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SOUTHERN CALIFORNIA EDISON EIX1
November 18, 2020 - 9:00pm EST by
sidhardt1105
2020 2021
Price: 22.85 EPS 0 0
Shares Out. (in M): 22 P/E 0 0
Market Cap (in $M): 1,945 P/FCF 0 0
Net Debt (in $M): 18,576 EBIT 0 0
TEV (in $M): 0 TEV/EBIT 0 0

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Description

For those readers who are tired of reading about Edison International, we have some great news for
you: this write up is not about Edison International (“EIX”) but about Southern California Edison (“SCE”),
the regulated subsidiary of EIX. Specifically, we would like to focus your attention on a very attractive
set of preferreds that sit at the regulated EIX subsidiary. The SCE cumulative junior subordinated
preferred shares provide an exceptionally low risk way to pick up a mid-teens IRR in this non-existent
interest rate environment. Assuming the SCE prefs trade in line with other prefs of comps, this
investment provides capital appreciation of ~9.5% and interest income of ~5.0% for a total one-year
return of ~14.5%. Furthermore, the prefs are subject to dividend received deduction tax treatment (eg
holders are paid with after tax dollars) which affords a qualified tax rate today at 23.8% including ACA
tax as opposed to the highest ordinary federal rate of 37%.
EIX common equity has been written up on VIC numerous times with the most recent write-ups coming
from ElCid in November 2019 and Wains21 in October 2020. Both write-ups do a fine job of explaining
the risks involved with investing in a California utility. While those risks are not meaningless to this
investment, they are far less important when evaluating the prefs vs. the common equity. As a quick
recap, EIX is a regulated California utility that services Southern California – virtually all of EIX’s earnings
come from its subsidiary SCE. The key to this investment is the prefs sit at the SCE level and are part of
the allowed rate base. Put simply, they are basically bulletproof and structurally senior to EIX’s $3.1bn
of Holdco debt and $23.5bn market cap. SCE’s 2020 Rate Base per their 10/27/20 presentation is
>$33bn resulting in a rate base coverage of 1.6x through the utility preferreds. Since virtually all
regulated utilities trade at 1.5x+ rate base, these bonds are well over 2x covered. Below is a high-level
overview of the EIX/SCE capital structure:
 
 
 
Important to note is certain of the prefs trade at lower dollar prices because their coupons switch from
fixed to floating rates at the dates highlighted below. We are focused on the Series L Prefs which remain
fixed although if you believe short term rates will go up, you have a full menu of options to choose from.
In the chart below we detail all the prefs outstanding, their step up dates, and back ended spreads. A
number of the prefs don’t go floating for 4+ years, leaving a lot of time for short rates to move although
 
the forward curve and the rest of the world doesn’t expect any fireworks thanks to the FED pinning
short rates.
 
In another fascinating twist, the prefs actually trade at a HIGHER yield than the holdco notes that are
junior to the prefs. So while the EIX (Holdco) 4.128% ’28 trade at 106 to yield 3%, the 5% perpetuals
trade at 23 which is 92% of par or 5.5% (or approximately 6.75% on a tax equivalent yield). So these
suckers are trading at more than two times the yield of the (junior) holdco bonds on a tax equivalent
basis! I know they are perpetual so you have a duration mismatch, but the discrepancy makes no sense.
One of the issues to note is that the prefs are rated below the holdco bonds simply because they are
preferreds (albeit cumulative). This clearly makes no sense but that is the way the rating agencies
operate. The fact that the prefs trade at a decent discount to par means that they should pull to par as
investors start to gain comfort that the recent Cali fire legislation actually works. The utility recently
called some of the Series G prefs at par because they were currently callable and represented capital
above the allowed pref percentage in the CPUC approved stack and hence no longer part of the
regulated return.
 
 
 
In the world of utility prefs (see chart below), these securities trade 100bps wide to securities of
similarly rated utilities where the prefs sit at the HOLDCO. Some of this may be due to the fact that the
EIX prefs are junk rated while perversely the holdco bonds are not. The prefs were downgraded to junk
by Moody’s in early 2019 so hopefully they will upgrade them in the next 6-12 months post fire season.
 
As shown in the below table, the cumulative Opco preferred of comparable utilities trade at an average
yield of 4.5%:
 
 
 
 
At a 4.5% yield to call, the Series L provide the above return ^
 
 
 
 In summary, with SCE’s Rate Base soundly covering the Opco preferreds, one would have to come up
with a truly draconian scenario where they are not at least worth par. As the market’s fear over fire
risks fade (if ever), or if California does away with its absurd Inverse Condemnation concept (now you
are pushing it) or if the ratings agencies decide to upgrade, SCE’s cumulative junior subordinated
preferred will trade more in line with comps leading to an extremely low-to-mid-teens tax friendly
return.
 
 
Risks
 
More fires, more sleepless nights.
The prefs stay junk rated forever which hampers a retail following and a pull to par
 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Ratings upgrade

End of fire season

issues are called at par

additional fires

 

 

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