Competitive Advantage & Recession Performance
There isn’t much guessing about Consolidated Edison’s competitive advantage. Utilities naturally lend themselves to natural monopolies.
Consolidated Edison’s natural monopoly happens to service New York City. New York City is the world’s 7th largest city (depending on how you define the size of a city) based on its metropolitan population of around 20 million.
The utility industry is highly regulated in the United States. This provides further barriers to entry into the market.
Growth will be slow for Consolidated Edison – but growth is very likely to continue due to the company’s strong and durable competitive advantage. As long as New York’s population grows and people need electricity, gas, and steam, Consolidated Edison will likely pay increasing dividends.
The company sells energy. It’s product is vital regardless of the overall economy. As a result, Consolidated Edison tends to perform well during recessions.
The company’s earnings-per-share from 2007 through 2011 are shown below.
– 2007 Earnings-per-share of $3.48 (high at the time)
– 2008 Earnings-per-share of $3.36 (3.4% decline from high)
– 2009 Earnings-per-share of $3.14 (9.8% decline from high)
– 2010 Earnings-per-share of $3.47 (recovery, 0.3% off all time high)
– 2011 Earnings-per-share of $3.57 (new all-time high at the time)
As you can see, the Great Recession modestly reduced earnings-per-share in 2008 and 2009. Still, Consolidated Edison’s earnings covered its dividend payments – even through the worst of the Great Recession.
The company’s stability gives it an exceptionally low stock price standard deviation. Consolidated Edison has the 2nd lowest stock price standard deviation of any Dividend Aristocrat over the last decade… Only Johnson & Johnson’s (JNJ) is lower.
The company’s low stock price standard deviation is a result of its low-risk operations.
Valuation
Consolidated Edison, Inc. (NYSE:ED) is trading for 17.8 times expected 2016 adjusted earnings-per-share.
The company has traded for a price-to-earnings ratio of around 14.5 over the last decade. For comparison, the S&P 500’s median price-to-earnings ratio over the same time period is 18.2
The reason the company’s price-to-earnings ratio is elevated is due to historically low interest rates. Low interest rates raise the value of bonds – and bond-like securities. With its slow growth and stable dividends, Consolidated Edison is similar to a bond. It’s share price tends to rise when interest rates fall – and fall when interest rates rise.
A ‘fair’ multiple for Consolidated Edison is around 80% of the S&P 500’s price-to-earnings multiple, based on data from the last decade.
With the S&P 500 currently trading for a price-to-earnings multiple of 24.8, this implies a fair price-to-earnings ratio for Consolidated Edison of just under 20.
There is uncharacteristically high risk with investing in Consolidated Edison today. If ultra-low interest rates continue to rise (as the Fed has suggested), Consolidated Edison will very likely see its price-to-earnings multiple revert downward – causing the share price to fall.
Final Thoughts
Consolidated Edison is a stable, slow growing utility with a long history of dividend increases. The company’s above average 3.7% dividend yield may be appealing to yield-starved investors.
What bothers me about Consolidated Edison today is the company’s sensitivity to interest rates. If interest rates rise, the share price could drop significantly. Consolidated Edison’s expected total returns of 6% to 7% a year would take years to ‘catch up’ if the stock price drops by 20%.
The company makes a potential long-term hold for investors who need above average income with very little risk of a dividend reduction. As a total return play, Consolidated Edison is unattractive.
The company has a mediocre rank using The 8 Rules of Dividend Investing. It scores well for yield and low stock price volatility, but its sluggish growth holds the company bank from ranking higher.
Note: This article is written by Ben Reynolds and originally published at Sure Dividend.
