Exelon vs Duke

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

It’s an age old strategy to invest in income stocks when the markets get choppy. However not all high yielding stocks have sustainable payouts and sound financials, which is why investors should carefully indulge in income investing.

Exelon Corporation (NYSE: EXC) is one of the largest utilities companies in the world and has a market cap in excess of $24 billion. The company has been paying out dividends since the last 8 years, and at the current yield stands at a massive 7.23%. Additionally its shares trade at a forward P/E of 11.44x indicating that its shares are undervalued. Also, its Q3 sales grew by 12.8% YoY and the management increased its full year EPS forecasts.

It’s a bullish case, right?

Incorrect! The “attractive” dividends come at a cost. The company pays out 104% of its earnings, even after announcing a dividend cut. Having a payout ratio greater than total earnings is justified if a onetime payout or if the company has huge cash reserves. However, Exelon has been paying out nearly 135% for the past few of quarters, which to an extent has degraded the company’s financials. When its share price began to plunge, the management instead of focusing on its core problems, chose to retain its shareholders. In order to continue its payouts, the company raised more debt, and the result?

As of today, its debt/equity ratio stands at a mammoth 90%.

So what’s management doing?

The management recently announced that it has removed around $2.3 billion of growth capital from 2012 to 2015, in order to strengthen the balance sheet. In my opinion, this would put a halt on the company’s expansion and acquisition plans, which would negatively impact Exelon’s long term growth story. I believe that investors should stay distant from this one, especially since the board is more focused on dividends, instead of its operations.

Duke Energy (NYSE: DUK) on the contrary, looks quite attractive. On a quarterly basis, the company reported better than expected financial results. Recently the company shut down two of its coal fired power plants. The move was expected as low prices of natural gas, volatile coal pricing and growing environmental concerns, presents natural gas as an excellent replacement for coal. Additionally the company has two natural gas fired power plants under development, which by the end of 2013 would have a combined capacity of 1.545 GW. This shift to natural gas would not only save money for the company, but also allow it to competitively price its power units, without violating emission norms.

The company has 2 rate cases filed with North Carolina, which are expected to resolve in 2013. Commenting on the outcome of those cases would be purely speculative, but some analysts believe that the worst is already priced in.  So, either the shares would decline slightly or it would surge sharply.

Duke’s annual EPS is estimated to rise by 3.63%, for the next 5 years. Couple this with a hefty 4.8% yield, and we have happy investors. Its long term debt/equity ratio of 88% might seem high, but it is significantly below the industry average. Duke Energy has had lower debt/equity levels in the past, and it was only after the acquisition of Progress Energy earlier this year, that the debt metric inflated. Also it should be noted that Duke Energy retains 17.3% of its earnings, which is higher than Exelon Corporation. Deutsche Bank has a Buy rating for Duke Energy with a price target of $69 (around 10% premium).

In my opinion, investors should look to avoid the lucrative dividend yield of Exelon Corporation, and try to look at its underlying problems. Duke Energy on the other hand, despite its lower yield appears to be a great investment option due to its strong fundamentals.

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 Exelon. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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