It's Hard To Make A Compelling Case For Consolidated Edison

| About: Consolidated Edison (ED)

Summary

Consolidated Edison has proven to be a profitable and rewarding company.

However, business performance and investment performance can sometimes vary.

It’s hard to make a case that shares of the company are compelling today.

Making a case for the company Consolidated Edison (NYSE:ED), is not particularly difficult. You have a corporation that traces its roots back 180 years with a legal monopoly in the way of being a utility. In turn the company is profitable year-after-year and is especially payout friendly - having not only paid but also increased its dividend for 42 consecutive years. Suggesting that Consolidated Edison could be around longer than you or I is an easy statement to make.

Yet this idea alone does not necessitate that an investment in the company must turn out well. Business performance and security performance can vary dramatically. Let's work through an illustration to demonstrate what I mean.

Here's a look at the business and investment history of Consolidated Edison from the end of 2006 through 2015:

As you might expect, the business performance could more or less be described as a "slow grower." Top line growth came in just 0.4% per year. However, the profit margin increased nicely which allowed company-wide earnings growth to increase by over 5% a year - a rather solid mark.

Of course in order to reach this mark, Consolidated Edison had to issue rather than retire shares. The total number of common shares outstanding went from about 260 million up over 290 million. So the company-wide benefit is diluted a bit on the shareholder level. Shareholders saw earnings-per-share growth of about 3.6% per annum.

The valuation that investors were willing to pay stayed basically the same during this period, resulting in share price growth that was roughly in line with EPS growth.

From there we can add in the dividend component, a main draw for a good deal of income investors. To start the period, you would be looking at a 4.8% yield that grew each and every year. Granted the growth has not been impressive (even below EPS growth) but the high starting point made up for this a bit. In total you would have collected about 45% of your beginning investment in cash over the nine-year period.

Your total annualized gain would have been about 6.7%. As a point of reference that's the sort of thing that would turn a $10,000 starting investment into $18,000 during the period. This is more or less what you'd expect from a stodgy utility. The business just sort of plugs along, and the dividend component is an important part of your return. You're not going to win any prizes for capital appreciation, but it has still been a nice way to create wealth over the last decade.

Which brings us to today. With the above information and business model in mind, I think it becomes quite difficult to make the case that Consolidated Edison ought to be a compelling security in the intermediate-term. I'll show you what I mean.

Here's a hypothetical situation for the next 10 years:

The middle column illustrates the exact same information that was detailed above for reference. The right-hand column creates a hypothetical example for the next 10 years. Keep in mind that this is merely a baseline, and you should adjust these numbers according to your own expectations.

Estimates for overall intermediate-term growth have routinely been in the 1% to 3% range, so I don't think a 2% top line expectations is out the question. This is certainly higher than what the company achieved in the past; you could even argue that it's too high.

Previously Consolidated Edison benefited from an increasing net profit margin. That's great for past business results, but it becomes more difficult to formulate through time. You can't expand this mark forever. Moving to the yearly share count once more I believe that this is a generous supposition. If anything you'd anticipate a higher rather than lower share count. If you put those items together you come to the expectation of 2% annual earnings-per-share growth; a bit below what happened in the past, but it should also be underscored that the "growth bar" is now higher as well.

If the valuation multiple stays the same at the beginning and end of the period, the share price appreciation will match EPS growth. Yet once again it seems you have a high hurdle in this area. In the last three months the share price is up 18%, indicating a trailing earnings multiple of around 19. Over the past couple of decades Consolidated Edison's average historical multiple has been closer to 14 or 15. More recently it's eked up to an average of 15, but this is still way below where shares sit today.

If you suppose Consolidated Edison can grow earnings by 2% annually, you would anticipate a future earnings-per-share number of about $5 in the next decade. Should shares trade at 15 times earnings, that equates to a future price of $75. In other words, should those circumstances formulate, today's investor could go ten years without any capital appreciation whatsoever.

Now naturally things could go better than expected. You could see the company grow by say 4% and continue to trade at 19 times earnings, yet even then you would only anticipate the share price growth to match the EPS growth rate. Moreover, I find it prudent to use a more cautious approach. Better to see an investment work out if things go marginally instead of needing excellent circumstances to do alright.

Finally, we can add in the dividend component. The company anticipates paying out 60% to 70% of its adjusted earnings in the form of dividends, which is basically where the payout ratio sits today. Previously investors benefited from starting with a 4.8% dividend yield. Today that number is closer to 3.5%.

If you put it together today's investor or prospective investor may anticipate simply collecting the dividend (or even less) in the coming years. A 3.2% annual gain (before inflation) would turn a starting $10,000 investment into about $13,700 after 10 years. To be sure this is better than a current CD rate or something of the sort, but in comparison to your equity alternatives it would be seemingly unattractive.

This is why I suggest that it's hard to make a case that shares of Consolidated Edison are compelling today. Even if you map out a "better case" scenario whereby the company grows faster than expected and trades with an above average multiple, you'd still only anticipate average investment results. You need things to go swimmingly to justify the investment. It's not like you can "grow out of" paying a bit more in this scenario.

Moreover, you should always consider a lesser possibility as well. Given already low assumptions, if something goes wrong you don't have a lot of wiggle room.

There's nothing fundamentally wrong about the business. However, the price you pay, especially with slower growing companies is very important to your eventual returns. Today you have the likelihood of slower growth, coupled with a now higher "growth bar," well above average valuation and much lower dividend yield. Combined these factors make it difficult to get enthused about the security.

Disclosure: I/we 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.