Excelon : Should You Buy

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

Note: This article originally misstated Excelon's owned capacity. This has been corrected.

The question that pops up when we see a high yielding dividend stock is that whether the stock is just a dividend yielding pick or a dividend yielding growth pick. If that company turns out to have a diversified business model, with good growth opportunities, the stock looks attractive. Additionally if the company turns out to be the leading player in its industry, coupled with good fundamentals, then the investment becomes hard to miss. The company that I think is a good dividend growth stock is Exelon Corporation (NYSE: EXC) and here are a few reasons why bullish about its future.

Exelon Corporation is one of the largest utility majors in the US which not only focuses on generating power from fossil and nuclear resources, but also from harnessing renewable resources like hydro and wind energy. The company provides its services to both households and industries with an owned capacity in excess of 34.5 Gigawatts and is the largest nuclear energy producer in the US.

The company acquired Wolf Hollow in August 2011, which is a natural gas based energy producer with a capacity of 720 megawatts. Exelon also acquired Constellation Energy in March this year. The deal was worth $7.9 billion, and made Exelon Corporation one of the largest power suppliers in the US. The financial benefits of the newly acquired Constellation Energy under a stock for stock exchange are yet to be seen on the books of the parent company.

The thing that troubles the investors is the debt in excess of $17 billion on the company’s balance sheet. It should be noted that most of the debt is long term due to the acquisition of Constellation, which has to be repaid between 2020 and 2037. Additionally the debt to equity ratio stands at 0.88 which is still below its peers in the industry.  In a bid to manage its debt, the company recently issued first mortgage bonds, which is expected to raise $350 million and has to be repaid by the year 2022 with a nominal interest rate.

Exelon has been consistently paying out dividends over the past 5 years and a steady increase over the period can be noticed from the attached chart. The company has a high yield of 5.9% which could easily push this stock to any income portfolio.

<img src="/media/images/user_13723/exc_large.JPG" />

However the company’s high payout ratio seems to be a cause of worry. It’s worth noting that at the end of 2011, the operating cash flows stood at $4.853 billion along with $811 million of free cash flows. The free cash flow in 2011 was reduced to half as compared to 2010. The picture for continued dividend payouts looks bleak, if we just look at the cash flows of 2011. The reason being, the company was involved in a couple of acquisitions in the year, which added to capital expenditures, and which ultimately dried up the free cash flows. Analysts expect that the cash flow situation is only going to improve, once the numbers of the newly acquired Constellation Energy start rolling in.

Another reason why I believe that the dividend payout will continue is that, Exelon Corporation has cash reserves of $2.5 billion, which is more than enough to meet the dividend payout. The company paid out $1.8 billion in dividends om 2011. Also the management of the company recently announced that it would continue to reward its investors for staying invested. All these facts give me a reason to believe that there won’t be a dividend cut.

The company shares it market space with Southern Company (NYSE: SO) and Dominion Resources (NYSE: D). Out of the three Exelon Corp appears to have the cheapest valuation, with the highest dividend yield. The company also has the least debt amongst the competitors.

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Forward P/E</p> </td> <td> <p>Dividend Yield</p> </td> <td> <p>Debt/Equity</p> </td> </tr> <tr> <td> <p>Exelon Corp.</p> </td> <td> <p>13.3x</p> </td> <td> <p>5.94%</p> </td> <td> <p>82%</p> </td> </tr> <tr> <td> <p>Dominion Resource</p> </td> <td> <p>15.41x</p> </td> <td> <p>4%</p> </td> <td> <p>170%</p> </td> </tr> <tr> <td> <p>Southern Company</p> </td> <td> <p>16.05x</p> </td> <td> <p>4.33%</p> </td> <td> <p>114%</p> </td> </tr> </tbody> </table>

In the recent earnings release, it was reported that the quarterly net income of the company, declined by more than 50%, owing to falling margins. The top-line however stood at $6.4 billion, up 42% from the year ago quarter. The company had ended the quarter with cash and cash equivalents of $1.34 billion compared to $1.05 in the same period last year.

Exelon has a diversified business model that involves energy production from renewable and nonrenewable sources of energy along with the logistics of the power produced. The acquisitions highlight the aggressive intent of the management and overall the company looks good, but its stock has failed to find a bottom for itself. I firmly believe that Exelon would make a great investment as the numbers of Constellation Energy are yet to reflect on Exelon’s books. I have a Foolish buy rating for the stock, but it's not for the risk averse.

PiyushArora has no positions in the stocks mentioned above. 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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