Edison International (EIX)

California-based Edison International (NYSE: EIX) is a utility holding company operating through three principal subsidiaries: Southern California Edison Company, Edison Mission Energy, and Edison Capital.

Southern California Edison (SCE) is a public utility providing electricity to central, coastal, and southern California (excluding Los Angeles). Revenue is derived mainly from commercial (41%), residential (37%), industrial (7%), public authorities (5%), and agricultural (0.8%) customers. SCE accounts for roughly 82% of EIX's total revenue and is one of the nation's largest electric utilities serving a population of 13 million, through 4.6 million customer accounts in a 50,000-square-mile service area.

Edison Mission Group (EMG) is a wholly-owned subsidiary of Edison International. EMG is the holding company for EIX's principal wholly-owned subsidiaries, Edison Mission Energy (EME) and Edison Capital. EMG is an independent power producer with net generation capacity of nearly 18,000MW located both in the U.S. and abroad. In addition to power generation, EME is principally involved in price risk management and wholesale energy marketing and trading activities. Mission Energy Holding Company (MEHC), another subsidiary of EIX, is the holding company for its wholly-owned subsidiary EME. Beginning in 2006, MEHC and Edison Capital began reporting on a consolidated basis as EMG. EMG, a subsidiary of EIX, has no other business activities other than through its ownership interest in its subsidiaries, including MEHC and Edison Capital. EMG accounts for roughly 17% of EIX's total revenue.

Edison Capital holds investments in energy and infrastructure projects. Approximately 1% of EIX's consolidated revenue comes from this subsidiary business.

Several issues that previously reduced visibility of the company's long-term prospects have been resolved. These factors include the favorable decision on SCE's general rate case in California and the positive outlook for EME following the resolution of its liquidity issues, combined with an improving operating outlook. The resulting positive earnings momentum due to these factors, in our view, will help promote EIX's equity value.

In the regulatory environment, SCE's 2009 2011 general case application was filed with the PUC in November of 2007. SCE requests a 2009 base rate revenue requirement of $5.199 billion, which is an increase of almost $858 million over the projected authorized base rate revenue requirements. Subsequently on April 15, 2008, the DRA recommended that SCE's 2009 base rate revenue requirement be increased by approximately $7 million from the current authorized base rate revenue. This is a difference of $719 million from SCE's request. The $719 million difference is mainly due to reductions proposed by DRA. The PUC will issue its final decision on the aforementioned rate case during the latter-half of 2008. The PUC decision hinges upon the extent of SCE's ongoing expansion and modernization programs. SCE also proposed revised base rate revenue increases of $108 million for 2007 and $113 million for 2008. Earlier on February 22, 2007, SCE declared its capital investment plan from 2007 through 2011, which included total capital spending of up to $17.3 billion and was consistent with SCE's 2006 GRC plan. This filing enabled an approval of 97% of 2006 to 2008 capital requests. It also approved 95% of operating expense requests. In June 2007, SCE's GRC application requested a 2009 base rate revenue requirement of $5.19 billion, an increase of approximately $856 million over the projected 2008 authorized base rate revenue requirement, or a $724 million increase over its current authorized base rate revenue. The PUC formally accepted the GRC application on September 19, 2007. With expansion plans for the development of the infrastructure of SCE lined up, the early acceptance of the application is significant as it indicates an earlier final decision and effective date for new rates. On August 1, 2007, SCE also filed its 2008 ERRA (Energy Resource Recovery Account) forecast requesting a revenue requirement increase of $515 million. Given the continued focus on reliability and resource adequacy in California, we expect a continuation of constructive regulation in California that will support incremental investment by the company. Finally in March 2008, SCE filed an application with the CPUC for implementing its Solar Photovoltaic (PV) Program with plans for developing 250 MW of utility-owned Solar PV generating facilities. The company estimates a base case capital cost for the Solar PV Program to be $875 million over the 2008-2013 period of the program. SCE proposes to develop the projects at a rate of approximately 50MW annually at an average cost of $3.50/watt. A final decision by the CPUC regarding the program is expected in March 2009. Finally, on August 1, 2008, SCE requested FERC for a 39% increase in its Transmission Owner Tariff with effect from October 1, 2008 reflecting a proposed $129 million rise. The proposed transmission revenue requirement is based on an overall return on equity of 12.7%.

Operationally, the company took a major step towards securing the financial recovery of MEHC by selling, at a substantial gain, its interest in Contact Energy and making excellent progress towards completing the sale of its remaining international projects. The sale of the company's wind-power assets, particularly of San Juan Mesa and Citi Renewable Investments LLC and its effort to sell the Doga project, coupled with constructive prior regulatory decisions for SCE by the CPUC, set a foundation for an increase in the dividend and a five-year outlook for earnings growth substantially above the average of its peers. MEHC is making additional progress with an agreement to sell its remaining international assets, which is also expected to provide the company with a substantial gain. Another beneficial change in the company's asset portfolio should be the acquisition of the 1,054MW Mountain View power station. The output from this natural gas-fired plant (currently under construction in California and expected to be completed soon) will be sold to SCE at fixed rates. In February 2007, Midwest Generation entered into a contract to purchase an additional 9 million tons of coal in 2008, and 6 million tons in both 2009 and in 2010. This increase in the amount of coal under contract substantially matches its generation hedges for 2008.

Likewise, the future outlook for the company's independent power subsidiary, EME, significantly improved in 2007, in part by building its portfolio of wind power assets. For instance, in May of 2007, EMG completed construction and commenced commercial operation of its newest wind energy project, located in the Texas Panhandle. Known as the Wildorado Wind Ranch, the 161MW project is the largest wind energy facility in the Texas panhandle region and the largest in EMG s portfolio of 14 wind projects totaling over 600 MW of wind power capacity. On July 31, 2008, EME had 756MW of wind projects in service and another 429MW of wind projects under construction, which are scheduled to be completed during late-2008. The company continues with its ambitious plans to increase the wind capacity of EMG to 2,000 MW by year-end 2009 and over 5,000MW over the long-term. Earlier during 2007, EME increased its number of wind projects under its purview by seven, representing a significant increase from 2004, when it was expected that Edison International might have to deconsolidate EME from its books, as the subsidiary was faced with a very serious liquidity crisis. EME had roughly $1.6 billion in maturing liabilities, and a Chapter 11 filing seemed unavoidable. However, the company successfully arranged for approximately $1.9 billion in financing, which essentially eliminated its near-term liquidity risk. EME s credit outlook has since been rated stable by Standard & Poor's.

Additionally, SCE's six contracts, if approved, would add as much as 427MW to its renewable energy portfolio following the completion of construction in 2009. Moreover, the transmission-improvement projects undertaken by SCE will strengthen the utility s transmission infrastructure so that it may carry heavier electrical loads. The transmission upgrade is a part of SCE s integrated company approach to meet electricity supply and delivery, as well as the service reliability needs of its customers. Additional storage capacity will continue to provide operational flexibility and to mitigate potential costs associated with the dispatch of SCE's tolling agreements. Furthermore, if approved by the CPUC, the Devers project (including a 230-mile transmission line) would provide SCE with an additional 1,200MW of cost-effective electricity. It also has the potential to reduce transmission and congestion and to provide increased operational flexibility for dealing with unexpected outages of major generation and transmission facilities. Due to growing concerns that Southern California may not have adequate generating capacity in the near future, SCE has issued a competitive request-for-offers to solicit bids for power contracts. In June 2006, a new bilateral contract to sell 500 MW of on-peak generation was signed for supply from 2007 to 2009. This is the first contract entered into by the company that does not require collateral associated with a hedge. The company also secured 4 additional contracting projects totaling 602 MW. The Kern River project, which is a 5-year market rate contract, was approved by the CPUC in May of 2006. The utility has also undertaken a technical and commercial feasibility study of a 500 MW hydrogen power project. In the light of rapid continuing growth in the utility service territory, EIX is concerned about having additional generation to potentially meet high peak-loads during the summer and winter seasons. With an order issued by the CPUC, the company continues to work to add 225MW of peaker projects, which are scheduled to be operational by next summer.

From a financial perspective, on June 30, 2008, SCE's credit rating on long-term senior secured debt from S&P, Moody s and Fitch were investment-grade A, A2, and A+, respectively. While numerous challenges remain for electric utilities operating in California, the SCE upgrade reflects demonstrated evidence of the sustainability of the strong credit quality measures due, in part, to more predictable regulatory actions by the California Public Utilities Commission (CPUC). The outcome of SCE's general rate case decision during the 2nd quarter of 2006, which authorized the base rate increases of approximately $274 million in 2006, $74 million in 2007, and $104 million in 2008, was a factor in the credit rating upgrades. On March 17, 2006, S&P upgraded the debt ratings on Edison International s EME subsidiary, citing the company s sale of its international assets. Proceeds from the sale of assets will be used to pay down debt. Later, on March 24, Moody s Investors Service raised its rating on MEHC, citing greater flexibility to upstream funds from its subsidiaries. Likewise, Moody s raised MEHC s senior secured rating to "B2" from B3 . Moody s also affirmed its B1 senior unsecured rating. The ratings upgrade helped lower the company s borrowing costs. Moody's raised SCE's senior unsecured debt by one notch to "A3," it s seventh highest ranking, from "Baa1". The outlook is stable, indicating that another ratings change is not anticipated over the next 12 to 18 months. Furthermore, the company recently declared a 5.2% increase in its quarterly dividend, equivalent to an annualized dividend per share (DPS) of $1.22, up from the previous rate of $1.16 per share, and currently yielding 3.8%. Given the recent dividend hike and low projected earnings payouts of 30.7% and 27.0%, respectively, of our 2008 and 2009 EPS estimates, the current dividend rate appears easily sustainable and very secure.

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