What if Exelon Did Cut Their Dividend?

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Shares of Exelon (NYSE: EXC) have fallen nearly 9% in the past week after CEO Christopher Crane hinted that the company’s dividend might not be safe.  This potentially marks a huge shift in company policy and it's leading investors to pull the plug on shares.  Many investors, retirees in particular, have invested because of the reliable dividend, and a potential cut is the last thing they want to hear. 

On the call Mr. Crane said that maintaining an investment grade credit rating was the company’s top priority.  If that became an issue, the dividend policy would be revisited as part of a range of options they’d consider in order to preserve that all-important rating.   What would happen if they did cut the payout?

Topping the list is that a lot of retirees and other income seekers would get a pay cut at a time that many can’t afford one.  With the economy under constant pressure and with uncertainty the only thing that’s certain these days, it was comforting to know that Exelon was committed to continue paying out their existing dividend at the same rate.  Other than a lot of frustrated shareholders, what else would a dividend cut mean for Exelon?

After maintaining an investment grade credit rating and paying the dividend, the rest of the cash the company generates is used to grow the business.  By maintaining the dividend, they’re reducing their capital expenses and delaying future growth.  They’ve already removed $2.3 billion in growth capital from their 2012 to 2015 capital plans.  From what management is saying, these projects won't add value to the company unless there is a market recovery from the electricity they generate. 

That would mean that the projects they are keeping are those that would add value, and they could be cut if it meant keeping the dividend flowing at full power.  Would it be better to cut the dividend and reinvest in the business if it meant better future returns?

That of course depends on who you’re talking to.  An investor like me who uses dividends to reinvest in growth would be annoyed but not turned off.  Other Exelon investors rely on its steady income for more important things like paying their own power bill or taking their grandkids to the movies.  Those are the investors that are nervous because it’s not clear how deep the cut could be.

When I named Exelon as the one utility I was buying, I saw upwards of 38% upside in the company if their shares simply reverted to the industry mean dividend yield.  At the time, that average yield of 4.64% was taken from a blended average of Dominion (NYSE: D), Duke (NYSE: DUK), NextEra (NYSE: NEE) and Southern (NYSE: SO).  If we thought about how far they could cut the dividend that would be the number I’d look at. 

As it stands right now, we are at least six months away from any cut according to the CEO.  You do have to commend management for not wanting to live on the edge with a 90% payout ratio for the long term.  They don’t appear to be alone at the edge, if you look at their peers there are quite a few bumping up against that upper end of the edge:

<img src="http://media.ycharts.com/charts/a2567e8a9afbfe934e5cfa72d08f5bee.png" />

EXC Payout Ratio TTM data by YCharts

For an industry that is built on being a safe and reliable source of income, this isn’t welcome news.  However, all this discussion could be a moot point if power prices recover enough.  At this point, all investors can really do is hope that prices do recover enough so that all this talk of a dividend cut is just that--talk. 

latimerburned has the following options: Exelon. 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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