California Distributed Energy And Wildfire Liabilities Will Erode Returns

Key Takeaways

• Shifts in energy generation, wildfire liabilities, and evolving regulations threaten long-term revenue growth and could erode profitability.
  
• Large capital needs, rising costs, and policy uncertainty may hinder investment returns and strain future earnings.
  
• Supportive regulation, clean energy growth, effective wildfire risk management, reliable cost recovery, and operational efficiency drive stable earnings and minimize downside for Edison International.

Catalysts

Through its subsidiaries, engages in the generation and distribution of electric power.

• Accelerated growth in distributed energy resources such as rooftop solar and battery storage in California is likely to reduce long-term electricity demand for utility-supplied power, eroding EIX's future revenue base and exposing the company to a secular decline in volumetric sales.
  
• The persistent need for massive capital deployment in electrification and climate adaptation, combined with the risk that regulators may not keep pace in allowing timely cost recovery, could drive insufficient returns on investment and ultimately compress net margins.
  
• The intensifying exposure to wildfire liabilities, highlighted by ongoing investigations into events like the Eaton Fire and rising litigation activity, threatens to weigh heavily on earnings and could result in higher insurance and compliance costs that pressure profitability over time.
  
• Upward pressure on interest rates and inflation will inflate EIX's borrowing costs, erode allowed returns, and make the company's significant infrastructure investment plans less financially viable, further impacting long-term earnings growth.
  
• Ongoing policy evolution toward more performance-based rate making or decoupling in California's regulatory environment may undermine EIX's ability to reliably grow revenues, and could impair the earnings outlook if traditional rate-based models become less favorable to utilities.

Edison International Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Edison International compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Edison International's revenue will grow by 2.0% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 15.0% today to 12.9% in 3 years time.
• The bearish analysts expect earnings to reach $2.4 billion (and earnings per share of $3.9) by about August 2028, down from $2.6 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 10.0x on those 2028 earnings, up from 7.9x today. This future PE is lower than the current PE for the US Electric Utilities industry at 20.7x.
• Analysts expect the number of shares outstanding to decline by 0.35% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.94%, as per the Simply Wall St company report.

Edison International Future Earnings Per Share Growth

Risks

• Regulatory stability in California appears strong, with Edison International expressing confidence that the legislature and regulatory entities will continue to support the health of investor-owned utilities and recognize the need for sizeable capital investments, which supports stable rate base growth and earnings over the long term.
  
• Anticipated growth from electrification and clean energy initiatives in California is significant, with the company and regulators both reinforcing the need for grid modernization, infrastructure replacement, and wildfire mitigation as critical investments, which should drive higher revenues and sustained earnings growth.
  
• Wildfire cost recovery is well-protected in the current environment, as Edison is able to access both a substantial customer-funded self-insurance layer and a robust $22 billion state wildfire fund, strongly reducing the risk of material long-term negative impact on net margins or solvency from wildfire events.
  
• Regulatory mechanisms such as true-ups, authorized recovery of prudently incurred costs, and securitization of past wildfire liabilities are in place and actively used, providing reliable avenues for cost recovery and limiting downside risks to earnings and free cash flow.
  
• Edison International maintains sector-leading operational efficiency and a track record of technological innovation (such as AI-driven grid monitoring), which contribute to lower average system rates than peers in California, supporting customer affordability and potentially reducing political or regulatory pressure on its allowed returns, benefiting both revenue base and profit margins.

Valuation

• The assumed bearish price target for Edison International is $50.5, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Edison International's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $86.0, and the most bearish reporting a price target of just $50.5.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $18.6 billion, earnings will come to $2.4 billion, and it would be trading on a PE ratio of 10.0x, assuming you use a discount rate of 7.9%.
  
• Given the current share price of $53.77, the bearish analyst price target of $50.5 is 6.5% lower.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.