Why Consolidated Edison Is Expensive For What It Offers (NYSE:ED)

Dear readers/followers,

As of about 2-3 years now, I’ve been a fairly heavy investor in all things utilities. My utility investments encompass companies such as Enel (OTCPK:ENLAY), National Grid (NGG), Black Hills (BKH), Northwest Natural (NWN), and many others. Over 10% of my total portfolio value is now made up of utilities, and I have no plans to lower this exposure. In fact, my goal is to increase it.

I believe utilities make up some of the safest and most conservative investment potentials for value-conscious dividend investors who are looking for something of a 12-15% annualized rate of return. if you follow my work, you know that 14-16% (usually 15%) is what I tend to look for. If I can find that in a conservative business that’s at a low value, with good fundamentals, chances are, I’m going to buy that business.

In this article, I mean to update my thesis on Consolidated Edison (NYSE:ED), a US utility business with sound fundamentals – but perhaps a bit of a valuation issue. In my latest article, which you can find here, I gave the company a conservative rating of “HOLD” because I did not believe the company could outperform. Even after the latest surge in valuation, the company not only underperforms the S&P500 inclusive of dividends, it vastly underperforms undervalued utilities that I have been investing in, and where I am up 50%+ – such as Enel.

In my previous piece, I clarified that the company could not offer a 15% annualized rate of return at a conservative valuation – let’s see what we’re looking at here.

Consolidated Edison – An update for a solid utility

When I last wrote about ConEd, I did not view it as especially attractive. The reason for that lack of attractiveness was not fundamental issues or a poor upside/forecast, but rather the valuation. As one of NYC’s primary utilities, ConEd has a lot of “crowding” in the investment. A lot of people buy the stock for its size, conservative nature, and safety.

This is a very good reason to buy a stock (any of them), but you also need to adjust your expectations to what you can then expect from the business in terms of performance.

One thing you can expect from ‘Ed’ is solid growth and forecastability. The company really doesn’t “fail” in forecast accuracy. Both on a 1-year and 2-year basis, looking at a 10-20% margin of error, there’s a 100% rate of accuracy (Source: Paywalled F.A.S.T graphs link)

Where I have an issue with Consolidated Edison is valuation – more on the valuation later, because that is my issue – and dividends. While most utilities I consider attractive today have somewhere between a 4.5-7% yield, ConEd comes to 3.44%, which is quite a bit lower.

The latest bit of news about the company is both earnings- and management-related. ED has done a bit of a change in the C-suite, changing CFO’s. This is also interesting to me because I own quite a bit of Evergy (EVRG), and the CFO who’s taking over is the current CFO of Evergy – I’m keeping an eye on both companies. Mr Andrews, the coming CFO, has a positive history of negotiation and deals in utilities from the banking sector – and has been part of several instances where activist investors and energy investment firms have been involved. Of course, the potential for making moves like the ones Mr. Andrews has been making in a giant with very clear trajectories like ED is limited – which is why the move was surprising to me. NYC regulators are some of the most protective across the US.

However, the positives of such a prominent CFO with banking connections, of course, have to do with the potential for raising capital for its investment plan, which falls under the purview of the CFO.

There’s no doubt in my mind that the company’s regulated NatGas and electric utilities will continue to provide the company with significant recurring incomes, despite what can mildly be described as a “challenging” regulatory environment. The latest settlement in 2023 for ConEd’s NYC arm, which I wrote about in my last piece, saw its ROE increase to 9.25% – it’s still not what I would consider “great”, but was much better than the previous 8.8% because that was the lowest in the entire utility sector for ConEd’s comps.

We have 1Q24 results as of 2nd of May, and 2Q24 are upcoming. This should be viewed as a recap and a bit of an earnings preview, with an outlook for 2024E.

ConEd is a company with BBB+/A- ratings with a market cap in excess of $31B. For the first quarter, there were absolutely no surprises in development. The company saw earnings reflecting its solid rate base, and ConEd is working to ensure the eventual goal of delivering 100% clean energy.

The characteristics of the company’s operating geography come with a very high degree of revenue forecastability. One of the company’s main goals as of late has been risk reduction, a transition to a purely regulated business. This goal has seen ConEd sell almost all of the assets it does not consider to be central to its operations. For some time, the company played around with things like clean energy, gas pipelines, and transmission infrastructure, but most of that was sold. Clean energy, for example, was sold to RWE (OTCPK:RWEOY), a company I also cover.

The company’s own forecasts come to 6.4% annual rate base growth all through 2028, with continued investments in cleaner energy. Like many utilities in Europe, including Fortum (OTCPK:FOJCF), ConEd is also installing more customer-facing systems, reducing personnel costs and admin costs through automated billing and metering/smart metering. These systems have been in place everywhere in Sweden for years at this point, and it does (if a comparison is possible here), reduce operating expenses.

ConEd was able as of 1Q24 to forecast the full-year range between $5.2-$5.4, but it’s important to remember that there was a company benefit from the steam rate plan that went into effect last November.

It also bears mentioning that ConEd is a dividend king, but the rate of growth has been slower than its history, with the latest rate increase of 2.5% not really managing to hit inflation. It’s also at a slower pace than its peers – though I expect that 2025E may get a higher raise given the completion of the RWE sale and the rate review for CECONY, which I intend to cover as well.

Overall, there are many things to like about Consolidated Edison, and 1Q24 has not in any way diminished those fundamentals or positives. I also happen to think that RWE was the one at the negative receiving end for the company’s clean energy assets, meaning that ConEd made a good deal, resulting in significant capital.

Aside from this, the main positive for the company really remains the forecastability of those earnings. It makes it relatively “easy” for me to say when I would be buying, and when I would be selling.

Consolidated Edison Valuation

Value is what you get when you invest in a company at any price. And in this case, unfortunately, I do not believe there to be a whole lot of value in ConEd. I work from a mid-line of the company forecast range, meaning a $5.3 adjusted EPS for this year. The company is one of the most expensive classical utilities out there in terms of P/E and averages roughly 18.5x P/E at this time. However, this does not reflect the longer-term trends. 20-year trends are closer to 16-17x P/E, which is also the multiple that I assign and is far closer to the sector mean.

And unfortunately, when forecasting using this, even taking into account an annualized EPS of $5.9 at the tail end of 2026, this would only imply a $96-$100 FV estimate at the midpoint.

The rate of return for such an assumption would be around 4.5% per year, or 11% in about 2-3 years. That’s not market-beating, or even potentially market-average. Even if you make the case that ‘Ed’ should trade closer to its shorter-term averages of 18-19x – fine, but you’re still only getting 9.5% at an 18.5x forward P/E on an annualized basis.

Expecting anything outside of a 6% earnings growth is not, in my view, compatible with historical CECONY or other base rate settlements. Not even efficiencies and streamlining can bring in the differences here – and let’s not forget that ConEd needs to invest $5B annually (almost) in its utilities through at least 2025E. The sale of renewables puts the company in a better position to handle this, but it does not change the ultimate fair value drivers for the company, as I see it.

You also need to account and discount, in my view, for the regulatory uncertainty.

For that reason, I view any case of assigning Consolidated Edison a higher fair value than $90/share as tricky. In my last article, I set my price target at $85/share, and I’m sticking to it. At or below this price, you can see an upside potential for the stock – above it, I don’t really see it generating even double-digit annualized rate of returns reliably.

Some risks here also that could impact the company’s appeal.

Risks for the Company

One of the reasons that I’m not more positive about the company has to do with regulation because New York regulators really have a history of making the operations tricky for the company. 9.25% may be good compared to 8.8%, but it’s still among the lowest in the utility sector in the US. The regulators have a history of giving below-average returns – and for good reason – the costs of living and the rather elevated political climate in the “Big Apple” means that pushing such things through is tricky both politically and logically.

There’s also the simple fact, as I’ve mentioned in one of my earlier articles, that the specifics of NYC are not exactly conducive to the efficient managing of assets and infrastructure. New York is one of the most densely populated areas on the planet. It also has one of the oldest infrastructures in places, which not only require frequent maintenance and upkeep but also comes with the risk for serious accidents, which due to exactly this density would be far heavier than in other areas where population density isn’t as high.

These are some of the reasons I believe that ConEd should be discounted and why I do not believe it to be materially attractive to invest in here.

I give the company the following thesis.

Thesis

• Consolidated Edison is a top-quality utility with a great set of assets and a good set of fundamentals. At the right valuation, the assets here are backed by incredible safety and a good geographical population base.
• However, unless the valuation is right, you’re at risk of putting your capital to “work” at below 4.5% annualized RoR even with yield, and that is at a realistic estimate.
• At the current valuation, I would consider this company to be a “HOLD” and a rotation target due to overvaluation. PT for the company remains at $85/share. I also took another look at the options chain, and consider selling put options to not be valid either – the company is too expensive for that to be of interest.

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.

Here are my criteria and how the company fulfills them (italicized).

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• The company is currently cheap
• This company has a realistic upside based on earnings growth or multiple expansion/reversion.

Due to not fulfilling my valuation-related criteria, this company warrants only a “HOLD”, and I believe you can rotate it here.