

Consolidated Edison: 45 Consecutive Years of Dividend Increases

Consolidated Edison (ED) was founded in 1884 and serves as a regulated electric and gas utility to the New York metro areas and Westchester County, NY. Con Edison's principal business segments are:

  • Con Edison of New York (88% of 2018 earnings): provides electric service to approximately 3.5 million customers and gas service to about 1.1 million customers in New York City and Westchester County. The company also provides steam service in parts of Manhattan for heating purposes.

  • Orange & Rockland (4%): provides electric service to more than 300,000 customers in southeastern New York and adjacent areas of northern New Jersey and eastern Pennsylvania and gas service to over 100,000 customers in southeastern New York and adjacent areas of eastern Pennsylvania. 

  • Con Edison Clean Energy Businesses (5%): develops, owns, and operates renewable and energy infrastructure assets and provides energy-related products and services to wholesale and retail customers.

  • Con Edison Transmission (3%): invests in electric and natural gas transmission projects that offer customers access to diverse, low-cost energy supplies.

Overall, regulated utility operations generate more than 90% of the company's earnings, making Con Edison's returns very predictable. Regulated electric operations account for 74% of the firm's total rate base, followed by gas (21%) and steam (5%) utilities.

Con Edison also owns a substantial amount of renewable energy assets, dominated by solar power that is sold to other utilities under long-term power purchase agreements, or PPAs. In December 2018, Con Edison acquired Sempra Energy's solar business for $2.1 billion, becoming the second largest solar power provider in the country. 

Thanks to this deal, the company's Clean Energy Businesses (CEB) segment is expected to account for around 10% of of the firm's total EBITDA in 2019. However, management projects that Con Edison's core business will remain dominated by its regulated New York electricity and gas utility services over the long term. 

Con Edison has increased its payout in each of the last 45 years, making the company a dividend aristocrat. Impressively, Con Edison boasts the longest period of consecutive annual dividend increases of any utility in the S&P 500 Index.

Business Analysis
Regulated utilities enjoy monopoly-like status in the markets they operate in, and Con Edison's situation is no different. After a wave of industry-wide restructuring in the 1990s, all of the electric and gas delivery service in New York State is now provided by four investor-owned utilities or one of two state authorities.

To ensure consumers have access to reliable utility services at fair prices, Con Edison's utility operations are regulated by the New York Public Service Commission, which determines the projects the company can invest in and how much profit it can make.

Given the capital intensity of transmission infrastructure and the government’s interest in keeping electricity prices reasonable for consumers, utilities typically earn a relatively low but stable return on equity.

As seen below, most of Con Edison's utilities are allowed a return on equity around 9% (somewhat below the national average of about 9.7%). New York regulators generally allow lower-than-average returns on equity (political pressure to keep rates low), so it can be harder for Con Edison to boost its profitability, especially given that most of its infrastructure is underground and thus costs more to maintain and expand.
Source: Con Edison Investor Presentation
However, as long as the business completes its projects on time and on budget, it still enjoys extremely predictable earnings, which has enabled Con Edison to reward shareholders with more than 40 consecutive years of dividend increases. 

The company's focus on regulated utilities, combined with the industry’s slow pace of change and recession-resistant services, makes Con Edison a highly durable business. Few companies have been in business since the 19th century, essentially solving the same problem for their customers.

While Con Edison’s earnings are among the most stable in the industry, at the same time the company has struggled to record meaningful earnings growth. This is mainly due to the mature markets Con Edison operates in, resulting in predictable results at the expense of rather anemic growth in electricity and natural gas demand.

In fact, management projects average annual demand to grow at a snail's pace across all of the utility's regulated businesses over the coming years and actually slowly decline in its Orange & Rockland (O&R) electric segment.
Con Edison's Demand Growth Forecast for 2019-2023
Another hurdle to growth is the high cost of living in New York City, which makes regulators less amenable to raising electricity and gas rates. In November 2018 the average price of electricity in New York was 45% above the national average, for example.
Source: U.S. Bureau of Labor Statistics
Similarly, New Yorkers are paying 20% more than the national average for gas, even despite New York City being close to low-cost shale formations in Pennsylvania, Ohio, and West Virginia. The company owns stakes in joint ventures that are working on gas pipelines meant to bring cheaper gas to the city, but that project could face numerous delays due to legal challenges from environmentalists (see risk section).
Source: U.S. Bureau of Labor Statistics
Due to these above-average costs facing consumers, the company’s Con Edison of New York subsidiary faced frozen electric and gas rates from 2012 through early 2017 when regulators approved a plan to let the utility raise its electric and gas rates by around 3% to 4% per year through 2019. In January 2019, management filed another proposal for rate increases in 2020.

Despite the high cost of electricity in New York, infrastructure still needs to be maintained and improved, and that work isn't cheap in such a dense, congested area. The rate hikes recorded in recent years will also go towards funding more smart meters and greater use of renewable energy, such as solar. 

Higher rates will generate hundreds of millions of dollars each year for Con Edison, helping support the large amount of capital spending the company plans to undertake.
Source: Con Edison Investor Presentation
Con Edison's latest three-year growth plan involves $12.5 billion in spending backed by an A- credit rating that supports low borrowing costs. The company is planning a major push into smart grid technology, electric efficiency initiatives, and renewable energy and storage. However, Con Edison's earnings seem likely to only grow around 3% to 4% annually over the long term, and its dividend will increase at a similar pace.

Essentially, Consolidated Edison is the definition of a bond-like stock: safe, predictable dividends, but very low growth.

Key Risks
Arguably the biggest risk to Consolidated Edison is its ability to grow in one of the more challenging regulatory markets in the country.

New York City's cost of living is among the highest in North America and around the world, mostly due to its extremely expensive housing costs, which are more than double the U.S. average.

This high cost of living can make regulators more skeptical about raising utility rates, which explains why Con Ed’s electric rates had been frozen for several years until early 2017. That's especially true given that regulators are political appointees that face pressure to keep rates low, both from the governor as well as city officials.

Overall, however, New York’s regulatory system has been consistent and reasonable over time. In fact, New York’s targeted return on equity has remained between 9% and 11% since at least 2006. 

Importantly, the state's regulatory framework also includes revenue decoupling for electric and gas services. This means that the utility company’s profits are disassociated from its sales of the energy commodity itself. In other words, rates are adjusted up or down to help the utility meet a targeted rate of return regardless of how much product is sold.

Despite some of these favorable mechanisms, investors should note that New York has ambitious plans for the future of energy. In 2016 the state developed a Clean Energy Standard, which "ensures that 50% of New York State’s electricity will come from renewables such as solar, wind, and hydro by 2030." 

Con Edison is investing in renewables and distributed energy to help make that a reality, but it's hard to say if or how regulations might change should the state desire to accelerate its progress in this area. Either way, Con Edison seems likely to be a key part of the solution.

Outside of the regulatory environment, some analysts worried about Con Edison's exposure to California utility PG&E, which filed for bankruptcy in early 2019. PG&E had power purchase agreements with Con Edison's renewables business. The concern is that PG&E might terminate its existing agreements and negotiate new contracts at lower rates. 

Management forecasted 2019 adjusted earnings of $25 million to $35 million from PG&E-related projects, which represent just 2% of Con Edison's total profits. In other words, there is no risk to the dividend even if PG&E was granted the ability to break its power purchase agreements and achieve a substantial price reduction on new ones. Con Edison's short-term growth rate would slow further, but its long-term outlook would remain unchanged. 

Finally, some investors might note that Con Edison suspended its dividend in 1974, which was the first time since 1885 that the company omitted its quarterly dividend.

Back then, Con Edison was more involved in power generation activities and depended heavily on various fuels to run its generating facilities. With little warning, the price of residual oil quadrupled, crimping the firm’s profits.

The company’s management team also made several executional missteps, and Con Edison was overly dependent on capital markets to fund its ongoing operations. Investors’ confidence in utility businesses plunged, cutting off affordable financing.

This shouldn’t be a concern today because Con Edison is not involved in electricity power generation (only distribution). However, it goes to show that even the “safest” companies can encounter unexpected challenges from time to time.

Closing Thoughts on Consolidated Edison
Con Edison is arguably one of the most reliable utility companies that conservative income investors can find. With an operating history going back more than 130 years and over 40 straight years of dividend increases, Consolidated Edison has proven to be very durable and committed to its dividend.

Owning the stock over the long term seems likely to preserve one's capital, and the income ED generates is steady, secure, and likely fast-growing enough to offset moderate inflation. However, Con Edison's future pace of growth will remain slow, and future rate hikes allowed by New York’s public utility commission could be more challenging given the region's high cost of living. 

Overall, Con Edison is mainly of use to investors who prize dependable income, dividend growth that will probably keep up with inflation, and some of the lowest volatility of any stock in the U.S. 


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