In 2012 Consolidated Edison (ED +0.40%) delivered $3.88 earnings per share to investors on a $22.1 billion rate base in New York State with a market capitalization of $18.6 billion. Of this EPS, $0.26, or 6.7%, was earned through competitive energy solutions that included infrastructure investment, demand management, and conservation. Net profit margin of 9.36% at year-end 2012 swelled to 13.32% by the end of September 2013.
For a regulated transmission and distribution utility with a relatively flat rate base and now frozen rates, energy solutions will be the only source of growth in earnings and dividends. The dividend payout rate of 67% implies that $0.17 of the $2.60 dividend per share comes from competitive growth.
Public-private partnership
ConEd, like other public investor-owned utilities, has complex public-private partnerships involving the pricing and delivery of ConEd's product, energy. ConEd earns regulatory revenues, net of various regulatory adjustments, equal to a regulatory return on equity times the regulator-determined rate base. Last year ConEd requested a 10.3% return on equity, or ROE, on its rate base. The New York State Public Service Commission, or NYSPSC, countered with an 8.3%. On December 31, the State of New York agreed to a two-year rate freeze proposal, subject to final approval by the NYSPSC, of a nearly 9.3% ROE on a nearly $20 billion rate base.
Flat revenues in a narrowly defined geographical utility market can only grow if the rate base grows with customer growth and the lag between rate cases shortens. ConEd serves most of New York City plus Orange and Rockland Counties in the State of New York, serving over 40% of all of New York State's peak energy demand. ConEd has published a $12 billion capital plan over four years, most of it new rate base, net of replacement investment. Rate base has grown by over 5% over the past five years. An indicator of customer and ratepayer growth, New York City employment has grown by 2.8% over the past year with more growth projected. The regulatory review lag is about two years now. This means that Con Ed will not be able to grow rate base and rates any time soon.
Competitive business growth
Peering into ConEd's competitive growth platform, we see that it operates energy solutions, wholesale energy, and infrastructure development businesses. It has an edge in performing these services through its knowledge of and relationships with the New York City Department of Design and Construction Services, the Department of Environmental Conservation, and the New York City Economic Development Corporation, or EDC.
In partnership with the EDC, ConEd offers services ranging from energy efficiency assessments to incentives to retain manufacturing businesses in New York City, where mandatory energy disclosure and benchmarking laws generate demand for retrofits. The NYC Energy Efficiency Corporation was created as a public-private mechanism to finance this demand.
To get an idea of the earnings potential of this platform we can consult a 2012 Rockefeller Foundation – Deutsche Bank report. It suggests that there is a $279 billion energy solutions investment opportunity in the U.S. that can save end-users over $1 trillion over 10 years with a 17% energy reduction.
Using the Manhattan commercial and industrial energy market we can perform a thought experiment around earnings potential. Manhattan office, retail, and industrial space is around 380 million square feet. Using Environmental Protection Agency EnergyStar data, usage of about 255 kilo-BTUs per square foot and a cost of $0.027 per kBTU for Manhattan commercial space would yield an annual energy expenditure of $2.77 billion in this customer segment. With a 17% increase in energy efficiency companies like ConEd could help the commercial segment save about $4.7 billion over 10 years.
At ConEd's third quarter 2013 net profit margin of 13.32%, 289 million outstanding common shares, and assuming a 40% market share, this $470 million market could translate into potential earnings of $0.08 per share. Projecting further there are the infrastructure, renewable energy, transportation, education, health, and other institutional markets to add to potential EPS growth. Granted this is all back-of-the-envelope analysis, the market is up and running now with government mandates, incentives, and high fuel prices.
Bottom line
Flat rate cases and frozen rates will yield no top-line growth for ConEd over the next couple of years from its regulated utility businesses. However, expansion of its competitive business platform is enabled by its public-private partnership with New York City and State. This platform is all ConEd has to grow earnings, pay dividends, and reinvest in more profitable assets for ratepayers and investors.
An earnings retention rate of 23% and a 2012 ROE of 9.77% imply only a 2.2% earnings growth rate. ConEd managers need to deliver over $0.07 EPS this coming year to meet this growth rate. They can look to improvements in operating efficiency on their rate base platform and now also to a growing energy solutions and infrastructure business to achieve this goal and keep dividends flowing.
