Edison International: Reasonable Performance But Too Expensive Given Risks

May 15, 2022 9:40 AM ETEdison International (EIX)DTB, DTE, DTP, DTW, ES, ETR, EXC, FE, PCG, PCGU17 Comments4 Likes

Summary

  • Edison International's operating income and net income both declined YOY, which is the exact opposite of what we typically expect from a utility company.
  • This was largely due to a one-off non-cash charge and does not accurately reflect the performance of the company's underlying operations.
  • Edison International plans to aggressively continue its growth trajectory by making significant capital investments between now and the end of 2025.
  • The company has been devoting a great deal of effort towards reducing the risk that it could cause a wildfire, which is a very good idea.
  • The company is somewhat riskier than its peers in other states, yet the stock trades at a premium. It might make sense to wait for it to drop down a bit.
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Electricity transmission towers with red glowing wires

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On Tuesday, May 3, 2022, California-based utility Edison International (NYSE:EIX) announced its first-quarter 2022 earnings results. Utilities in general tend to be very popular with conservative investors such as retirees by virtue of their remarkably stable cash flows regardless of conditions in the broader economy. However, ever since the bankruptcy of PG&E (PCG) following a series of wildfires, Californian utilities like Edison International have been surrounded by litigation fears that we do not find among utilities located elsewhere in the country. With that said though, Edison International's first-quarter 2022 results were quite solid as the company beat the expectations of its analysts in terms of both earnings and revenues, although the earnings were overall somewhat weaker than what the company reported in the prior-year quarter. The stock also appears to be somewhat richly valued at the current price, which is another point of concern. The report is not all negative however and Edison International does still have some things going for it. Overall though, it may pay to be cautious here.

As my long-time 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 Edison International's first-quarter 2022 earnings results:

  • Edison International brought in total operating revenues of $3.968 billion in the first quarter of 2022. This represents a 34.05% increase over the $2.960 billion that the company brought in during the prior-year quarter.
  • The company reported an operating income of $259 million during the reporting period. This compares somewhat unfavorably to the $399 million that the company reported in the year-ago quarter.
  • Edison International revised its loss estimates related to a series of wildfire events in 2017 and 2018, which forced the company to take an after-tax charge of $281 million during the period.
  • The company deployed nearly three thousand miles of covered conductor during the quarter, which was twice as much as in the first quarter of last year.
  • Edison International reported a net income of $136 million during the first quarter of 2022. This represents a 53.10% decline over the $290 million that the company reported in the first quarter of 2021.

One of the defining characteristics of utilities like Edison International is that they tend to enjoy remarkably stable revenues, profits, and cash flows regardless of economic conditions. This is the thing that makes these companies popular investments among retirees and other conservative investors. The reason for this should be quite obvious. After all, electric utilities provide a product that most people would consider to be a necessity so they will typically prioritize paying their utility bills above other discretionary expenses during times when money gets tight. While we do see this general stability reflected in Edison International's first-quarter revenues, more observant readers will notice that the company's operating income and net income declined year over year. This is certainly disappointing as it is very much out of line with the year-over-year growth in these figures that are generally reported by the company's peers. The biggest reason for this was that the company revised its loss estimates regarding a series of wildfire and mudslide events that occurred in 2017 and 2018, as mentioned in the highlights. As a result of these revisions, Edison International now expects to receive lower amounts of money from insurance and the government's disaster funds than it did previously. As a result of this, accounting rules require that the company take an after-tax charge of $281 million in the quarter to reflect the lower amount that it will ultimately receive. This naturally reduced the company's accounting income relative to the prior-year quarter. It is important to keep in mind that this is a non-cash charge and does not represent any money leaving the company. As such, we can safely ignore this one-time event when actually analyzing the performance of the company's ordinary operations. Edison International actually does this by reporting something called core earnings, which the company describes in the press release:

Edison International uses core earnings, which is a non-GAAP financial measure that adjusts for significant discrete items that management does not consider representative of ongoing earnings. Edison International management believes that core earnings provide more meaningful comparisons of performance from period to period.

Thus, the company's core earnings should provide us with a fairly good idea of how well the company's basic utility operations actually performed without the impact of one-off events. In the first quarter of 2022, Edison International reported core earnings of $407 million compared to $301 million in the first quarter of 2021. Therefore, it appears as if the company's underlying utility operations delivered the growth that electric utilities typically deliver every year.

Edison International is well-positioned to continue this growth streak. This is because the company intends to grow its rate base. The rate base is the value of the company's assets upon which Edison International is allowed to earn a specified rate of return by regulators. In Edison International's case, this regulatory rate of return is 10.30% so if the company's rate base increases then Edison International is allowed to adjust the price that it charges its customers upward in order to earn this rate of return. The usual way for the company to increase the size of its rate base is by investing money into upgrading, modernizing, and possibly even expanding its infrastructure. During the earnings conference call, Edison International stated that it intends to do exactly this and invest between $27 billion and $30 billion over the 2021 to 2025 period that is intended to improve the safety and reliability of its infrastructure:

Edison International CapEx Program

Edison International

This is a rather odd time period for Edison International to be presenting considering that most of its peers have been discussing their capital investment plans for the 2022 to 2026 period instead. Additionally, the fact remains that 2021 is in the past so it would be more insightful for the company to provide a forward-looking five-year period instead. Another thing that we need to keep in mind is that the capital spending program will not increase Edison International's rate base by the full $27 billion to $30 billion that the company plans to spend. This is because things such as asset retirements and depreciation will offset some of the spendings. The capital investment program is expected to still grow the company's rate base at a 9% compound annual growth rate over the period in question. This projected rate base growth resulted in management guiding to a 5% to 7% compound annual earnings per share growth rate over the time period. When we combine this with Edison International's 4.28% current dividend yield, investors can likely expect a total return of 10% to 12% over the 2021 to 2025 period, which is very reasonable for a conservative utility stock.

As stated in the introduction, following the bankruptcy of PG&E due to the effects of a devastating wildfire, investors have become somewhat concerned about the risks associated with Californian utility companies. After all, we do not often see litigation related to wildfires targeting utilities in any other state. It thus may be somewhat comforting to know that Edison International has been devoting a great deal of effort towards reducing the risk that its equipment will spark a wildfire and that the company will suffer the accompanying problems. One of the primary ways that Edison International has been doing that is by replacing its overhead transmission lines with covered conductor. These are wires in which the conducting material is insulated by a covering that protects it against accidental contact with other conductors or grounds such as tree branches. Edison International states that the usage of these wires is one of the most cost-effective ways to reduce wildfire risks. As stated in the introduction, Edison International replaced three thousand miles of transmission and distribution lines with covered conductor through the first quarter with the company aiming to have 40% of its overhead wires replaced by the end of the year. Edison International has now also begun conducting annual safety inspections of all of its gear and installing weather stations that allow it to monitor local conditions and shut down the power if needed to prevent a wildfire. Although all of these measures will certainly reduce Edison International's risk of sparking a wildfire, the risk still exists. Investors should keep this in mind when considering whether to invest in Edison International or in a peer that does not have this risk. As such, we would expect Edison International to trade at a discount to its peers to compensate for this risk.

Unfortunately, Edison International does not appear to be trading at such a discount to its peers. We can see this by looking at the price-to-earnings growth ratio. This is a modified form of the familiar price-to-earnings ratio that takes a company's earnings per share growth into account. Generally speaking, a price-to-earnings growth ratio of less than 1.0 is a sign that the stock may be undervalued relative to its forward earnings per share growth and vice versa. According to Zacks Investment Research, Edison International will grow its earnings per share at a 3.90% rate over the next three to five years, which is a lot less than the company has guided for. This would give the stock a price-to-earnings growth ratio of 3.74 at the current price. Here is how that compares to some of the company's peers:

Company PEG Ratio
Edison International 3.74
DTE Energy (DTE) 3.59
Eversource Energy (ES) 3.49
Entergy (ETR) 3.02
FirstEnergy (FE) 2.75
Exelon (EXC) 3.25

As we can clearly see, Edison International appears somewhat more expensive than many of its peers. This is despite the fact that the company is somewhat riskier than its peers for reasons that were discussed. This could be a sign that the stock is overvalued today and thus it may make some sense to wait until the stock price drops a bit before buying in.

In conclusion, Edison International's financial performance was certainly better than it may appear at first. Unfortunately, the stock appears to be overvalued at the current price because it has some risks that its peers do not but yet it trades at a premium to other utilities. While the high yield is quite nice, the price still looks a bit high at present. The company may definitely be worth considering if its share price drops a bit to account for the company's wildfire risk, which still exists even though Edison International is certainly taking steps to reduce it.

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