Con Edison has prospects for growth
Author: Stock Analyst Date: 2020/12/01
Con Edison is one of the largest US electric power holdings focused on serving New York and the counties, with a combined asset value of about $60 billion.
We rate Con Edison Hold with a 12M TP of $ 83.78. The upside potential is 9.88%. Long Con Edison positions should be formed on price corrections.
- With stable revenue and EBITDA growth in the generation portfolio of Con Edison, 70.8% is accounted for by renewable energy sources, and 29.1% is accounted for by gas production. The firm's strategy is focused on further increasing green generation and upgrading the network infrastructure.
- As part of power distribution, the company generates 47.4% fewer planned outages compared to the US average.
- The company is not only increasing alternative generation, being the 7th largest solar energy producer in the world, but also investing in the infrastructure of charging stations and energy storage technologies.
- ConEdison has paid a continuous dividend for 46 years and has the longest dividend ramp-up period of any US utility. The dividend policy assumes payment of 60-70% of the profit to shareholders.
- This year EBITDA is expected to grow by 2.89% and revenue to grow by 1.51% YoY.
Con Edison is a large American electricity holding, represented by 4 operating branches:
- Consolidated Edison Company of New York, Inc. (CECONY) - Gas and electricity supply in New York City and Westchester County;
- Orange & Rockland Utilities, Inc. (Q&R) - gas and electricity supply in the southeast of New York and electricity in the north of New Jersey;
- Con Edison Clean Energy Businesses, Inc. - projects in the field of renewable energy and services for the maintenance of renewable energy systems for retail and wholesale customers;
- Con Edison Transmission, Inc. - investments in gas and power grid infrastructure.
The first two operating divisions of the company are fully regulated, therefore, the pricing system is built on the principle of full cost recovery. The total revenue of the Con Edison holding group for 2019 was about $ 12.5 billion.
The total assets of the company at the end of 2019 amounted to $ 58.08 billion. The company's network services are focused on serving New York and the metropolitan area.
From the point of view of the company's strategic development, it is advisable to single out the following structural components:
- Growth in the generation of clean electricity, a complete rejection of the use of hydrocarbons in production activities and a decrease in the impact on the environment.
- Overhaul of fixed assets, in particular investments in the stability of the network infrastructure and in the latest technologies for power supply and metering systems.
- Stable growth of financial flows to the company's shareholders while maintaining a stable "healthy" structure of the balance sheet liabilities.
1. The results and policies of Con Edison in the field of ESG generation and transmission of electricity are very impressive: in 2019, 71% of electricity was generated from SPP and WPP.
The total volume of electricity generated at our own power plants amounted to 9.7 million MWh. At the same time, the electricity transmitted by the Con Edison networks (CECONY and O&R) in 2019 was also produced mostly from green sources. It should be noted, however, that power distribution is not controlled by Con Edison and is handled by NYISO (New York's Independent System Operator).
Thus, the company needs to get rid of 0.1% of its own generation from petroleum products and reduce electricity production from gas. Between 2005 and 2019, Con Edison was able to avoid an additional 33.4 million tonnes of CO2 into the atmosphere. One of the company's key goals is to increase renewable generation in the state of New York: by 2040, the company plans to completely cover the territory of the largest US metropolis with "clean" electricity.
To finance green investments, Con Edison issued green bonds in March 2020 for a total of $ 1.6 billion. to the infrastructure of charging stations in the service area.
As of Q3 2020, Con Edison holds an AA ESG rating from the MSCI, marking the company as a leader in managing the most significant ESG risks.
2. The investment program for 2020–2022 assumes significant investments in the renovation of the network infrastructure and the development of intelligent metering systems.
The bulk of investments will be directed to three areas: power grid facilities, gas networks and renewable electricity.
The total capital expenditure on renewable energy is not limited to investments in the Clean Energy Businesses: for example, in 2017, 2018 and 2019, CAPEX spent $ 381 million, $ 490 million and $ 507 million, respectively, on environmental protection. At the same time, it should be understood that within the framework of generation, taking into account the percentage received from renewable resources, most of the CAPEX is directed to investments in "clean" energy.
Within the structure of the company's balance sheet, it should be noted that the use of financial leverage mechanisms is lower relative to key competitors in the industry.
At the same time, the firm maintains a fairly low amount of liquidity in the balance sheet, preferring to invest it in longer-term projects.
3. The companies' dividend policy in the medium term will continue the 46-year trend of growth in payments to shareholders.
Among the S&P500 utilities, this is the largest continuous payout period, adding confidence in further dividend increases.
Over the past five years (2016–2020), the CAGR for dividends paid was 2.82%, which suggests further growth in payments. The average payout ratio from 2005 to 2020 was 67.21%, and the company intends to maintain its values in the range of 60-70% in the coming years. This fact adds investment attractiveness to the company's shares due to the regulation of tariffs noted earlier and typical for the two largest divisions. In this regard, it is reasonable to assume that Con Edison will have the necessary base for payments to its shareholders.
- ConEdison is already generating 70.8% of its generation from "renewable" resources. At the same time, the complete rejection of the use of coal occurred more than 50 years ago. In 2020, the company plans to implement an additional 607 projects in the field of power generation using renewable energy sources, in addition to the 2,767 existing ones. The generation structure in Con Edison's portfolio significantly outperforms the industry average in ESG assessments and has an MSCI ESG rating of AA. The company ranks seventh in the world and second in the United States in solar energy production and plans to increase these volumes in the coming years both in the key service region (New York and the county) and in other states (California, Texas, Montana, South Dakota, Nebraska, etc.). As part of the wind generation, the company is actively working on the coastal areas of the east coast of the United States (Bay State Wind and a number of other projects).
- ConEdison has a low unscheduled outage rate in absolute terms and relative to the US national electricity system as a whole. In 2019, Con Edison had an unscheduled outage rate of 526 (per 1,000 customers), compared with a national average of 1,000. In the Con Edison service region, this figure is 1030 cases per 1000 consumers. The company is investing heavily in smart metering, storage and supply systems, with Con Edison being the first to install an intelligent gas leak detection system on its networks.
- ConEdison owns the largest networked steam infrastructure in the United States, which avoids additional emissions of about 1 million tonnes of CO2 annually.
- ConEdison is one of the key contributors to projects to build charging infrastructure for electric vehicles. NYSPPS (New York State Department of Public Service) has prepared a program to support the development of this segment, in which $ 314 million is provided for Con Edison. At the same time, $ 52 million for the construction of charging stations is included in the Con Edison electricity tariff. Significant emphasis in the development of electric charging stations is focused on the SmartCharge NY program, which aims to mitigate peak loads on the grid by providing incentives to charge vehicles outside the "peak zones". Another promising direction of the company's development is energy storage systems.
- ConEdison's balance sheet structure is more deleveraged relative to key industry competitors. With a Net Debt / EBITDA ratio of 4.91x, the industry average is 5.16x. The balance of total debt is even more relaxed: their ratio to total capital is 1.24x for Con Edison, while the industry average is 1.66x.
- The company's dividend policy is attractive to investors: the average annual growth rate (CAGR) of the dividend per share for 16 years was 1.90%. ConEdison has been paying dividends continuously for the past 46 years and has been increasing dividends for the longest term among the utilities of the S&P Con Edison targets dividend payments in the coming years at the level of 60-70% of profit, which indicates a likely continuation of the trend in the medium term ... The company pays dividends on a quarterly basis in equal installments. Dividend yield for 2021E is 4.2% to the current exchange rate.
- The renewable energy industry under the Democratic president will wait for an additional $ 1.7 trillion stimulus over 10 years. Biden is more inclined towards solving environmental problems as one of the key priorities for the development of the American and world economy. At the same time, the cost of electricity production based on renewable energy sources will decrease due to the development of technological infrastructure. Regional operators are ready to actively cooperate with renewable energy companies, which is undoubtedly beneficial for ConEdison against the backdrop of projects to develop charging infrastructure and energy storage technologies.
- The regulated nature of utilities provides them with protection against increased tax burdens due to the inclusion of corporate taxes in the final tariff.
- Despite the decrease in the actual generation of electricity in the USA in 2020 (minus 7.3% as of September 2020), the production of energy at the facilities of a number of types of renewable energy sources grows with a drop in generation due to traditional generation: + 13.8% due to solar energy at -20.2% from coal (September 2020, yoy).
- In the first nine months of 2020, ConEdison's net income remained virtually unchanged compared to the same period in 2019 (an increase of $ 9.0 million). The company attributes such a slight increase to the crisis that hit the global economy in connection with the COVID-19 pandemic. In the ESG presentation of the company from November 2020, the fact of an increase in reserves for doubtful debts by $ 17.4 million was reported, due to which an additional decrease in net profit was formed. In addition, the company adopted a package of measures to waive penalties for violation of payment deadlines, and this had an impact on the final financial result.
- Amid the pandemic, the company did not change its dividend policy and paid a quarterly dividend of $ 0.77 per share.
- Net debt since the beginning of the year has increased by 10.47% to $ 22.8 billion, while the Net Debt / EBITDA ratio of 4.91x is acceptable at the level of the industry average of 5.16x.
In the comparative approach, we used 2 techniques - multiplier estimation relative to peers and historical multiplier estimation.
Valuation by multiples relative to peers implies a target capitalization of $ 28.59 billion, or $ 85.37 per share.
Valuation based on historical multiples assumes a target capitalization of $ 27.52 billion, or $ 82.20 per share.
The combined target price was $83.78 per share with a potential of 9.88% to the current price.
Based on the potential level, we are not yet ready to recommend shares for purchase and assign Con Edison a Hold rating, but it makes sense to track the price and form long-term long positions on the issuer on corrections, taking into account the current development strategy, operational and financial growth of the business.
Stock market performance
ED shares are trading worse than the S&P 500: with the S&P 500 rising 16% since December 31, 2019, Con Edison shares have fallen in price by 9%. Such dynamics, in our opinion, is due to the projected decrease in profits in 2020 relative to 2019 (-0.40%). Nevertheless, there is reason to say that the company's shares are undervalued by the market taking into account the projected growth in EBITDA (+ 3.10%), the continued practice of paying dividends and their growth, as well as the "green" profile of Con Edison's business. At the same time, the S&P 500 Utilities sectoral index has grown by 1.29% since the beginning of the year. Con Edison lagging behind industry data is primarily due to