Will Natural Gas Overpower Exelon's Nuclear Power Business?

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Until five years ago, Exelon (NYSE: EXC) was an excellent investment. It was providing stable capital appreciation and dividends to its investors. After slashing its dividend by 40% in the beginning of the year, Exelon lost most of its charm. The company has also been affected by the fall in natural-gas prices due to which electricity prices fell.  

Exelon is trying to expand its production capacity from gas but its main source of energy production is still nuclear, which is about 55% of the company's total capacity. The production of energy from nuclear plants does not come cheap as the initial set up costs are huge. Moreover, due the nature of nuclear plants, it is not feasible to stop production as and when desired.

The drop in gas prices has affected Exelon in a major way because of the company's concentration being mainly toward nuclear energy. Further, natural-gas generators are cheaper to construct and operate than a nuclear plant, making power generation more profitable especially when gas prices are low. If the same situation continues, Exelon will find it hard to survive as electricity will be available from other sources.
A few analysts believe that the scenario might change in Exelon's favor if the energy department approves for more export terminals to ship gas overseas. With increased exports, what would happen is that gas prices would increase. If gas prices become inflated,  the operating cost of energy generation from natural gas would increase without affecting Excelon's cost of production. I strongly believe that there won't be any major approval for export terminals that can potentially prove a boon for Exelon in the near future.

Exelon's dividend cut no doubt was strategic, as it gave the company a margin of safety and improved its debt-to-equity ratio initially, thereby helping it retain its credit rating. However, investors will not put up with a continuous decline in earnings and return in the long run.

Amidst competition

Though Exelon has slashed dividends, another utility player and competitor, PPL (NYSE: PPL), is currently paying a yield of 5%, which makes it a safe bet for income investors. The company has a long history of increasing its dividend payments gradually, so investors can be sure that their dividend income is here to stay.
While Exelon is currently returning 8.4% operating margins to its total sales, PPL enjoys a 28.2% margin. In the last couple of years PPL has had some major regulatory wins in the U.S. and U.K. that have improved its position and further, its ongoing earnings too have surged 19%.

Compared to Exelon, PPL is less concentrated towards nuclear energy placing and is concentrated more into wind energy and natural gas. The company is thus in a better position to extract some additional benefits of falling natural-gas prices. It is moving more toward clean and renewable energy as it has completed a hydroelectric expansion project in Montana, which increases its capacity by around 70% of its current renewable capacity. PPL no doubt is headed strong into the future. 

Another utility stock with a decent dividend yield of 4.4% is Ameren (NYSE: AEE). The company is trying to move more into regulation, which will make it neutral toward fuel price wars, making its returns more stable. Further, the company's success depends on how quickly it offloads its three gas centers and is able to move forward with the sale of its five coal-generated power plants to Dynegy

Currently, Ameren is under a financial crunch with a heavy debt sitting on its balance sheet and a lot of regulatory pressures surround its plans of moving ahead with the sale of any of its plants. No doubt the company has some very strategic plans by moving toward regulation and offloading its merchant- generation fleet, but an air of uncertainty that surrounds Ameren does not make it a very solid investment option. 

Final words

Exelon is well equipped to derive benefits from the demand shifting toward clean sources of energy, but that is a thing of the future  -- if it is cost efficient until then. If gas prices remain flat over time, Exelon might find it hard to even survive with negative earnings. At the moment, there are no reasons for me to be willing to put this utility stock in my portfolio.

As the nation moves increasingly toward clean energy, Exelon is perfectly positioned to capitalize on having the largest nuclear fleet in North America. This strength, combined with an increased focus on balance sheet health and its recent merger with Constellation, places Exelon and its resized dividend on a short list of the top utilities. To determine if Exelon is a good long-term fit for your portfolio, you're invited to check out The Motley Fool's premium research report on the company. Simply click here now for instant access.

tarun bachhawat has no position in any stocks mentioned. The Motley Fool recommends 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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