The dreadful scores hinted at the 22 percent decline in Edison's share price experienced during the recently concluded third quarter. This drop was more substantial than the declines in the S&P 500 (INDEXSP:.INX) and the Dow Jones Utilities Average (INDEXDJX:.DJU ) during the same period, as can be seen in this charted created with Google Finance.
"Net Provisions for Regulatory Adjustment Clauses" took a huge, $279 million bite out of Net Income in the second quarter. These provisions fluctuate wildly from quarter to quarter and complicate analyses.
On the other hand, we have no doubt that the 32 percent drop in Cash Flows from Operations over the most recent four quarters, compared to the four previous quarters, is a negative factor worth an analyst's attention.
Edison International (NYSE: EIX) is the parent of Southern California Edison and other companies that generate or distribute electricity or that provide financing for these activities. Edison, which traces its roots back to 1886, is one of the largest investor-owned electric utilities in the U.S.
Edison is scheduled to report its third quarter results on 6 November 2008. In anticipation of this report, we've modeled the company's Income Statement for the quarter. The intent of this exercise was to produce a baseline for identifying any unexpected deviations, positive or negative, in the actual data. GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.
In the company's announcement of its second-quarter results, Edison "reaffirmed its previously announced 2008 earnings guidance of $3.61 to $4.01 per share." The guidance excludes certain items that are part of GAAP earnings, but are not part of "core earnings" as defined by Edison management. GCFR only tracks GAAP earnings.
Third-quarter Revenue is usually about 30 percent of the year's total. Revenue growth in the last four quarters was 6 percent, but the growth pace was noticeably quicker in the more recent quarters when Edison was able to pass on sky-high energy prices to consumers. For example, Revenue in this year's second quarter was 11 percent more than in the June 2007 quarter. With these factors in mind, our Revenue target for the third quarter is just under $4.3 billion. This value is 9 percent more than the September 2007 quarter (i.e., robust but slower growth), and it would result in year-over-year Revenue growth of 8 percent.
Of Edison's various Operating Costs, we group Fuel, Purchased Power, Other Operation and Maintenance, and Property and Other Taxes as Cost of Goods Sold. Gross Margin in the difference between Revenue and CGS, and we express it as a percentage of Revenue. History shows that Edison's Gross Margin in a quarter can be anywhere between 15 and 50 percent of Revenue. It's hard to see a pattern in the variations, but the Gross Margin is usually higher in the third quarter than the second. Since the Gross Margin was 31.4 percent in the second quarter, our target for the September period in 32.5 percent.
If this Margin is achieved in the third quarter, and our Revenue estimate proves accurate, the CGS will equal (1 - 0.325) * $4.29 billion = $2.9 billion.
Expenses for Depreciation, Decommissioning, and Amortization usually total around 10 percent of Revenue, give or take a percentage point. However, in high-Revenue third quarters, the average Depreciation expense is closer to 8 percent. Given our Revenue estimate, we would expect these expenses to equal 0.08 * $4.29 billion = $343 million in the third quarter.
Other Operating Expense includes "Net Provisions for Regulatory Adjustment Clauses." This item, which fluctuates substantially, is income in some quarters and an expense in others. The particular value can have a significant impact on quarterly results. In quarters where the Gross Margin has been especially high, the Net Provisions expense has also been more than normal and vice versa. This suggests that expenses move between CGS and Net Provisions, perhaps balancing each other out to some extent. For the September 2008 quarter, we will assume a "Net Provisions" charge equal to its average value in the last 10 quarters, ignoring the highest and lowest value. This figure is $103 million.
These figures would result in Operating Income of $949 million, compared to $899 million in the year-earlier quarter, a 5.6 percent gain.
We group the various Non-operating income and expense items into three categories. The first category is Investment gains and losses. For Edison, we group Equity in Income from Partnerships, etc., and Minority Interests in the Investment category. Historical data suggest that a $15 million charge is a reasonable assumption per quarter. The second Non-operating category is gains on asset sales, which is typically not a material item for Edison. We will assume a $6 million gain. The final category is for interest expenses and a plethora of other items. In recent quarters, these items have resulted in a net expense of about $157 million.
These figures would result in pretax income of $783 million. if we assume an effective tax rate of 33 percent, Net Income in the quarter would be $525 million (about $1.59 per share), a 14 percent increase over earnings in the year-earlier quarter.
Please note that the presentation format below, which we use for all analyses, may differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.
| ($M) | | September 2008 (predicted) | September 2007 (actual) |
| Revenue (1) | | 4,294 | 3,942 |
| Op expenses | | | |
| | CGS (2) | (2,898) | (2,799) |
| | Depreciation (3) | (343) | (310) |
| | Other (4) | (103) | (66) |
| Operating Income | | 949 | 899 |
| Other income | | | |
| | Investments (5) | (15) | (34) |
| | Asset sales | 6 | (1) |
| | Interest, etc. (6) | (157) | (136) |
| Pretax income | | 783 | 728 |
| Income tax | | (258) | (263) |
| Net Income | | 525 | 464 |
| Discontinued ops | | 0 | (4) |
| | | $1.59/sh | $1.41/sh |
| Shares outstanding | | 330 | 330 |
2. Fuel + Purchased Power + Other Operation and Maintenance + Property and Other Taxes.
3. Depreciation, Decommissioning, and Amortization.
4. Provision for Regulatory Adjustment Clauses + Miscellaneous.
5. Equity in Income from Partnerships, etc., + Minority Interests
6. Interest and Dividend Income + Other Non-operating Income - Interest Expense - Other Non-operating Deductions - Dividends on Preferred Securities
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