The Ins & Outs of the Largest Utility in the US

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

I believe most analyst's writings are subjective. They give you their stance--bullish or bearish, backed by their reasoning. But sometimes an average investor wants to go by his own gut. What he looks for is a complete insight into the potential investment and thus he wants the discretion of making the final decision himself, based on a simple framework. In this light, I'll be giving you a perspective of what the company is (its strengths), what it isn't (its weaknesses), what it could be (its opportunities of growth) and what it shouldn't be (the threats to its growth). We, the B-school grads, call it the SWOT analysis.

I started following the utility sector only recently and this week covered Duke Energy's (NYSE: DUK) third quarter earnings. DUK has nearly approached its fair valuation and has lately seen strong buying activity, despite a revenue miss this quarter and declining EPS. So come a dip or more positive news, should you consider buying this stock? Or should you short it? I'll hold my opinion to myself for now and let you decide.

Strengths

  • Largest Utility: With the acquisition of Progess Energy, Duke has become the largest utility company in the US. With a capacity of 58,200 megawatts of energy generation and the largest market cap of $43.62 billion, Duke finds its place in the Fortune 250 companies. 
  • Strongest Leadership: Duke is run by a CEO who's equally respected in and outside of his circle. President and CEO, Jim Rogers, has acted in the CEO position in the utility industry for more than 23 years now and holds a very strong insight in the industry. He's been a part of the two big mergers--Duke with Cinergy in 2006 and Duke with Progress Energy in 2012. The man knows what to do and how to do it. Jim Rogers is also a very active community participant and is very well connected across various industries outside of the utilities.
  • Political Backing: With Jim Rogers at its helm of affairs, Duke is positioned as a very strong utility in business. CEO Jim Rogers holds strong political connections within the Democratic party and is rumored to succeed U.S. Energy Secretary, Steven Chu. Although, Rogers has denied it explicitly, this just gives us a hint of his political stature for having been considered for the position. The Government's support in rulings in Duke's favor will give it a position like no other peer utility.
  • Modern Environment-Friendly Fleet: Duke is closing in on the completion of its $9 billioon fleet modernization program which positions it as a company with one of the most efficient and environment-friendly energy generation plants (both coal-fired and natural gas). All of its projects are moving within time and budget. No major lags!

Weaknesses

  • Huge Debt Burden: Duke has a very heavy load of debt on its balance sheet, compared to peers like Southern Co. (NYSE: SO), American Electric Power (NYSE: AEP), Exelon (NYSE: EXC) and Consolidated Edison (NYSE: ED). It has particularly jumped this high after the merger with Progress Energy. Long-term debt increased to $35.2 billion this year from $17.7 billion at year-end 2011.

<img src="http://media.ycharts.com/charts/322a3e3d64fa7a52506924e4d1c2d34f.png" />

DUK Long Term Debt data by YCharts

  • Crystal River 3: The Crystal River nuclear plant which is estimated to cost Duke more than a billion dollars to repair, cost the utility company $100 million in customer refunds in the latest quarter Q3, which was offset against its goodwill account. Management has not yet decided whether it'd go ahead with repairing the plant or instead retire it. The decision on that is expected to come by mid next year. Meanwhile, the plant continues to dent Duke's operations. The plant is still out of order and wil stay closed for another two years at least and not generate a penny in return.

Opportunities

  • Edwardsport: Duke Energy is in the process of building its Edwardsport plant in Indiana that will employ a cleaner coal integrated gasification combined cycle (IGCC). It will be one of the cleanest and most efficient coal-fired power plants in the world--emitting less sulfur dioxide and nitrogen oxides, while providing more than 10 times the power of the existing plant (630 MW). The project is expected to begin commercial operation in 2012 and will place Duke in a much more competitive position, once operational.
  • Progress Energy Synergies: The merger with Progress Energy took place in the last quarter but synergies will not follow until another quarter or so. Duke is expected to benefit from the savings that will be realized from merger-related synergies once they start paying off.
  • Rate Revisions: Despite large capital investments this year, which were the result of Duke's change in its energy generation mix from coal to natural gas, the company was able to retrieve some of the costs through increases in consumer rates. The company has filed for revised rates in the Carolinas now and here lies its opportunity to earn back some more of its costs. If accepted, the new rates will go into effect in mid-2013. Duke's margins will improve as a result.
  • Commercial Renewable Energy: The company is growing its portfolio of commercially produced renewable energy and expects to touch total renewable capacity of 2,000 megawatts by year end. That's going to be a leap forward towards green energy--something our President loves. 

Threats

  • Weak Demand: When adjusted for weather, demand for Duke's energy in five states was 0.3% lower than the same period a year earlier. Bloomberg reports that total U.S power consumption for the 12 months ended in August fell 1.9%. The company anticipates that electricity demand in future, excluding the effects of weather, will grow at a rate of less than 1%.
  • High Input Costs: Increase in nuclear costs and natural gas costs are expected to put pressure on the company's margins. Natural Gas spot prices are starting to rise already.
  • Switch to Natural Gas: As Duke makes a transition from a heavy-reliance on coal to cleaner natural gas energy, heavy costs and debt burden will be borne associated with building new plants.
  • Hike in O&M: Not only will the new plants put pressure on Duke's balance sheet and cash flows statement, in the form of capital investment, but also on its income statement. The expenses of Operating and Maintaining (O&M) these plants will also have to be charged.
  • Unfavorable Weather: In areas of Duke's business (North Carolina, Florida, Ohio, Indiana), weather this year was comparatively cooler than a year earlier which led to a reduced demand for electricity to run air conditioners. Uncertainty of future weather conditions is yet another potential threat.
  • Exchange Rates: Duke's international business segment faces threat of unfavorable forex translations. The utility's power plants in Latin America have suffered in the latest quarter (EPS lower by $0.02) from unfavorable exchange rates.

Bottom Line

Going forward, Duke Energy has quite a few threats to look out for. However, its strong position in the market and future opportunities may help it live up to the 'over-rated' impression that it carries. But most importantly, the company needs to strictly consider paying down its heavy debt load.


PalwashaS has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend 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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