Safety, Safety, Safety.
This should be a mantra for most investors at a time when conflicts are ramping up and we’re seeing ever-lower degrees of stability in the markets. That’s what I’m looking for as I start moving capital into position. The first half of any given year is a significant dividend income period for me – so I need to be ready as to where to invest, how much, and why.
Edison International (EIX) is potentially on my list this year.
This article is about why that is.
What Is Edison International?
Edison generates and distributes electric power to consumers. Its customer number is at 15 million, and all of them are located as residential, commercial, industrial, public, and agricultural customers across the southern, central and coastal areas of the state of California. It also provides some energy solutions for larger clients.
The company’s assets consist of transmission infrastructure and distribution systems of about 39,000 miles of overhead lines, 31,000 miles of underground lines, and 800 substations to go with it. It’s over 135 years old, and its headquarters are found in Rosemead, CA.
Edison has a market capitalization of $22B. It carries a BBB credit rating, making it investment-graded.
If you’ve read my earlier articles on the utilities I follow and invest in, such as E.ON (OTCPK:EONGY), Pinnacle West (PNW), Fortum (OTCPK:FOJCF), Enel (OTCPK:ENLAY), and Iberdrola (OTCPK:IBDRY), you’ll know that most of them share some very similar characteristics. We’re talking about extremely stable cash flows thanks to clearly set rates by oversight, we’re talking services that can’t be somehow ignored or considered non-essential. Electricity is one of the most important resources on earth – behind food, water and heat (and it does at times provide heat).
That’s not to say that there aren’t risks to utilities. There are. But generally speaking, utilities are bond-type sort of investments with low growth, low beta, and relatively high yields.
That’s what makes them theoretically appealing. Edison International is no different. When I went through some of the earlier pieces on the company, few of them address the overall organization and structure of the business. So that’s part of what I’m going to show here.
Edison International is the holding company of SCE and the Edison Energy Group. The former is an investor-owned utility, the latter is a holding company for Edison Energy which provides data-driven energy solutions as mentioned before, though these numbers are not reported separately.
As with any utility play in the western part of the US, a primary question that needs asking is wildfire/climate work. As early as the end of 2020, the company is reporting a plan for this with ongoing targets.
The case for a Californian utility is pretty simple. A Californian utility is going to have an appealing demographic and fundamentals, even if we’ve lately seen some population outflow. These positive fundamentals and the overall economic climate in California are likely, and historically confirmed, to set some fairly positive base rate cases, which contribute to annual earnings growth for the company.
However, because of wildfire prevention and the need to retrofit/upgrade existing assets, a lot of that capital and those earnings for the coming years will go into maintenance CapEx.
On a theoretical worst-case scenario based on the CalPA base rate forecast, we can expect a base rate growth of 6.1% CAGR until 2023. The company’s future income growth is pretty much entirely dependent on these rate cases, and generally speaking, on a historical basis, we have very good trends to lean against.
The issue really is the various climate problems in California, notably wildfires and mudslides. The costs for such crises and issues can go up into the billions, with 2017/2018 events claims and insurance fund expenses for wildfire topping $1.1B, or more than 50% of 2020 Edison International’s core earnings (Source: 10-K). This isn’t even finished yet, by the way, as the story was still ongoing when last annual results were still ongoing, with over a third of the claims not done back in 2021. While more of them are now finished, it does a lot to showcase the overall risk to a company like EIX.
The last period we have is the 3Q21. This period saw an upward revision of the loss estimate of almost $1.5B, again showcasing how volatile this can be. As of 3Q21, more than $2.2B was still left in unsolved, which was pretty much unchanged from FY21. However, with the new total, this is now less than 30%.
It’s also very fair to say that EIX is doing its part to try and mitigate wildfire risk. The company is actively retrofitting, reducing fault likelihood, expanding vegetation management, increasing inspections and doing other things that, overall, would have reduced wildfire damage by over 90%, had they been in place before.
Where SCE/EIX has retrofitted and covered bare wire, there hasn’t been a single reported ignition incident from object/wire2wire contact. In short, it’s working. The company estimates that its work thus far has resulted in a 55-65% lower probability of losses – and expects to reduce it further.
On a rate case basis update, the first decision is a confirmation of solid base rate growth through 2023. The company maintains its EPS growth forecast.
Overall company requests come in at around a 10-10.5% RoE on a forward basis. The company also narrows its EPS guidance to a very small range for 2021, has given us early 2022 considerations, including no significant rate base growth assumption changes, and expects a 5-7% EPS CAGR starting 2021FY to 2025. Returns are targeted in the high-single digits or low-double digits, which is usually what you can expect for a utility.
Risks include climate and wildfires. That combined with a long-term debt/cap of 56%+ at this point means that the current credit rating outlook is actually negative. While the company has begun to spend and work CapEX into the aforementioned retrofits, there is likely to be a years-long continuation of this. Risks are also that the company’s liability insurances are going to be increasing in price more and more – which in turn will drive CapEx spending higher as the company is incentivized to prevent these things more and more in the first place. Overall, it’s not unlikely that the next few years will see significant cost pressure.
However, on a high level, this should be viewed as nothing more than a non-recurring item after these measures are finished. Utilities should be viewed on a multi-year level sort of appeal. The global trends are for ever-increasing consumption of electricity, and California certainly is no different.
The company’s wildfire expenses have hounded EIX for years – and it’s likely with the number of unsettled cases that this will continue for some time – but there’s a fundamental appeal to this business. Consider that California is one of the fastest-growing EV markets of the world, with EV/hybrids capturing double-digit percentages of sales.
The company also has a safe dividend with nearly 18 years of dividend tradition. Even the wildfire issues have not dropped coverage to a degree here where EIX has deemed is necessary to cut it. Current coverage, on an adjusted EPS basis, is at a payout ratio of below 60%, and growth/bumps are expected.
Overall, I consider it likely and do a forecast for continued uncertainty in EIX due to the remaining, unsolved cases from wildfires and mudslides. I also think that continued investing and spending for prevention of fires and liabilities will continue to weigh on the company’s earnings and balance sheet for several years.
However, all this does is dictate that this company does not deserve a premium. It does no longer trade at a premium. Back before the wildfire/mudslide, EIX traded at nearly 18.5X P/E. That’s beyond high for a utility such as this.
Today, the same number is 13.35X.
Now, things are getting interesting.
What Is The Valuation?
So, at a 13.35X P/E and on a 10-year basis, EIX has averaged EPS growth of around 2.5%. That’s including the catastrophes in 2017-2019 and a slightly weighted-down earnings level due to these effects. EIX trajectory since the COVID-19 crash has been pretty much like a Jojo, going up and down between highs of 15.25X and troughs of around 11X. So at 13.36X, that’s about the midpoint of that valuation.
An unimpacted EIX is clearly worth more than 12-13X P/E. It pays a 4.67% dividend yield at today’s valuation – which is significantly higher than when someone last reported on the company. At a 13.36X, the current upside to normalization of around 15X P/E, which I believe to be is a good long-term proxy for fair value, is roughly 14-15% per year.
Analysts don’t really miss on EIX that often. FactSet analysts have a negative miss ratio of 8% with a 10% margin of error on a 1-year forward basis. That’s a relatively high certainty of accuracy. The analysts even forecasted the troubled periods during the wildfire accurately or had EIX beat forecasts. That earnings miss I spoke about, the 8%, was back in 2009.
So, I will say that the upside is decent here, and we’re starting to really see a working thesis for a “BUY”. I didn’t see that thesis a few months back, when the company’s upside was less than 8-9%.
There’s also the very real possibility that we might be looking at further drops. Remember, 11X was trough for the past few years. We might reach that level again, and then the long-term upside would be over 20% conservatively.
At that point, I would definitely move in on this investment and start really buying shares at an accelerated pace.
Street targets for EIX confirm this positive thesis. 15 analysts have a range of $54-$82/share for the company, with an average of $71/share. This indicates an upside of close to 18%. I would call this target fair over the long term. Over 50% of S&P Global analysts hold a “BUY” or “Outperform” target for the company here.
Overall, I’d say the company has an above-average “BUY” appeal here given the chaotic market situation we’re in. Safe yield is a rare thing, and I do believe this 4.5%+ yield is safe on an above-average level in the long term. While we’re likely to be under some pressure for the next few years, I doubt that pressure will somehow cause the company to break the dividend here.
I’m going with a “BUY” with a $65/share PT – at most.
Thesis
My thesis for EIX is the following:
- Edison International is a Cali utility with a good asset base, good rate base cases, and an above-average amount of current liability – but liabilities they’re working through.
- At a good price, this company is a profitable utility stalwart. The value can get even better – but I believe a 13X P/E justifies a “BUY” here.
- For even safer, you can head into options and look at the $55 strike @ July -22 PUTS, with a current implied annualized RoR of 10.13% based on a $2.1 premium. Still, given the upside and yield, I’d probably go for the common here prior to exposing $5000 of capital.
- EIX is a “BUY” here. A price target that I would consider attractive for investment based on my goals would be around $65/share – though every investor, of course, needs to look at their own targets, goals, and strategies. I would also always consult with a finance professional before making investment decisions such as this.
Remember, I’m all about:
1. Buying undervalued – even if that undervaluation is slight and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn’t go into overvaluation but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
This process has allowed me to triple my net worth in less than 7 years – and that is all I intend to continue doing (even if I don’t expect the same rates of return for the next few years).
If you’re interested in significantly higher returns, then I’m probably not for you. If you’re interested in 10% yields, I’m not for you either.
If you, however, want to grow your money conservatively, safely, and harvest well-covered dividends while doing so, and your timeframe is 5-30 years, then I might be for you.
Thank you for reading.