Will These Utility Companies Shine in Your Portfolio?

Shweta is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Rate base is the value of a utility company's assets on which it can earn a specified rate of return. This factor helps regulatory agencies determine the price that a utility company can charge its customers. It is a vital figure for utility companies; it ensures that the company makes adequate profits to operate and expand in order to meet future demands.

I have analyzed three utility companies dependent upon rate base for future growth and discussed how the rate base will affect the profitability of each.

Rate base and dividend growth story

Southern California Edison (SCE), a subsidiary of Edison International (NYSE: EIX), will file a general rate case in July for the 2015-2017 period. A general rate case is a process by which California utility companies request examination of their operations and costs incurred. This general rate case filing by the company will support a rate base growth by 6%-8% in 2015, which will add to the company's profits. This will also increase its earnings per share to $3.62 in 2015, up from $3.34 in 2013. The estimated rate base for SCE will be around $23.8 billion in 2015, as compared to $21.0 billion in 2013.

Edison International has set a target dividend payout ratio of 45%-55% of SCE's earnings in the next few years. The company’s capital spending will be moderate in the next two years after higher levels of spending from 2010 to 2013. The estimated capital spending in 2013 will be around $4.2 billion, dropping to $4.0 billion in 2014 and then $3.9 billion in 2015. With capital spending leveling off, Edison International will raise dividends in order to achieve its target dividend payout ratio. It is expected that the company's dividend per share will grow 10% annually over the next two years, going from $1.35 in 2013 to $1.49 in 2014 and $1.65 in 2015.

Capacity auction signals lower revenue

In May 2013, the Senate passed Senate Bill 9 to clarify the intent of Energy Infrastructure Modernization Act, or EIMA. The bill made the annual formula rate process more constructive for Commonwealth Edison (ComEd), a unit of Exelon (NYSE: EXC), by clarifying the provisions in EIMA. This will lead to timely recovery of cash flows and faster implementation of its grid modernization program. It is expected that the passage of the bill will increase Exelon’s revenue by $25 million in 2013 and $65 million in 2014.

PJM Interconnection is the operator of the regional power grid in 13 U.S. states, which includes most of Exelon's power plants. A yearly auction is conducted by PJM to set the prices paid to utility companies for reserving the power. In May 2013, PJM released the results of the annual capacity auction held to ensure that there is sufficient electricity for the period of June 2016 to May 2017. The capacity market price for this period is $59.37 per megawatt-day, which is reduced by 56% from last year’s auction price of $136 per megawatt-day for period of 2015 to 2016.

This will lead to a fall in Exelon capacity revenue by 41% to $847 million for period of 2016 to 2017, as compared to $1.4 billion the previous year. It is estimated that Exelon’s earnings per share will also decrease to $2.00 in 2016, as compared to $2.45 in 2013.

Unconvincing rate case and de-levering the business

Jersey Central Power & Light (JCP&L), a subsidiary of FirstEnergy (NYSE: FE), is undergoing general rate case proceedings ordered by the Board of Public Utilities in New Jersey. JCP&L requested a $31 million rate increase in November 2012, and it updated the filing to a $112.3 million rate case in February 2013 to include costs associated with Hurricane Sandy. In June 2013, however, the New Jersey Division of Rate Counsel (NJDRC) recommended a rate cut of $203 million for JCP&L. The next major hearing will be in September 2013, and a final rate order expected around the end of year. The negative testimony from NJDRC will lead to a less constructive decision for JCP&L. As a result, the company's revenue will see a decline in its year-over-year growth rate from 13.1% in 2013 to 5.3% in 2014.

FirstEnergy will reduce its debt by $1.5 billion in 2013 to maintain its investment-grade credit rating. The company has already started executing its debt reduction plan. FirstEnergy tendered $1.1 billion for its subsidiaries, FirstEnergy Solutions and Allegheny Energy Supply, a move that will support the credit rating of these subsidiaries. The company is also in the process of selling its hydro assets enhance its liquidity. The successful execution of these events will help the company to maintain its investment-grade credit rating while improving its balance sheet.

Conclusion

The expected growth of rate base will add to the profits of Edison International, and the company’s strong dividend growth profile will benefit the investors. I recommend buying this stock.

Meanwhile, the passage of Senate Bill 9 will generate additional revenue for Exelon but the PJM capacity auction signals lowering of capacity revenue. FirstEnergy began its debt reduction plans to maintain its credit rating. The unconvincing nature of its rate case will lead to a less constructive decision for JCP&L. I recommend holding these two stocks.

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Shweta Dubey has no position in any stocks mentioned. The Motley Fool recommends Exelon. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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