13 May 2007

EIX: Financial Analysis through March 2007

We have analyzed Edison International's (EIX) financial results, as reported to the SEC on Form 10-Q, for the quarter ending on 31 March 2007. This post reports on our evaluation.

Edison is the parent of Southern California Edison and other companies that generate or distribute electricity or that provide financing for these activities. Edison, which traces its roots back to 1886, is one of the largest investor-owned utilities in the U.S.

In the late 1990s, the State of California deregulated the electric industry, which, due to loopholes and questionable practices, led to the famous power crisis in the early years of this decade. Edison managed to skirt bankruptcy during the debacle, and its stock price has recovered dramatically from a low point in 2002 under $8.00.

When we analyzed Edison after the results from December 2006 became available, the Overall score was a weak 20 points. Of the four individual gauges that fed into this composite result, Cash Management was the strongest at 16 points. Value was weakest at 0 points.

Now, with the available data from the March 2007 quarter, our gauges display the following scores:

Cash Management. This gauge dropped 15 points from an artificially inflated 16 points in December. The Current Ratio is now 1.3, and it has been stable at this level since September 2004. Long-Term Debt/Equity is a leveraged 102 percent, which might seem high, but it is not excessive for the Electric Utility industry. The debt ratio, which has been declining for almost three years, was 106 percent in December and 116 percent 12 months ago. Accounts Receivable are 27.0 days of Revenue, up a fraction from 26.7 days one year earlier. [This analysis, as a few others have before, indicates that we need to tweak the scoring of the CM gauge for non-manufacturers to prevent excessive quarter-to-quarter changes. The score for EIX this quarter was low because a couple of the parameters didn't improve, not because of problems.]

Growth. This gauge increased 4 points from 6 points three months ago. However, this positive move change wasn't because of Revenue growth, which declined to 5 percent year-over-year from 15 percent a year ago. Net Income growth is a solid 12 percent, but down from a post-crisis 131 percent a year ago. The increase was slowed by a change in the income tax rate from 30 to 33 percent. CFO growth is an impressive 47 percent, although this value also pales in comparison to the unsustainable 123-percent growth rate from a year ago. Revenue/Assets has steadied at 35 percent.

Profitability. This gauge increased 7 points from the prior quarter's 6 points. ROIC grew to healthy 13 percent from 11 percent a year ago. FCF/Equity jumped up to 11 percent from 6 percent. Operating Expenses/Revenue moved down sharply in the last year from 81 percent to 74 percent. The change was primarily due to an increase in Gross Margin. The Accrual Ratio, which we like to be both negative and declining, moved in the wrong direction from +2 percent to +1 percent. This tells us that a little less of the company's Net Income is due to cash flow, and, therefore, more is due to changes in non-operational balance sheet accruals.

Value. Edison's stock price rose over the course of the quarter from $45.48 to $49.13. The Value gauge, based on the latter price, is a weak 2 points; it has been low for a few years now. The P/E at the end of the quarter was 13.2, which doesn't seem too high, but it is above historic averages. Reuters tells us that the average P/E for the Electric Utilities industry is 20, which is, um, shockingly expensive to those who remember when utilities had single-digit multiples. The Reuters average includes many non-U.S. companies, which might be pushing up the average. To remove the effect of overall market changes on the P/E, we note that the company's current P/E is 20 percent less than the average P/E, using core-operating earnings, of stocks in the S&P 500. This discount has been common in recent years, but there was a time when 30-40 percent discounts were typical. The market is telling us that utilities might grow at a slower rate than the average company, but not that much slower. The very reasonable PEG ratio of 1.1 could be used as evidence that the higher valuation is reasonable. The Price/Revenue ratio, which is less affected by the one-time factors that cause wide swings in earnings, has increased to 1.3 from a five-year median below 1.0. The average Price/Sales for the Electric Utilities industry is 1.85.

Now at 23 out of 100 possible points, the Overall gauge has been below 30 for the last few years. One reason for the low scores is that the rebound from the California power crisis can only carry the company so far. But, the greater concern is that utility stocks have become popular -- as has every stock associated with the energy industry -- and most valuation metrics have moved substantially above historic levels. This might be justified in many cases, but Edison's revenue only grew 5 percent year over year. What will happen to cash flow and earnings if interest rates increase? We suggest caution.

No comments:

Post a Comment