Will Utility Companies Continue to Trade Down?

Lior is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The top U.S utility companies, including FirstEnergy (NYSE: FE) and Exelon (NYSE: EXC) continued to under-perform the market. Moreover, the recent quarterly report showed these companies didn’t do well. Will these companies' stocks further fall in the weeks to follow? Let’s examine the recent financial reports of these companies, the changes in these companies’ main inputs, and figure out where these companies are headed.

During the year, shares of utilities companies haven't perform well. The stock price of Exelon has tumbled down in recent weeks; as a result, the company's stock has declined by nearly 28% year-to-date. Shares of FirstEnergy have declined by "only" 0.8%. The S&P500 index, on the other hand, rose by nearly 11%.  The chart below presents the prices of Exelon, FirstEnergy and &P500 index, in which they are all normalized to the beginning of the year.

<img src="/media/images/user_12845/first-energy-and-snp500-dec_large.jpg" />

Exelon's operating profitability declined during the third quarter of 2012 and reached only 9%. In comparison, the company's operating profitability reached 12% in the second quarter and 23% in the parallel quarter in 2011.

Moreover, the company's operating profitability is much lower than that of other similar utility companies: during the third quarter the operating profitability of FirstEnergy was 21%; the profitability of American Electric Power (NYSE: AEP) reached 22%. The chart below shows the developments in the profitability of the above-mentioned utility companies. 

<img src="/media/images/user_12845/first-energy-and-other-profitability-dec_large.jpg" />

Major utilities companies continue to pay relatively high dividend and this high dividend yield is one of these companies' strong point: FirstEnergy is paying a quarterly dividend of $0.55 per share per quarter, which represents an annual yield of 5.27%; Exelon is offering a $0.52 per share per quarter, which comes to 7.13% annual yield; American Electric Power is paying a $0.47 per share –- a 4.44% yield.  This means that, of the three utility companies, Exelon is leading them in terms in dividend yields.

It's worth noticing these utilities companies have different sources of energy and the mixture of input differs among these companies: FirstEnergy is generating 64% of its power from coal, 18% from nuclear and 6% from natural gas.  American Electric Power  is also generating 66% of its power with coal, 22% with natural gas and only 6% with nuclear. On the other hand, Exelon  is generating 55% of its electricity by nuclear power, 28% by natural gas and only 3% by coal. These different cost structures could partly explain the different operating profits.  Let's examine the developments in these companies' main inputs.    

Exelon and nuclear power

Exelon is the largest utility company in the U.S in terms of operating nuclear power. The company's nuclear power generation represents nearly 55% of its total electricity generation.  Exelon has nuclear power generations in Illinois, Pennsylvania, and New Jersey. According to the recent EIA report, the net generation from nuclear energy in these regions moderately increased; for example, in Illinois net generation from nuclear energy increased by nearly 0.8% in September 2012 compared to September 2011. On the other hand, certain reports suggest a decline in nuclear power generation due to temporary shutdowns. But these reports didn’t specify the locations of these shutdowns. At the same time, Bloomberg reports a rise in Exelon's production in its reactor in New Jersey. These reports paint an unclear picture as to the progress of Exelon in its nuclear power generation in recent months. If Exelon's nuclear power generation will fall, this could lower its revenues and profitability.   

Natural gas and coal prices are rising

In recent months the prices of natural gas and coal have increased. This rise tends to occur by the end of the year as the demand for these commodities increase in the power sector. Moreover, the price of natural gas rose by a higher rate than coal. This means many utility companies are likely to use coal more than natural gas. The chart below presents the normalized price of coal and natural gas and the average retail price of electricity during the first nine months of 2012. As seen, the price of natural gas rose by a much higher rate than coal or electricity did.

<img src="/media/images/user_12845/price-of-electricity-coal-and-natural-gas_large.jpg" />

The prices of natural gas and coal hiked during October and November. Therefore, unless the average retail price of electricity will rise by a greater rate, the profit margin for utility companies that heavily rely on natural gas and coal will fall.

The recent rise in the prices of natural gas and coal could lower the profit margin for natural gas and coal based utility companies such as FirstEnergy; it will have a lesser effect on nuclear power based utility companies such as Exelon, but Exelon might face a drop in nuclear power generation that could also impede this company's progress.

For further Reading:  

Will Oil Continue Its Tumble?

Is Exxon Due for a Rally?

Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.


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