 billion Mountain Valley Pipeline (MVP) has faced some pushback from environmental activists. However, most of the protests pertain to specific localities and wetlands, rather than to the overall construction of the pipeline. Construction is well under way and the pipeline is expected to be fully operational by 2021.
EARNINGS & GROWTH ANALYSIS
Consolidated Edison is organized into three operating segments: CECONY (86% of 3Q20 sales), O&R (7% of sales), and Clean Energy Business (7% of sales). CECONY and O&R are regulated electric & gas utilities. The Clean Energy Business owns and operates renewable energy infrastructure and provides energy to wholesale and retail customers. The company uses derivative instruments to hedge against fluctuations in commodity prices.
In the CECONY regulated utility segment, electric kilowatt-hour sales declined 7% from 3Q19. Weather was favorable and usage declines were attributable to coronavirus shutdowns. On a nonweather-normalized basis, operating revenue was roughly flat at $2.87 billion as declines in commercial and industrial revenue were offset by gains in revenue from residential customers and religious institutions. Below the top line, GAAP EPS declined 3% to $1.21 per share, as cost management on the O&M line was offset by higher depreciation and property taxes.
In the O&R regulated utility segment, electric kilowatt-hour sales were flat with 3Q19, as strong demand from residential customers and religious institutions was offset by lower commercial and industrial usage. On a nonweather-normalized basis, revenue increased 2% to $210 million due to a usage mix shift toward residential and commercial customers. GAAP EPS increased to $0.08 from $0.07 a year earlier, benefiting from changes in rate plans.
In the Clean Energy segment, 3Q20 operating revenues declined 10% to $222 million on lower energy prices. Operating income decreased 8% to $92 million due to higher O&M expense and depreciation and amortization expense. Interest expense decreased substantially, however, as losses on interest rate swaps came narrowed from 3Q19. GAAP EPS increased to $0.17 from $0.07.
FINANCIAL STRENGTH & DIVIDEND
The adjusted net margin in 3Q20 was 14.9%.
Our dividend forecasts are $3.06 for 2020 and $3.12 (lowered from $3.14) for 2021. ED has increased its dividend for 46 straight years.
MANAGEMENT & RISKS
Robert Hoglund is the CFO and has been with the firm since 2004.
Capital expenditures will also drive rate-base and earnings growth. Con Edison will continue to invest in infrastructure projects in New York City and Westchester County. These expenditures are focused on maintaining and upgrading the company’s electric, gas, and steam systems, as well as on new transmission cables and substations; the expansion of the company’s underground and overhead distribution system; and the installation of new computer equipment and software. Given the company’s strong cash flow, we do not foresee any erosion of the balance sheet as a result of this spending.
Low natural gas prices and New York City clean-air initiatives have boosted interest in oil-to-gas conversions and led to increased peak gas usage. ED management expects 1.5% growth in peak gas usage in the New York City area for the next five years (2020-2024). Future conversions are expected to boost earnings growth.
COMPANY DESCRIPTION
Consolidated Edison provides a wide range of energy-related products and services through the following subsidiaries: Consolidated Edison Co. of New York, a regulated utility providing electricity, gas and steam in New York City and Westchester County; Orange and Rockland Utilities, a utility serving customers in a 1,300-square-mile area in southeastern New York State and adjacent sections of northern New Jersey and northeastern Pennsylvania; Con Edison Solutions, a retail energy supply and services company; Con Edison Energy, a wholesale energy supply company; and Con Edison Development, which owns and operates generating plants and participates in other infrastructure projects. The company employs approximately 15,000 people.
VALUATION
We do not think ED merits a premium to peers given our expectations for relatively slow growth. Additionally, ED operates in difficult jurisdictions, and approved ROE has historically been below the peer average.
On November 18 at midday, HOLD-rated ED traded at $78.99, down $0.26.
Source: Argus
