Eversource Energy

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 3/5

Eversource Energy is a regulated utility company engaged in electric and natural gas transmission and distribution, primarily serving customers in New England. They operate in a highly regulated industry and are known for reliability, but recent challenges with rising energy costs have impacted their financial health and investor sentiment.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Eversource Energy (ES), headquartered in Boston, Massachusetts, is a public utility holding company that is primarily engaged in the transmission and distribution of electricity and natural gas. The company operates mainly within New England, serving Massachusetts, Connecticut, and New Hampshire.

  • Revenue Distribution: ES primarily generates revenue through regulated rate structures. The majority of the revenue comes from the distribution of electricity and natural gas to residential, commercial, and industrial customers within their service territories. Transmission is a smaller portion of the business, and the company also has a small business segment in the energy efficiency space.
  • Industry Trends: The utility industry in the US is generally characterized by stable, albeit slow, growth. Several factors are currently influencing the industry, including a significant push towards renewable energy, increasing demand for electric vehicles, and aging infrastructure requiring upgrades. In New England, where ES is primarily focused, the region’s energy policy aims towards a more sustainable and lower carbon intensity fuel mix. Utilities are facing significant spending on infrastructure upgrades to accommodate renewables and for grid resilience. There has also been rising customer dissatisfaction with soaring energy prices, as well as increasing government regulations regarding environmental concerns.
  • Margins: Given that ES operates in a highly regulated environment, margins are set by regulatory bodies rather than market forces. They tend to be relatively stable over time within the limitations imposed by these regulatory mechanisms and also tend to lag changes in the economy. The current environment of rising rates to consumers and an increase in operating costs might result in a lag in profitability compared to these increases.
  • Competitive Landscape: The utility industry is generally a natural monopoly, where competition is limited by the large capital requirements and established infrastructure to provide these services. ES’s primary competitive threat is the other public utilities in its service territories, such as Avangrid and National Grid and a number of municipal utilities. However, the true competition is less about capturing new customers or market share in existing service territories, and more about providing better service, managing operating costs efficiently, and keeping pace with technological innovation and regulatory compliance.

The main competitive threat to Eversource is not another utility provider capturing market share but its own ability to manage operating costs effectively, including infrastructure upgrades, all while adhering to new regulations.

  • What Makes the Company Different: While utilities in general provide a commodity service, there are some differentiators. Eversource’s service territory tends to have a high population density, requiring complex and significant investments in infrastructure and a lot of maintenance work. It is therefore important that a utility operating in such a region can perform very efficiently, as these are the true keys to earning returns at regulated pricing. A focus on green and renewable energy has also set ES apart from many other players in this space.

Financials

ES’s financials are complex and have recently been negatively affected by several factors.

  • Revenues: Over the past couple of years, operating revenue has increased, driven both by higher volumes and also higher rates. Growth is not consistent, as some markets see significant growth while others see small growth or even declines. They also have a small revenue component due to a push into efficiency investments.
  • Operating Margins: Operating margins, while stable compared to most other businesses because the industry is highly regulated, have come under pressure due to rising operating expenses, mainly caused by high natural gas and energy prices and higher capital expenditure costs.
  • Return on Invested Capital (ROIC): The company’s return on invested capital has been below its cost of capital for several years, and they are just now getting the regulatory approvals to increase that. This metric needs to be watched closely to see if they are being successful in delivering appropriate returns on invested capital.
  • Debt: The company has an enormous amount of debt, with total long-term debt exceeding $20 billion, but they are a highly capital-intensive utility that requires a lot of debt financing to operate. High levels of debt, which might prove to be concerning for many other companies, is rather standard in the utility sector as a whole, but the rate at which the debt is taken and the associated interest rate is what to watch. They have a pretty good record of maintaining reasonable rates given their asset base and the nature of the revenue they generate.
  • A primary driver of returns for a utility such as ES is the ability to manage operating costs and the speed at which they are granted increases in consumer facing rates to make up for their investments. While the financial obligations of the company require the generation of large revenues, there is often a lag between when an expense occurs and when rate increases are granted.
  • Cash Flows: Free cash flow for ES has been relatively stable over the last few years. In the latest quarter, adjusted operating cash flow was $638.6 million, a $142.8 million increase compared to the same period in the prior year driven largely by a rate increase.
  • Management reiterated they expect to be able to have funds from operations above capital spending for this year, which might indicate some improvement in FCF.
  • Management has been focused on debt reduction, as well as an increase to the dividend, both are usually good things. They have also made some organizational changes to put more emphasis on cost management, which should improve margins over time.
  • ES stock has underperformed due to investor concerns of their high leverage, and increasing interest rates, so there might be some upside if they are successful in improving their balance sheet and financial health,

Moat Assessment

Eversource Energy has some factors that give it a degree of competitive advantage, but also some limitations.

  • Intangible Assets: ES benefits from its regulatory licenses and its franchise to serve a specific region. However, as most companies in the sector, there is no unique technology involved.
  • A big advantage is that they have a quasi-monopoly, being one of the few companies allowed to operate in their service territories, which means they have a guaranteed set of consumers.
  • Switching Costs: Customers do have a cost associated with switching to other providers, but this is mainly from costs of switching between energy plans with no other alternatives that they could use. This can be considered a low/moderate switching cost, and this adds some stability to the business.
  • Cost Advantages: The company can benefit from economies of scale due to the size of its infrastructure and customer base and they can take advantage of low capital costs due to their lower risk profile than most other businesses. However, their costs are not that different than their other competitors.
  • Network Effect: None

Considering these factors, ES is assigned a narrow moat, with a score of 3 out of 5. This reflects the company’s stable, yet not overwhelming competitive advantage due to regulations and its customer base, as well as some competitive pressures.

Risks to the Moat and Business Resilience

Several factors may harm ES’s moat and financial performance.

  • Regulatory Changes: The regulatory environment is constantly changing, and any new policies that limit or prohibit rate increases could significantly affect profitability. Also, increased regulatory scrutiny of operations may increase operational expenses.
  • Rising Interest Rates: As interest rates rise, so do their borrowing costs, which puts further pressure on margins and profitability.
  • Infrastructure Spending: Any unexpected capital spending could hurt their future free cash flow, especially since the industry is going through a period of great technological change.
  • Weather: Extreme weather events can wreak havoc with transmission and distribution lines, resulting in increased operating expenses and lower profitability.
  • There is the risk that the company has an enormous amount of debt, and rising interest rates could affect their profitability by making their interest payments balloon over time. There have been recent investor concerns regarding the company’s debt, but so far management has been able to maintain a balance.
  • The company operates in a highly regulated environment, which means their prices are controlled by the regulators and their pricing power is very limited.

While some risks seem to be on the horizon, the company should have some resilience. The government will always need utilities to generate energy and ES is generally a well-regarded operator. This means they are still well positioned to deliver good returns to shareholders, especially in the long term.

Understandability

The business of ES is somewhat simple to grasp at a high level, but becomes complex when one looks at the technicalities, regulatory environment, and financial structure. This gives ES an understandability rating of 3 out of 5.

Balance Sheet Health

ES’s balance sheet health rating is 3 out of 5. This is due to the high levels of debt that they have incurred over the years. However, they do not have any immediate debt-repayment obligations. They have been actively working to improve their financial health by aggressively managing costs and paying down debt, and are also taking measures to increase their margins over time. As such, while not extremely unhealthy, they should still do some more work to be considered a very healthy company.