Edison International recently increased its dividend and is currently yielding 4.2%
Shares have risen in the past 3 months
The potential liabilities of wildfires are large and difficult to estimate
Wall Street Consensus Is Bullish, Albeit With Very Limited Upside Potential
The market implied outlook (calculated from option prices) is neutral for 2022
Edison International (NYSE:) owns Southern California Edison (SCE), a major utility that provides power to 15 million Californians across a 50,000 square mile service area. EIX also owns Edison Energy, a global consulting and service company. Faced with significant uncertainty and lingering risks related to wildfire liability, SCE recently agreed to pay $550 million in fines for safety violations that caused major fires in 2017 and 2018.
EIX reported on Nov. 2 with EPS slightly below consensus expectations. This was also the case for the second quarter, as reported on July 29. YTD after a gain of 16.65% in the past 3 months. Even with the recent rally, EIX's total returns have lagged the utility sector over the past year. The Utilities Select Sector SPDR® Fund (NYSE:) had a total return of 14.95% over the most recent 12 months, compared to 10.25% for EIX. In the longer term, for the lagging periods of 3, 5 and 10 years, equities also underperformed the regulated electricity sector. Shares remain significantly below the pre-COVID 2020 high close of $78 on Feb. 11
EIX Trailing Total Returns vs. Regulated Electricity Companies and US Stock Market
Source: Morningstar
On December 10, EIX announced a dividend increase and the forward yield is 4.2%. Despite ongoing costs and concerns about wildfire risks in the company's service area, the company has now increased its dividend for 17 consecutive years. The 3-, 5- and 10-year annualized dividend growth rates are 3.1%, 6.7% and 7.6%, respectively. While SCE engages in a variety of wildfire mitigation activities, extreme drought conditions persist. across California. The question for investors is whether the stock is trading at a sufficiently attractive valuation to justify the economic risks of fire liability.
To answer this question, I rely on two forms of consensus outlook for EIX. The first is the well-known Wall Street analyst consensus assessment and the 12-month price target. The second is the market implicit outlook, a probabilistic price forecast calculated from option prices. The market implied outlook is of particular interest as it shows how the market estimates downside risk to EIX. Options prices reflect the market's consensus estimates about the probability of price gains or losses. The market-implied outlook shows the distribution of price returns that reconcile option prices. Wall Street Analyst Consensus Outlook for EIX
E-Trade calculates the Wall Street consensus outlook for EIX by combining the opinions of 5 ranked analysts who have published ratings and price targets over the past 90 days. The consensus rating is bullish and the 12-month consensus price target is 3.45% above the current share price. The consensus rating for EIX has been bullish throughout 2021.
Consensus assessment and price target of EIX analysts
Source: E-Trade
Investing.com's version of the Wall Street consensus is calculated based on ratings and price targets of 17 analysts. The consensus rating is bullish and the consensus price target is 6.2% above the current share price. Source: Investing.com The prevailing view among Wall Street analysts is that EIX is a buy, although the expected 12-month price target is not far above the current share price. With an expected price increase of 3.5% or 6.2%, depending on the source of the consensus estimate, the expected 12-month total return is 7.5% to 10.4% (average 8.95%). The high end of this range is close to the total return over the most recent 12 months and the average is comparable to the 10-year annualized return. The price of an option on a stock reflects the market's estimate of the probability that the stock will rise above (call option) or below (put option) (the option's strike price) between now and when the option expires. By analyzing the prices of options against a range of strike prices, all with the same expiration date, it is possible to calculate a probabilistic price return forecast that reconciles option prices. These are the market-implied outlook.
I calculated the market-implied outlook for EIX for the 13-month period from now to January 20, 2023 by analyzing the prices of options expiring on that date. I chose to analyze these options because this is the closest expiration date to 1 year in the future. This also suggests that not a lot of money is bet on bad results. This corresponds to the low short-term interest rate, 1.52% of the percentage of shares.
The standard presentation of the market implicit outlook is in the form of a probability distribution of price return, with probability on the vertical axis and return on the horizontal axis. The implied outlook for EIX is generally symmetrical, with a similar probability of positive and negative returns of the same magnitude, although the spike in probabilities is tilted to favor negative price returns over the next 13 months.
The calculated annualized volatility of this distribution is 26.6%. This is quite low volatility for an individual stock, but high compared to other utilities. For example, in a recent analysis by Consolidated Edison (NYSE:), annualized volatility calculated from the market-implied outlook was 20.5%. In an October analysis by Southern Company (NYSE:) market-implied year-over-year volatility was 20.4%. EIX has expected volatility to be 30% higher than SO and ED.
To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative return side of the distribution around the vertical axis (see chart below). E-commerce. The negative return side of the distribution is rotated about the vertical axis.
This view shows that the market implied probabilities for negative returns are consistently higher than for positive returns of the same magnitude (the red dotted line is above the solid blue line across the chart).
Theory suggests that the market implied outlook is expected to have a negative bias, as investors generally tend to be risk averse and thus willing to pay more than fair value for downside protection. There is no objective way to measure this effect. The slightly higher probability of negative returns corresponds to the existence of this type of negative tilt. As such, the best interpretation is that this market implied outlook is neutral for the 13-month period.
Summary
I don't know why investors would choose to own EIX, rather than buy a utility index fund, such as XLU, or shares of a high-yield utility that doesn't have the kind of extreme loss potential of carries forest fires.
EIX has a higher dividend yield than XLU (2.8% yield) ), but only slightly higher than the yield of Duke Energy (NYSE:) (3.8% yield) or Southern Company (3.9 % yield). While EIX trades at a low P/E ratio compared to DUK , SO and the industry as a whole, that doesn't mean the stock is undervalued. The substantial, idiosyncratic risks facing EIX certainly warrant some discount.
Expected volatility calculated from the market implied outlook for EIX is 30% higher than for two other large utilities with similar yields, SO and ED. This corresponds to the market assigning an increased risk to EIX. Wall Street analysts' consensus outlook for EIX is bullish, with the 12-month consensus price target implying a total return of 8.95%. As a rule of thumb for a buy recommendation, I want to see a 12-month expected return that is at least half of the expected annualized volatility (26.6%). EIX does not meet this criterion. The market-implied outlook for the next 13 months is neutral. While EIX appears to be moving in the right direction, managing the company's liabilities from the 2017-2018 fires and improving operations to mitigate future risks, the potential returns on EIX are not attractive in proportion to the risks. I give a neutral rating to EIX.
