An Underdog to Wager on
Palwasha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Exelon Corp (NYSE: EXC) reported its second quarter earnings today. It lagged slightly behind the forecasted $0.63, returning an EPS of $0.61. But today's earnings miss is only a small speed bump along Exelon's smoother journey that lies ahead. Let’s dig deeper to understand this!
Ranked the No. 1 utility company for the last two years by Forbes, Illinois-based Exelon is an S&P 500 utility company with a power generation capacity of 35,000MW electricity that serves the Northeastern parts of the US. Its power generation sources include nuclear, fossil, hydroelectric and renewable energy sources (solar and wind). Primarily, it generates electricity via nuclear sources and is the largest operator of nuclear plants in the US. Exelon also deals with wholesale customers in addition to residential and commercial, and meets demand of over 6.6 million customers in total.
Exelon was able to beat earnings forecast in three out of the past four quarters. The one quarter that it missed was the December quarter of 2011, the time of year when naturally the demand for electricity is down because of colder weather and lack of need for air conditioning. The company’s average earnings surprise for the last four quarters is an admirable positive 2.3%.
Interesting financials
Compared with immediate competitors, Ameren Corp (NYSE: AEE), Consolidated Edison (NYSE: ED), Southern Co. (NYSE: SO), American Electric Power (NYSE: AEP), Dominion Resources (NYSE: D) and Duke Energy (NYSE: DUK), Exelon has the best financials. It has a forward P/E and valuation multiples like EV/EBITDA, P/S and P/B amongst the lowest, indicating relative undervaluation. As if this isn’t enough, the undervalued company has returns to equity amongst the highest of peer ROEs and at the same time the lowest debt to equity ratio compared with the rest.
That’s not all. Exelon also has the highest dividend yield of 5.34% followed by Ameren with 4.61% and Duke with 4.49%. Exelon’s dividend yield historically increased over the past years. All other utility stocks have had their dividend yields declining over the same period.
Even more interesting price summary
All peer stocks, barring Duke Energy, are trading at or close to their 52-week highs. Duke is trading at a 5% discount from its 52-week high. But the most undervalued of all is Exelon trading at a big 14% discount. What’s interesting is how, with best financials in the sector, the highest dividend yield and the most undervalued stock, Exelon is not as favorite a buy as some of the other sector players.
EPS forecasts for Exelon for this year hover between $2.58 to $3.05. A forward P/E of 14.15 gives the stock a fair valuation from $36.51 to $43.19.
Answering some ‘what-ifs’ and ‘but-whys’
First up, a ‘but-why’. So, Exelon has a great history of meeting earnings forecasts, returning investors a healthy dividend stream and properly managing and maintaining low debt levels, but why wasn’t it able to deliver on the forecasted EPS this quarter? (or was it?) If my readers can recall, Exelon merged with Constellation Energy in March this year. The merger took place with a stock offering by Exelon to Constellation Energy, which led to an increase in the number of outstanding shares of the company. That increases the denominator of the EPS fraction. Secondly, the Q2 earnings were also impacted by $57 million in costs associated with the merger and integration of the newly formed company. That decreases the numerator of the fraction. The two reinforcing impacts on the EPS, among some other, caused it to fall behind the target.
Now, some ‘what-ifs’. After Exelon and Constellation Energy merged, Exelon was able to add Constellations’ three nuclear reactors to its portfolio. The company relies on its nuclear plants as the biggest contributor to its revenues. Some investors think nuclear power generation is too risky. They weigh Exelon on a scale of what-ifs—what if Exelon’s nuclear plants malfunction ending up in a bigger disaster than the Fukushima Daiichi nuclear disaster in Japan; what if its reactors come down; what if this happens or that happens.
I believe such arguments hold no weight. Just like there’s a what-if worst case scenario, there can be a what-if best case scenario as well. What if natural gas becomes so expensive in the coming years that nuclear power generation is the only cheapest source? You think that’s absurd? Think again. I have a real life example that supports this idea. Pakistan ranked amongst the top producers of natural gas in the last decade. In the beginning of 2000s, the country switched to CNG vehicles. Within a decade it greatly depleted its reserves, so much so that today you won’t be able to find CNG on gas stations across the country on 2-3 out of 7 days of the week. Gas prices have reached their record highs in history. So the idea is not so absurd after all.
Besides, Exelon plans to slowly make a switch from nuclear to natural gas power generation in the coming years, which is estimated to account for two-thirds of its total energy generation. Again, some argue what if natural gas prices go down and utility companies are not able to meet revenue forecasts. So, again, I’ll tell them to go back to my what-if scenario in the preceding paragraph. Obama so far likes the thought of CNG run vehicles, right? So, what if the switch to CNG vehicles happens? Domestic demand will go up, so will prices. US natural gas reserves account for only 2-3% of the total world reserves. Heavy reliance on natural gas will start depleting resources. Foreign import demand will also rise and again so will prices. Oh, and in case you got lost somewhere in all this mumbo jumbo, let me remind you that we were having a casual conversation on what-if scenarios. Back to Exelon now!
Bottom line
Exelon has good prospects, great financials and decades of steady dividend payout. The Exelon-Constellation merger will help boost Exelon's plants upgrade program, helping it to produce an estimated 420 million watts of additional carbon-free power in the next five years. The new Exelon also holds a bigger market share now, and growing. Above all, the stock is relatively undervalued compared to other players in the utilities sector. Time to buy! Or at least add to your watchlist.
PalwashaS has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.
