Description

Description

Edison International (“EIX”) is a high quality and defensive utility that has been disrupted by recent wildfires in Southern California. These headwinds are temporary, especially after the passage of AB 1054 (see below) which significantly improves the California regulatory environment for utilities. Over the long term, EIX should recover and trade inline with peers. The stock currently trades at 14.5x forward PE (vs peers at ~18.5x) and has a 3.7% dividend yield.

Business Overview

EIX is a regulated utility in California that services the majority of Southern California. The Company has $29.6 billion of rate base assets as of the end of 2018. All of EIX’s earnings come from its utility subsidiary Southern California Edison (“SCE”). The other subsidiary, Edison Energy, is involved with energy services helping commercial & industrial customer improve management of their energy costs.

Over the last 2 years, EIX and PCG have both been facing some of the largest wildfires in California’s history. In fact, of the top 10 most destructive California wildfires (base on # of structures damaged), 6 occurred in 2017 and 2018.

Inverse Condemnation

Inverse Condemnation (“IC”) theory states that losses borne by the person whose property was damaged through a public use undertaking should be socialized across the community that benefited from such undertaking. IC is typically applied to municipalities because they can easily pass on these costs through tax rate increases, however in CA, IC is applied to investor-owned utilities as well. If a utility’s facilities are determined to be the cause of one or more fires, and the theory of IC applies, the utility has strict liability for property damage regardless of whether they were negligent or not. The idea is that utilities should be able to pass on these costs through rate increases, however, the CPUC decision on the Witch fire from over 10 years ago where they denied SDG&E’s wildfire cost reimbursement demonstrated that this was not the case.

Legislators have recognized the untenable position this creates for utilities as PG&E filed for bankruptcy and the rating agencies threatened a downgrade to junk of the other two California utilities unless some relief was passed for wildfire risk.  CA legislator passed AB 1054 this summer, which created a $21 billion Wildfire Fund (50% funded by CA utilities and 50% funded by rate payers) that utilities can access to pay for future wildfire liabilities after insurance coverage. More importantly, AB 1054 states that for utilities to avoid paying back what they draw from the insurance fund, they will not bear the burden to demonstrate that its conduct was reasonable, based on a preponderance of evidence, if it has a valid safety certification for the time period in which a wildfire occurs.  The burden of proof has shifted to a FERC standard where they are presumed innocent until proven guilty. To receive such a certificate, a utility must submit, and be in compliance with a CPUC approved wildfire mitigation plan.

Thesis

1.       Wildfire overhangs are more than fully priced into the stock and are temporary given the passage of AB1054

• Headlines around 2019 wildfires (Saddleridge, Maria and Easy fires) in EIX’s service territories caused the stock to drop ~17%, losing ~$4.7 billion of market cap. Meanwhile, damage/liability estimates for these three fires are in the tens of millions, below EIX’s $1 billion of wildfire insurance coverage
• 2019 wildfires are much smaller in both size/acreage burnt and number of structures destroyed compared to the Thomas and Woolsey fires of 2017 and 2019
• Additionally, EIX has access to $1 billion of wildfire insurance and the AB1054 wildfire fund to handle any wildfire related liabilities. EIX received its safety certification in September 2019
• Furthermore, the wildfire fund should last the duration until grid hardening investments fully take hold

2.       EIX’s wildfire mitigation efforts are working

• San Diego Gas & Electric (“SRE”) has invested $1.5 billion into wildfire mitigation since the Witch fire in 2007 and has experienced no major wildfires since despite global warming
• EIX has followed SRE’s footsteps and invested in similar wildfire mitigation efforts including grid hardening, windometer installations, 24/7 situation awareness centers, 450+ weather stations and 130+ HD cameras
• The number of structures damaged thus far in the 2019 wildfire season has been significantly less vs prior years as a result of these efforts

3.       EIX is a high-quality utility operating in a favorable regulatory environment (excluding inverse condemnation), resulting in attractive growth, consistent earnings and limited regulatory lag

• California’s regulatory environment is favorable because of (1) decoupling of revenues from sales/volumes, (2) forward test year GRC with 3 year cycles, (3) cost recovery balancing accounts for sales, and (4) Operating & Maintenance cost savings flow through to shareholders rather than passed on to ratepayers until the next GRC cycle
• EIX should have above average rate base growth because of (1) their focus on safety and reliability of an infrastructure entering the end of its useful life, (2) CA’s ambitious low carbon objectives that require grid modernization, (3) current rates that are not out of line w/ inflation and nominally look lower than peers, and (5) tax reform should provide headroom for rates

4.       Strong management team with history of execution

• Prior to the 3Q19 equity issuance, EIX had managed to avoid equity issuances for 15+ years, a period of time that included CA’s energy crisis, PG&E bankruptcy and two financial distress situations
• The Company has maintained and grown its dividend for the last 15 years at a CAGR of 7.7%

5.       EIX trades at an attractive valuation given its underlying stability, growth and defensiveness

• EIX trades at 14.5x forward PE vs comparable large cap regulated utility peers at 18.5x forward PE (22.0x forward PE excluding CA and highly levered utilities)
• EIX is at a 35% discount to peers when it historically traded at a premium due to its more favorable growth and regulatory characteristics
• EIX will be responsible for what we estimate to be ~ $3.5 billion of wildfire liabilities related to the Thomas and Woolsey fires, but even including these future liabilities, the stock is heavily discounted vs peers

6.       Defensive industry with limited downside in a market downturn

• Pure play regulated electric utilities declined substantially less than the market during the Great Financial Crisis
• There is no earnings risk during a downturn in the economy for EIX
• Over long periods of time, utilities do not trade with the 10 year treasury yields due to the ability to pass through inflation. They should trade at some spread to real yield

Catalyst

Earnings results