Is This Utility Company able to turn it around?

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Exelon Corporation (NYSE: EXC) hasn't performed well during 2012: shares of the company plummeted by nearly 29% year-to-end. Other leading utility companies such as FirstEnergy (NYSE: FE) and American Electric Power (NYSE: AEP) also haven't done well last year. But Exelon, unlike other utility companies listed above, relies mostly on nuclear power to generate electricity. This could be one of the main factors that adversely affected the company's stock. Will this company be able to turn it around in 2013? One of the main factors that will determine this matter is the development in natural gas prices.

Before analyzing the performance of Exelon, it is worth noticing that the company generates 55% of its electricity by nuclear power, 28% by natural gas and only 3% by coal. In comparison, FirstEnergy  generates 64% of its electricity via coal, 18% by nuclear and 6% by natural gas.  American Electric Power  generates 66% of its electricity by coal, 22% by natural gas and only 6% by nuclear.

The price of electricity is mostly based on the changes in natural gas prices; the price of nuclear input costs has a lesser effect on the price of electricity. Thus, it is assumed that as natural gas prices fall, the price of electricity follows. Because Exelon uses mostly nuclear power to generate electricity, as natural gas price falls its profit margin tends to shrink. In 2012, this was the case.

Profitability Is Falling

The operating profitability of Exelon fell in the first nine months of 2012 to 10%. In comparison, the company's operating profitability reached 24% in 2011 and 25% in the 2010. Moreover, the company's operating profitability was much lower in 2012 compared to other leading utility companies. The chart below shows the operating profitability of Exelon, FirstEnergy and American Electric Power between 2009 and 2012 (first nine months). As seen, the profitability of FirstEnergy and American Electric rose in 2012 compared to 2011. 

<img src="/media/images/user_12845/first-energy-operating-profitability-and-exelon-2009-2012_large.jpg" />

The drop in Exelon's profitability may have crowded out the positive effect of the company's growth in revenues in recent quarters on the stock: during the third quarter of 2012 the company's revenues rose by 24% compared to the third quarter in 2011, while Exelon's operating profit tumbled by 49%. This may have been among the factors for the drop in the company's stock in 2012.

During last year, shares of Exelon tumbled down. The chart below shows the normalized prices of Exelon, S&P500 and FirstEnergy set to the beginning of 2012. As seen, the S&P500 index has outperformed both companies as it rose by 12%.  FirstEnergy slipped on a yearly scale by nearly 2.5%.

<img src="/media/images/user_12845/first-energy-and-snp500-dec_1_large.jpg" />

Dividend Yield Is Rising

Due to the sharp drop in Exelon's stock, the company's dividend yield rose to a higher dividend yield than other major utilities companies. Exelon is paying a quarterly dividend of $0.52 per share, which comes to 7.02% annual yield; FirstEnergy is paying a quarterly dividend of $0.55 per share per quarter, which comes to a yearly yield of 5.23%; Duke Energy Corp (NYSE: DUK) paid in the recent quarter a dividend of $0.76 per share, which represents an annual yield of 4.73%; American Electric Power paid a $0.47 per share – a 4.3% annual yield. 

U.S policymakers have decided to augment the taxes on dividend and capital gains from 15% to 20% for only households making more than $450k annually. Thus, for households making below this threshold will continue to pay a 15% rate on dividend and capital gains. This means, for many investors the high dividend yield the above-mentioned utility companies are offering is still favorable.

Electricity Prices 

The main factor that could determine the direction of the company is the price of natural gas. During the year the price of natural gas rose by nearly 29%, but the average annual price was nearly 30% lower than the average rate in 2011. This drop in the price of natural gas contributed to the decline in the price of electricity. The chart below presents the average retail price of electricity during 2010-2012.


<img src="/media/images/user_12845/price-of-electricity-jan-2013_large.jpg" />

The chart shows the peak price in August 2012 was nearly 1.4% lower than the peak a year back.

Natural Gas in 2013

The price of natural gas was very low in 2012 compared to recent years. The average price of natural gas in 212 reached $2.83/mmbtu. In 2011, the price reached $4.02/mmbtu. The current natural gas storage levels are still higher than the 5-year average despite the recent cold front that hit the East Coast. It's still unclear what kind of winter the U.S will have in January and February. But if this winter will be warmer than normal – it currently seems to be the case – the price of natural gas will resume its downward trend. In such a case, natural gas prices will remain low in 2013 as they were in 2012.

Therefore, Exelon might not be able to turn it around in 2013. Moreover, if the price of natural gas will continue to fall, this could further cut Exelon's profit margin and thus lower its valuation over time.

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