03 July 2009

EIX: Look Ahead to June 2009 Quarterly Results

Edison International (NYSE: EIX) reported that earnings in the first quarter fell from $0.91 per share to $0.76.  This result kept the GCFR Overall Gauge of Edison in the low-30's, a weak score but better than it had been.

Our analysis report reviewed the first quarter in some detail.  In summary, lower energy prices, especially for natural gas, reduced Edison's costs for fuel, purchased power, etc., by 13.5 percent.  Revenue fell only 9.7 percent, however, and this gap had the beneficial effect of increasing Gross Margin profitability by a substantial 3 percent, from 29.6 percent to 32.6 percent.

We had to look elsewhere to explain the drop in earnings.  One factor was a $10 million increase in capitalized software amortization costs.  In addition, "cross-border leveraged leases" had to be terminated as part of a federal tax settlement at a cost of $21 million.

We have now modeled Edison International's Income Statement for the June 2009 quarter.   The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data the company will announce in August.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we set the stage with some background information about Edison International and the business environment in which it is currently operating.  Readers that keep close tabs on the company are invited to skip ahead.

Edison International is the parent of Southern California Edison and Edison Mission Group.  SCE, which traces its roots back to 1886, is one of the largest investor-owned, regulated electric utilities in the U.S.  Edison Mission Group owns, or has interests in, power-generation facilities across the U.S., plus the Doga Energy power plant in the Esenyurt, Turkey.

Already a leader in renewable energy sources, SCE signed agreements in June with suppliers for an additional 960 megawatts of wind and solar power, beginning in 2013 and 2014.  Edison International claims to deliver more energy from these sources to consumers than any other U.S. utility and to have "delivered 65 percent of the nation’s solar energy to its customers in 2008."

The Renewables Portfolio Standard originally set 2017 as the year by which regulated utilities in California had to obtain 20 percent of their energy from renewable sources.  In 2006, the deadline was legally advanced to 2010.  In 2008, Governor Schwarzenegger signed an Executive Order requiring that 33 percent of energy sold in 2020 be created from renewable sources.  Edison's CEO, in a Bloomberg interview, has indicated there are limits to the growth of renewable energy sources.

We're now ready to look ahead.

Our starting points were (1) the transcript at SeekingAlpha.com from Edison's conference call with financial analysts on 8 May 2009 and (2) the Business Update presented by the company. 

The presentation includes guidance to expect "Core" earnings in 2009 between $2.90 and $3.20 per share.  Guidance for GAAP earnings per share is $1.98 to $2.51.  The Core figures exclude the lease termination and other charges associated with the tax settlement. 

Note that the non-core expenses for the year are now expected between $0.69 and $0.92 per share, which dwarfs the $0.04 charge in the first quarter.  The per-share range is equivalent to Net Income charges between $225 million and $300 million.  On a pre-tax basis, the charges could be as high as $450 million.  The transcript indicates that this charge, less the $21 million taken in the first quarter, will be recorded in the second quarter.

Edison's Revenue varies with customer demand for power, the rates it is authorized to charge, and energy prices.  Demand is dependent on factors such as the economy, population growth, and weather.  The third quarter of the year is responsible, on average, for 31 percent of the year's total Revenue.

Because the first quarter is almost always the period with the least Revenue, we can reasonably expect Revenue in the June 2009 quarter to be higher than the $2.8 billion in the March 2009 quarter.  An increase of 10 to 12 percent would not be unusual.  However, given the weak economy and mild Spring, we consider a 7 to 8 percent March-to-June increase to be more likely.  Therefore, our estimate for the second quarter is 1.075* $2.8 billion = $3.0 billion.

For convenience, we group the Fuel, Purchased Power, and Other Operation and Maintenance operating expenses reported by Edison and call the subtotal Cost of Goods Sold.  On this basis, Edison's Gross Margin averaged 27.2 percent in 2008, with a wide variation from quarter to quarter.

In the first quarter of 2009, the Gross Margin soared to 32.6 percent, which was unusually high (because of the retroactive rate increase?).   We, therefore, expect it to be lower, down to 28 percent, in the second quarter.  Given this assumption and our Revenue estimate, our target for the CGS is (1 - 0.28) * $3.0 billion = $2.2 billion.

Expenses for Depreciation, Decommissioning, and Amortization were about $340 million in the last two quarters, and we will assume a similar amount for the June quarter.

We're now at the point where we need to add a provision for the pre-tax special charges discussed above.  Based on what little we know, we have chosen $300 million as our estimate.  There is much uncertainty about this value.

These figures would result in Operating Income of $206 million.  If the special charges were excluded, Operating income would be $506 million, up from $450 million in the June 2008 quarter.

Edison also reports a plethora of non-operating income and expense items, which we partition into three categories.  The first category is Investment gains and losses.  The second Non-operating category is gains on asset sales.  The final category is for interest expenses and a plethora of miscellaneous items.  We are assuming these figures will be similar to those reported in the first quarter.

These figures would result in pretax income of $36 million ($336 million with charges excluded).  If we assume an effective tax rate of 31 percent, the tax provision would be $11 million.  We also need to subtract values for Minority Interests and Dividends on Preferred Shares.  With these adjustments made, we end up with a minuscule (but positive!) $5 million (about $0.02 per share) estimate for Net Income.  If we exclude the uncertain $300 million special charge, Net Income would be $212 million ($0.65 per share).

Please click here to see a full-sized, normalized depiction of the projected results next to Edison's quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Full disclosure: Long EIX at time of writing.

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