Published October 3rd, 2017 by Bob Ciura
The Dividend Aristocrats are a group of stocks in the S&P 500 Index, with 25+ years of consecutive dividend increases.
The list of Dividend Aristocrats is diversified across multiple sectors, including consumer goods, financials, industrials, and healthcare. One group that is surprisingly under-represented, is the utility sector. There is only one utility stock on the list of Dividend Aristocrats: Consolidated Edison (ED).
The fact that there is only one utility on the list may come as a surprise, especially since utilities are widely regarded for being steady dividend stocks.
Consolidated Edison is about as consistent a dividend stock as they come. With over 100+ years in operation and a 3%+ dividend yield, Consolidated Edison makes it onto our list of “blue-chip” stocks. You can see the full list of blue chip stocks here.
This article will discuss what makes Consolidated Edison an appealing stock for income investors.
Consolidated Edison is a regulated electric and gas utility. The company generates approximately $12 billion in annual revenue, and has $49 billion in assets. It has four operating segments:
- Electric (71% of revenue)
- Gas (14% of revenue)
- Steam (5% of revenue)
- Non-Utility (10% of revenue)
It serves over 3 million electric customers, and another 1 million gas customers, in New York. It operates electric, gas, and steam transmission, and green energy businesses.
Source: Q2 Earnings Presentation, page 4
In 2016, ConEd increased earnings-per-share by 2%, to $4.15. Growth was due to favorable weather, higher electric and gas revenue, and customer additions. ConEd has continued to generate steady growth in 2017. Adjusted earnings-per-share increased 4% over the first two quarters of the year.
Electricity is not a growth industry. The addressable market for those who do not yet have electricity in the U.S. is small. Earnings growth for the utility industry will typically exceed inflation by a few percentage points each year. Using ValueLine estimates, analysts Consolidated Edison to increase earnings by 3% in 2017, and 4% in 2018.
Going forward, the growth drivers for Consolidated Edison are new customer, and rate increases. One of the benefits of operating as a regulated industry is that utilities are permitted to raise rates on a regular basis, which virtually assures a steady level of growth.
Source: Q2 Earnings Presentation, page 20
In 2017, the company received approval for rate base plans over the next three years, in both the electric and gas delivery segments. Consolidated Edison expects to increase its rate base by 5.5% each year, through 2019.
One potential risk for future growth is rising interest rates, which threaten to raise the cost of capital for companies that utilize debt, such as utilities. Fortunately, Consolidated Edison is in strong financial condition. It has an investment-grade credit rating of BBB+, and a modest capital structure with 51% debt and 49% equity.
The company has $1.28 billion of debt maturities in 2018, but maturities wind down to $574 million in 2019, and $788 million in 2020. Consolidated Edison should have the financial resources to handle debt maturities and capital expenditures, with enough left over to pay the dividend.
Competitive Advantages & Recession Performance
Perhaps the biggest competitive advantage for utilities is the heavy regulation of the industry. Electricity and gas generation and transmission are a matter of national security. Because of the regulatory hurdles involved, utilities do not face many competitive threats.
While many companies experienced large earnings declines in 2008 and 2009, Consolidated Edison held up relatively well. Earnings-per-share during the Great Recession are shown below:
- 2007 earnings-per-share of $3.48
- 2008 earnings-per-share of $3.36 (3% decline)
- 2009 earnings-per-share of $3.14 (7% decline)
- 2010 earnings-per-share of $3.47 (11% increase)
Consolidated Edison’s earnings fell in 2008 and 2009, but recovered in 2010. The company still generated healthy profits, even during the worst of the economic downturn. This resilience allowed Consolidated Edison to increase its dividend each year.
One of the reasons why utilities generate steady earnings, is because their business models are highly stable. Everyone needs electricity, even during recessions.
Valuation & Expected Returns
Consolidated Edison appears to be slightly overvalued. Based on adjusted earnings-per-share of $4.15 in 2016, the stock has a price-to-earnings ratio of 19.5. This is below the S&P 500 Index average, which stands at roughly 25. However, utilities typically trade at lower valuations than the broader market, due to their low earnings growth.
The stock has enjoyed a prolonged rally over the past several years, which has caused its elevation to expand.
Consolidated Edison’s price-to-earnings ratio has expanded significantly in the years since the Great Recession ended.
This has had the additional effect of lowering Consolidated Edison’s current dividend yield, since stock prices and yields are inversely correlated.
If Consolidated Edison’s valuation multiple contracts, it would negatively impact returns. Aside from changes in the price-to-earnings multiple, future returns will be generated by earnings growth and dividends. A potential breakdown of expected returns is as follows:
- 4%-6% earnings growth
- 3.4% dividend yield
Under these assumptions, investors would earn total returns of 7%-10% per year, plus or minus any changes in the price-to-earnings multiple. Importantly, the dividend is secure. Consolidated Edison has a target dividend payout ratio of 60%-70% of annual adjusted earnings-per-share.
The current dividend of $2.76 per share, represents less than 70% of 2017 earnings-per-share guidance, which means the dividend is well within the target payout ratios.
The combination of low growth, a high valuation, and a lower-than-average dividend yield, make Consolidated Edison a relatively unattractive choice for value and income investors right now.
That said, Consolidated Edison can still serve a valuable purpose for income investors. The stock offers secure dividend income, and while the 3.4% yield may not be too impressive, it still beats the 2% average dividend yield of the S&P 500 Index. And, Consolidated Edison should raise its dividend modestly each year.
As a result, while dividend growth and value investors may not find Consolidated Edison attractive, the stock is still worth considering for retirees.