PSEG Introduction & Description of the Business

The Public Service Enterprise Group (PSEG) is a publicly-traded utility company, incorporated in New Jersey. The company has two subsidiaries, those being PSE&G and Power. The former is a franchised public utility in New Jersey, a provider of "gas and electric commodity service," with a range of customer types including residential, commercial and industrial. Power integrates nuclear, fossil and renewable generating asset operations and wholesale functions. It sells in the wholesale and commodity markets both in the spot market and in the futures market (PSEG 2014 Form 10-K, 2014). PSEG also has a subsidiary on Long Island in New York, operating the Long Island Power Authority's transmission and distribution system (Ibid). Transmission and distribution are two of the major businesses that the company is in.

In terms of the electric and gas distribution business, PSEG has 2.2 million electric customers and 1.8 million gas customers. It does 40,737 gigawatt hours in electricity and 2628 million therms in gas. The former business is slowly shrinking, while the gas business has a 2% annual growth rate (Ibid). The company notes that while supply is a major revenue source, accounting for 43% of gross revenues, it does not take a profit margin on this revenue, as all costs are passed through to the customers; profits are "derived from selling a range of products and services under contract to power marketers and to others, such as investor-owned and municipal utilities" (Ibid). The following analysis will investigate how the financial and economic performance of PSEG has been, and this will be compared with a competitor in Ohio-based First Energy, the largest investor-owned utility in the U.S.

Key Metrics

A good example of an operating metric that can be used to evaluate the performance of a utility is capacity utilization. This is an efficiency measure, which highlights the degree to which the company is making use of its existing assets. Power generation and transmission requires a substantial up-front investment in fixed assets, so it is important to ensure that these assets are being used as efficiently as possible. The Power subsidiary is one of the means by which PSEG can sell excess power to other users, thereby improving its capacity utilization. Utilizing at 100% would indicate that the company does not have enough capacity and therefore might be leaving money on the table by not investing in further capacity.

PSEG notes in its 2014 10-K that is has several key units operating at varying degrees of capacity. Of its nuclear facilities, Peach Bottom Unit 3 operates at 99.2% capacity, but the other units are less, down to a low of 72.6% for Salem Unit 2A. Nuclear capacity is at 97.9% for Hope Creek but two other reactors are at around 85% capacity, so there are at least three reactors that are not running at full capacity, representing some inefficiency in the system, unless there are mitigating circumstances. The company notes that Salem Unit 2A, the poorest-performing reactor, faced an extended outage for repairs, and that is why it was so low in terms of capacity utilization. The company's coal plants, by contrast, did not have good capacity factors. Keystone was at 77.4% capacity and Conemaugh was at 73.9%, both figures indicating that there is some inefficiency within the coal system at PSEG.

The company also notes that there are different types of units. The above are base load units, but there are also load following units and peaking units. The cost of these units increases on a $/MWh basis, and some of the peaking units come with a very high operating cost indeed. Several of the underperforming peaking units are scheduled to close in June 2015, which should improve the overall performance of the company in terms of cost per megawatt hour (Ibid).

In terms of revenue, PSEG works with long-term contracts. Its contracts run through May 2018 at present, and there is some minor fluctuation in the MW-day price of power under those contracts. The company uses long-term contracts to ensure revenue certainty, which allows it to plan infrastructure capacity and also to ensure sufficient supplies of key inputs like uranium. The company also makes extensive use of hedging in order to limit the volatility of its results, something that should be reflected in the financial statements (Ibid).

Stock Performance

PSEG reports in its 10-K on its stock performance over the past several years. In general, the utility has underperformed the market, using 2009 as an index. PSEG has gained 53.8% since 2009, while the S&P Electrics group has gained 75.52% and the...

Utilities in general have underperformed the broader market, which has more than doubled since 2009.
Horizontal Analysis

A horizontal analysis helps to compare the last year's results with the results from years prior. PSEG enjoyed revenues of $10.886 billion in 2014 and while this was an improvement from the two prior years, it nevertheless represents a decline from 2010-2011, when the company was earning more than $11 billion annually in revenue. Net income, however, only lags 2010 and again represents an improvement over the past couple of years. Exhibit 1 illustrates the past five years of revenue and profits.

Exhibit 1. Revenues and Profits, PSEG, 2010-2014.

The company's cost of revenue and operating income show similar results. Expressed as a percentage of revenues, the operating income for the past five years is as follows:

2010

2011

2012

2013

2014

COGS % of revenue

44.60%

42.80%

38%

35.30%

35.70%

What this shows is that while the company had higher revenues in 2010-2011, it was also paying more for its energy, and a decline in energy costs came with a decline in revenues. The company did note that a lot of its costs were passed on to its customers directly, a fact that has some explanatory power over the relationship between input costs and revenues.

The balance sheet can also be evaluated in terms of a horizontal analysis. A healthy balance sheet will show that the company is liquid and solvent, and that equity is increasing year over year, indicating a positive return to shareholders. The company has remained liquid over the past five years, with a current ratio above one, and a healthy portion of that current ratio being in cash and receivable. The company has been fairly steady in terms of its liquidity performance during this period.

In terms of solvency, there has also been little change in the capital structure of the firm. It is presently weighted to 64.3% debt and 35.7% equity, and those proportions have not changed all that much. The company has grown slowly over the past five years, from total assets of $28.678 billion in 2010 to $32.522 billion in 2014, a gain of just 13.4% in five years. Total equity has grown in the same period from $8.788 billion to $11.608 billion in the same period, which is a gain of 32%. This indicates that while the company overall has grown slowly, almost all of that growth has gone to equity. Both long-term debt and lease obligations, and total liabilities, have not changed much in the past five years, so gains are going to the shareholders, who have been able to enjoy an increase in the book value of their shares over the period (MSN Moneycentral, 2015).

In terms of market returns, while the company has lagged the overall market, it has still performed well, considering that it is in a mature industry. With its recent gains, the company enjoys a gross margin that, at 62.35%, is greater than the industry average (of 56.63%). This flows down to superior pre-tax margins and net margins as well. The low debt ratio was noted earlier, and it compares with an industry average of 1.17, so many firms in the industry have a high degree of leverage. Yet, that borrowing does not translate to more efficient facilities. Nevertheless, operating in a slow-growing market, PSEG does not get the benefit from the market, and has a P/E ratio of only 16.45, less than the industry average of 16.75 (Ibid).

This comes despite superior returns on equity (10.61%, versus an industry average of 7.73%), assets (3.72% versus 2.33%) and capital (7.28% versus 3.5%). PSEG earns $125.62K per employee, nearly double the industry average of $64.87K (Ibid). Again, this indicates that PSEG may have a slow-growing operation, but it also has a very efficient one. Many of its facilities are close to capacity, the company has a subsidiary to sell its surplus power and PSEG has a relatively small geographic area so its transmission costs per megawatt hour should be lower than those of many utilities in the United States. The numbers indicate that this is a well-run company that outperforms its peers.

Peer Comparison

It is best, however, to do a direct comparison with a peer. Since efficiency appears to be one of the key strengths of PSEG, a good peer to evaluate its performance against is First Energy, the largest investor-owned utility. With a larger size, Ohio-based First Energy should have the ability to be even more efficient. That should play out in its financial performance, in particular…