Is Pepco Holdings, Inc. Destined for Greatness?

Let's see what the numbers say about Pepco (POM).

Feb 12, 2014 at 2:00PM

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Pepco Holdings (NYSE:POM) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Pepco's story, and we'll be grading the quality of that story in several ways:

  • Growth: Are profits, margins, and free cash flow all increasing?
  • Valuation: Is share price growing in line with earnings per share?
  • Opportunities: Is return on equity increasing while debt to equity declines?
  • Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Pepco's key statistics:

POM Total Return Price Chart

POM Total Return Price data by YCharts

Passing Criteria

3-Year* Change

Grade

Revenue growth > 30%

(33.6%)

Fail

Improving profit margin

(954.8%)

Fail

Free cash flow growth > Net income growth

(722.8%) vs. (667.5%)

Fail

Improving EPS

(638.5%)

Fail

Stock growth (+ 15%) < EPS growth

24.85% vs. (638.5%)

Fail

Source: YCharts. * Period begins at end of Q3 2010.

POM Return on Equity (TTM) Chart

POM Return on Equity (TTM) data by YCharts

Passing Criteria

3-Year* Change

Grade

Improving return on equity

(651.6%)

Fail

Declining debt to equity

9.9%

Fail

Dividend growth > 25%

0%

Fail

Free cash flow payout ratio < 50%

Negative FCF

Fail

Source: YCharts. * Period begins at end of Q3 2010.

How we got here and where we're going
Well, this is embarrassing for Pepco, which has failed every single assessment on our test today. During the past three years, the company's revenue and earnings have cratered due to mild weather in the Northeast U.S., which has reduced demand for electricity. Pepco's free cash flow has also been devastated, and is presently unable to support its dividend. Will Pepco be able to patch up its sinking ship, or should investors turn the lights out on this stock? Let's dig deeper to find out.

While Pepco has seen long-term declines on both its top and bottom lines, as a result of the aforementioned mild weather that afflicted the Northeast last fall, the company did report better-than-expected earnings for its third quarter. Earnings per share grew by 16% compared to the year-ago quarter, while revenue declined by 3%. Fool contributor Sean Williams notes that the company has been facing significant resistance from state energy regulators on its quest for rate increases. This would certainly help it support its ongoing expansion projects -- in fact, as the graphs above show, such increases may be financially necessary.

During the past few months, Pepco has undertaken several new energy and infrastructure development projects, which might soon bolster its top line. Spartanburg County School District Three awarded a $5.5 million Energy Savings Performance Contract to Pepco Energy Services, and the company also inked a $16.3 million deal with Appalachian State University for a Phase II energy efficiency project. Pepco Energy Services will also install $3 million in energy saving measures and infrastructure for Sarah Bush Lincoln Health System (SBLHS).

Fool contributor Reuben Brewer points out that Pepco is poised to benefit from smart meters developed by both Badger Meter (NYSE:BMI) and Itron (NASDAQ:ITRI), which eliminate the need for employees to physically read meters on site, and thus reduce operational costs. The company's already completed the installation and activation of smart meters in its Delaware service territory, and installations are under way in the District of Columbia and Maryland territories. These smart meters also allow Pepco to remotely track faults in the event of power outages, speeding up repair times and saving money on fault testing.

These upgrades won't come cheap -- Pepco plans to spend more than $5.8 billion to replace aging infrastructure and to install advanced technologies, a puzzle in which smart meters are only one small (but valuable) piece. Superstorm Sandy damaged a great deal of infrastructure on the east coast in 2012, necessitating large amounts of capital to fix everything up.

Putting the pieces together
Today, Pepco has few of the qualities that make up a great stock; but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

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Alex Planes has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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