Consolidated Edison Q4: Dividends Keep Growing But At A Minimal Rate (NYSE:ED)

Business Overview

Consolidated Edison (NYSE:ED) is a utility company that distributes and delivers electricity, gas and steam energy in New York to about 4 million people. The company operates power plants, distribution centers, distribution routes and natural gas pipelines among other things in order to create and distribute energy. As with most regional utility companies, it enjoys a monopoly status in the markets it operates, but its actions and its business practices are highly regulated by the laws of the local government, which means, for example, that it can’t raise its prices as much as it wants.

In recent years, New York state and New York City passed some of the most aggressive laws regarding energy generation in order to fight or minimize the effects of climate change. While these laws created a lot of political debate and not all people agree with them, they will start affecting this company’s business very shortly, one way or another. For example, using fossil fuels for new small buildings in New York City starts as early as 2024 and a similar statewide ban starts in 2026 for small buildings and 2029 for large buildings. Keep in mind that these bans don’t apply to older or existing buildings, but only new constructions, which should be built suitable for renewable or clean energy. Putting politics and all those debates aside, what this means for the company is that there will need to be a lot of additional investments made to ensure that the transition to clean energy goes smooth and efficient. If this trend continues, there will be more and more aggressive laws in the future, which will trigger more investments for cleaner energy creation. It may be good for the environment, but it won’t come cheap.

This movement creates some additional costs for the company, but it also creates some opportunities. One possible opportunity for the company is the electrification of transportation. As more vehicles (cars, busses, trains, trucks) start getting powered by electricity, the more demand there will be for electric power generation. A couple years ago, the company started installing electric vehicle charging stations with power plugs all over its service area. By the end of 2023 it had 4k Level 2 plugs and 199 DC fast charge plugs in its charging stations or a variety of parking lots (roughly 40% of these plugs were added in 2023 alone) and it has the goal to have 21k Level 2 plugs and 528 fast charge plugs by the end of 2025 so it aims to quadruple its plug count in 2 years which is pretty aggressive. Initially, this will cost a significant amount of money to build out, but it should pay off nicely in the future, especially if the anticipated electrification of transportation continues to accelerate.

Another rising trend in this company’s business area is higher usage of solar panels and higher utilization of battery storage. Even though New York is not the sunniest place in the world and its solar energy production might be limited, a lot of New Yorkers are investing in solar panels and battery storage. I would also think that most of these people are also the same people who are buying electric vehicles, and they are most likely using solar energy to power their electric vehicles. The company itself also installs a large number of solar panels and batteries in order to accelerate electrification. It’s still unclear how this will affect the company’s long-term profitability though, so we will have to wait and see.

Last year the company started selling its non-core assets that are not directly contributing to its new business model, including some real estate assets, in order to increase its focus (and investment funds) on renewable energy as it will be investing more than $5 billion between now and 2030 for the clean energy initiatives. It looks like the company is making some big bets that will either pay big or cause the company some trouble in the long run. In addition, the company also used proceeds from its asset sales to pay off some debt, which helped reduce its existing leverage risk.

Operating Metrics

The company surprised some investors a few weeks ago when it announced its earnings and its EPS rose significantly from the previous year as its full year EPS hit $7.19, up almost 50% from the previous year, but the majority of this growth came from one-time items such as asset sales and tax benefits.

When we look at the company’s normalized EPS, there is still some growth, but it’s not as drastic as what we saw above. Most of the normalized growth was driven by price increases which were approved by regulators last year. In fact, price increases contributed about 78 cents to the company’s EPS last year, which was pretty significant, but it was mostly expected since utilities were allowed to have larger than average price increases last year due to higher inflation rates. Typically, most utilities will be able to raise their price by about 2-4% per year, but last year this number was closer to 7-8% in many regions. Moving forward, as inflation slows down, we can expect price increases to slowdown in a similar fashion. Also, keep in mind that price increases won’t automatically convert into higher profits because these types of companies have a highly unionized workforce and their employee costs will also rise at the same rate of inflation if not more in many cases.

The company’s own predictions call for 6.4% average compounded rate increases for the next 5 years, but I find it hard to believe unless inflation proves to be highly sticky for the next 5 years. If regulators approve such price increases when the inflation rate is around 3%, they might have trouble justifying this to the public. Then again, regular people don’t have much say in these things, and they may not have much choice other than to pay their bills even if they might think that price hikes are outrageous.

Dividends

The company currently has a dividend yield of 3.8%, and it has a 50-year history of hiking dividends. Still, don’t expect the company to hike its dividends by 15-20% per year. This company’s dividend growth will come at a slow but sure pace. In the last 10 years, the company hiked its dividends at an annual average rate of 2.79% which barely keeps up with the inflation and significantly below the sector average of 5.21%. Its 5-year dividend growth rate is even smaller at 2.47% when the sector average was 5.20%. In short, this company has a habit of hiking its dividends by about 2-3% each year, which means investors shouldn’t expect any aggressive dividend growth, but they might not worry about a dividend cut either.

From a dividend sustainability standpoint, ED has a dividend payout ratio of 45% on a GAAP basis and 64% on a non-GAAP basis, as compared to the sector average of 63-65% for both metrics. Keep in mind that the GAAP basis payout ratio is low because the earnings were boosted by one-time items, so the non-GAAP figure is probably more realistic, which puts the company’s payout ratio within 1% of the sector median. Moreover, the company currently enjoys a forward earnings yield of 6.15% (forward P/E reversed) which means that it can support the current dividend comfortably, but it may not have a lot of room to hike the dividend much though unless its earnings keep growing. Finally, currently the company generates about $2.16 billion from its operations, which should sustain its annual dividend payments of $1.15 billion by itself but also keep in mind that the company still makes about $960 million on debt servicing so between that and the dividend, the cash from operations is mostly spent.

Last year, the company also spent $1 billion on buying back some of its shares, but this might not have a lot of effect on its dividends because it barely made a dent in the company’s total share count which received quite a dilution in recent years. From 2019 to 2023, the company’s share count rose from about 325 million to close to 360 million shares and last year’s buybacks reduced the count back to 347 million, but it’s still up from a few years ago. If the company wants to boost its dividends in a meaningful way, it may have to reduce its share count or at least stop diluting its investors so much.

Debt

Speaking of debt, the company currently has about $22.17 billion in debt and about $21.15 billion in equity, and most of its debt and equity sits with the company’s CECONY business segment. We are looking at a debt to capital ratio of 54% and debt to total equity ratio of 118% and the company enjoys a Baa1/BBB+ credit rating as a result of its debt structure. For most sectors these numbers would have been alarming, but utility companies tend to have large debt loads because they have to make a lot of expensive investments, some of which are related to renewable energy I mentioned above. Current debt levels are not alarming for the dividend, but if the debt were to rise more without equity and assets rising in similar fashion, there might be concerns about it in terms of sustainability of the dividend.

Valuations

The company’s valuation is about average. In some metrics, it appears on par with its sector average, in others, it appears either slightly more expensive or slightly cheaper. Compared to its peers, the company appears neither cheap nor expensive. It appears to be fairly valued if we are to compare it to other utilities. For example, ED enjoys a P/E ratio of 17.38 versus the sector median of 16.99 which is pretty close with a differential of only 2%. The company’s PEG ratio appears to be 2.78 which reflects its P/E ratio when compared to its growth rate and this is within the ballpark of its peers that have a PEG ratio of 2.50. Since interest rates are currently higher than where they were a few years ago, most utilities saw their P/Es come down in recent years as compared to where they were when interest rates were near 0%. Interestingly enough, there isn’t much differentiating them and many of them trade at a similar valuation and this company appears to be no exception.

Risks

There are several risk factors for this company. First, all those expensive investments it’s been making for clean energy initiative might not pay off. Clean energy infrastructure tends to be very costly, and it may be difficult to turn this initiative into profits. Second, the company might not get approval for the rate hikes it will be seeking for the next few years, especially if inflation remains low. Third, utility companies are typically one big accident or disaster away from paying a hefty fine or settlement due to the nature of their business. Companies like PG&E (PCG) and Hawaiian Electric (HE) are a couple examples of this in recent years.

Conclusion

The company has been spending a lot of money to convert to clean energy, and it may or may not pay off in the long term. This could be a good income play for some investors with its dividend yield close to 4% and 50-year history of hiking dividends but don’t expect any large dividend hikes since the company’s dividend hikes tend to come in smaller chunks of 2-3% in most years and barely keep up with the inflation. This is a purely income play for more conservative investors who don’t expect much growth.