This Utility is Just Too Cheap to Ignore

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“Do you know the only thing that gives me pleasure?  It’s to see my dividends coming in.” – John D. Rockefeller.

I’m a lot like John.  I remember buying my first dividend paying stock and just waiting.  I’m sure I checked my account every day looking to see if that dividend had been deposited.  When it finally was I was hooked.  My days as a working stiff would soon be over, or so I thought. 

Fast forward nearly a decade and I’m still hooked but unfortunately still working.  I’ve learned a lot over the years and one of the more important lessons was to beware of big dividends as they can sometimes signal that something’s amiss.  However, if you do find a company with a tantalizing dividend and the businesses to back that up then you’ve got it made. 

If John were still around today I think he’d be salivating if he came across the utility I’m about to discuss.  Not just because they generate an above average dividend for their shareholders, that’s just part of the allure.  What’s really caught my eye is that their stock has gotten just too cheap.  

Home to the nation’s second largest regulated utility as well as the largest nuclear generating fleet, Exelon (NYSE: EXC) also has one of the higher dividend yields in the utility sector at nearly 6%.  Usually when dividends get that high the market’s signaling that they either don’t trust the company’s ability to pay or the company’s is out of favor for one reason or another.  There is no doubting Exelon’s ability to continue generating their dividend even as they invest heavily in their business.   So then why have the fallen out of favor with the market?

Before I answer that question I want to look at one metric that demonstrates what I mean when I say that Exelon is cheap.  For utilities a good metric to use is their price to book ratio (links to a video which explains price to book ratio in easy to understand terms).  Take a look at how low Exelon’s ratio is when compared to their peers:

 

<img src="http://media.ycharts.com/charts/ebf2be89b581a2783b32250fea2fb54c.png" />

EXC Price / Book Value data by YCharts

Both Dominion (NYSE: D) and Southern Company (NYSE: SO) have ratios above two while NextEra’s (NYSE: NEE) is still above one and a half times.  Finally, while it would appear from the chart that Duke’s (NYSE: DUK) ratio is less than Exelon, there appears to be a data error in the chart due to their merger with Progress as I’ve seen their ratio listed at two.  All this to say, on a relative basis Exelon is much cheaper than their peers. However, there is another basis which is even more important that I’ll get to in a moment.

Back to my earlier question of why Exelon’s fallen out of favor, I see three reasons for this.  First, a general unease with nuclear power post Fukushima.  Second, their recent merger with Constellation is still a long way from being completely integrated and a lot can go wrong with integrating mergers.  Finally, with low natural gas prices it makes it difficult for their nuclear weighted generating fleet to compete. Over the long term however, I think the discount is unjustified.

In the short term investors seem to be disregarding Exelon because of the operating environment of today; however, we’re not just investing for the landscape of today.  We’re investing for the decades ahead and Exelon is very well positioned.  That Exelon will continue to have one of the cleanest generation fleets with a base of nuclear generation and a growing portfolio of both solar and wind assets. 

There are two keys to their nuclear fleet that you need to know.  First and foremost, they are simply irreplaceable.  Southern Company has spent more than nine years and over $14 billion to build two new nuclear generators.   Exelon has a fleet of more than a dozen which just cannot be replicated in today’s economic and regulatory environment.  Not only that but because of their large fleet they’re able to engage in an uprate program which has the potential to add the capacity of another nuclear generator at half the cost.  The size of their fleet gives Exelon a long term competitive advantage in an industry where it’s not commonly found. 

Peers like NextEra and Dominion are investing heavily in wind and gas generation which have compelling economics in today’s environment.  However, over the long term they’ll be hard pressed to generate the stability of generation and fuel costs as Exelon can with their nuclear fleet.  Finally, Exelon has their own solar and wind projects under development to combine with their clean nuclear fleet as they’ll continue to be one of the cleanest utilities in the country.     

To sum things up we’ve got a utility with a high dividend that’s selling at a significant discount to their peers and owns assets that are irreplaceable.  That’s a long term formula for capital appreciation that would make John D. Rockefeller’s beloved dividend checks puny in comparison.  It’s one reason why I’ve reconsidered my own thoughts on the company. 

Exelon might not be a dividend growth story I was looking for, but it has become a capital appreciation story.  Not only that but they’ll pay investors plenty to wait until the market realizes just how much they’ve undervalued the company’s assets.  That’s why I’m adding Exelon’s name to the top of my utility candidates watch list for my virtual “No Drip, No Mess” portfolio.  I’ll soon be deciding which utility to add, but it’s hard to argue with the discount the market’s offering for Exelon. 


latimerburned has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Dominion Resources, Exelon, and Southern Company. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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