Consolidated Edison Inc (NYSE: ED) generated an above average return on equity of 10.4% over the past twelve months, while the Utilities sector returned 8.9%. Even though Consolidated Edison’s performance is impressive relative to its peers, it’s useful to understand what’s really driving the company’s healthy ROE and how it’s trending. Understanding these components may change your views on Consolidated Edison and its future prospects.
Consolidated Edison’s Return On Equity
Return on equity represents the percentage return a company generates on the money shareholders have invested. Return on equity or ROE is defined as follows:
ROE = Net Income To Common / Average Total Common Equity
A higher return on equity suggests management is utilizing the capital invested by shareholders efficiently. However, it is important to note that ROE can be “manufactured” by management with the use of leverage or debt.
Consolidated Edison’s historical ROE trends are highlighted in the chart below.
source: finbox.io data explorer – ROE
It appears that the return on equity of Consolidated Edison has generally been increasing over the last few years. ROE decreased from 9.3% to 9.1% in fiscal year 2016, increased to 10.3% in 2017 and increased again to 10.4% as of LTM Mar’18. So what’s causing the general improvement?
What’s Driving Consolidated Edison’s Improving Return On Equity
The DuPont analysis is simply a separate way to calculate a company’s ROE:
ROE = Net Profit Margin * Asset Turnover * Equity Multiplier
Created by the DuPont Corporation in the 1920s, the analysis is a useful tool that helps determine what’s responsible for changes in a company’s ROE. It highlights that a firm’s ROE is affected by three things: profit margin, asset turnover, and its equity multiplier or financial leverage.
Analyzing changes in these three items over time allows investors to figure out if operating efficiency, asset use efficiency or the use of leverage is what’s causing changes in ROE. Strong companies should have ROE that is increasing because its net profit margin and/or asset turnover is increasing. On the other hand, a company may not be as strong as investors would otherwise think if ROE is increasing from the use of leverage or debt.
So let’s take a closer look at what’s driving Consolidated Edison’s returns.
Consolidated Edison’s Net Profit Margin
A promising sign for shareholders, Consolidated Edison’s net profit margin has increased each year since 2015. Margins increased from 9.5% to 10.3% in fiscal year 2016, increased to 12.7% in 2017 and increased again to 12.9% as of LTM Mar’18.
As a result, the company’s improving margins help explain, at least partially, why ROE is also improving. Now let’s take a look at Consolidated Edison’s efficiency performance.
Consolidated Edison’s Asset Turnover
It appears that asset turnover of Consolidated Edison has generally been declining over the last few years. Turnover decreased from 0.28x to 0.26x in fiscal year 2016, decreased to 0.25x in 2017 and increased to 0.25x as of LTM Mar’18.
source: data explorer – asset turnover
Therefore, the company’s ROE improvement is not as a result of its asset turnover performance which has generally been decreasing.
Finally, the DuPont constituents that make up Consolidated Edison’s ROE are shown in the table below. Note that the table also compares Consolidated Edison to a peer group that includes Dominion Resources, Inc. (NYSE: D), Entergy Corporation (NYSE: ETR), Sempra Energy (NYSE: SRE) and DTE Energy Company (NYSE: DTE).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that Consolidated Edison’s general improvement in return on equity is the result of steadily improving net profit margin, a declining asset turnover ratio and declining leverage. Therefore when looking at the core operations of the business, Consolidated Edison shareholders have reason to be excited due to the company’s steady improvement profitability along with a general decline in operational efficiency and declining leverage.
The DuPont approach is a helpful tool when analyzing how well management is utilizing shareholder capital. However, it doesn’t necessarily tell the whole story. For example, how do the company’s ROE trends compare to its peers or sector? How about in absolute returns? I recommend that investors continue to research Consolidated Edison to gain a better understanding of its fundamentals before making an investment decision.
As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.