Consolidated Edison - Be Cautious On A Full Valuation

Nov.23.13 | About: Consolidated Edison (ED)

Shares of Consolidated Edison (NYSE:ED) have been under pressure following a downgrade from Jefferies. As the company does not show many prospects for growth, investors' returns are tied to the current dividends.

Shares could see a correction on the back of an uncertain regulatory environment or a spike in interest rates.

I remain on the sidelines with a slight bearish stance.

Jefferies Turns Cautious

Analysts at Jefferies downgraded Consolidated Edison from "Hold' to "Underperform", lowering the price target by $11 to $49 per share. Based on Thursday's closing price, the target implies that shares might see some 12% more downside.

The broker believes that the utility company will not be able to reach a settlement in the current electric, gas and steam rate case. A one-year litigated decision is predicated based on a 9.0% return on equity.

Jefferies believes that the company will file a new rate plan in February of 2014, causing more regulatory uncertainty with the second filing in just two years' time.

On top of that, the broker cuts its earnings per share estimate for this year by fifteen cents to $3.60 per share.

Third Quarter Results

As reported about 2-3 weeks ago, Consolidated Edison generated third quarter revenues of $3.48 billion, up 1.3% on the year before. Net earnings inched up by 5.5% to $464 million, with diluted earnings coming in at $1.58 per share.

Valuation

Consolidated Edison ended its third quarter with $74 million in cash and equivalents. Total debt stands at $12.2 billion, resulting in a sizable net debt position.

Revenues for the first nine months of the year came in at $9.49 billion, up 2.1% on the year before. Earnings fell to $828 million in the meantime.

At this pace, full year revenues are seen around $12.5 billion as earnings are seen around $1.1 billion.

Trading around $56 per share, the market values Consolidated Edison at around $16.5 billion. This values equity in the firm at 1.3 times annual revenues and 15 times earnings.

The quarterly dividend of $0.615 per share provides investors with a yield of 4.4% per annum.

Some Historical Perspective

Long-term holders in the firm have seen steady returns, nothing more, nothing less. Over the past decade, shares have risen from the low end of the $35-$65 trading range towards the high end of that range, currently trading at $56 per share.

Obviously investors have received relatively fat dividend checks in the meantime. Between 2009 and 2012, the firm reported a cumulative 6-7% fall in revenues towards $12.2 billion. Net earnings rose by about 30% to little over $1.1 billion in the meantime.

Investment Thesis

Consolidated Edison is a well-respected name providing some 3.3 million customers with electricity and gas. Like many other regulated businesses, key is to focus on the payouts, debt position, growth and regulatory environment.

Fact remains that the company underperformed in recent years. While operations were impacted by Hurricane Sandy last year, the company has shown negative revenue growth over a longer time period. Combining this with an already sizable debt load and uncertain regulatory environment, and it is understandable why Jefferies is cautious.

Yet shares trade at historical high levels, as dividend payouts at about 70% of earnings provide investors with a nice 4.5% yield which is quite attractive in this low rate interest rate environment. This leaves shares and the valuation at large exposed to a spike in interest rates, as witnessed at the start of this summer.

I believe Jefferies is rightfully cautious and I would remain cautious as well. I am happy to re-evaluate the prospects if shares were indeed to break the $50 barrier.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.