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Avoid This Stock, Despite The Earnings Beat
Posted by: Sarfaraz A. Khan (IP Logged)
Date: November 16, 2013 01:28PM

About two weeks ago, one of the leading American nuclear power producer and one of the largest suppliers of wholesale electric power, Exelon Corp (EXC), released its quarterly results in which its profit significantly increased due to lower expenses and a positive impact from hedging activities. Excluding the one-off items, the company still managed to beat market’s consensus estimates.

However, despite the better than expected performance, the business environment looks very challenging while its shares will likely remain under pressure due to pessimist sentiments expressed in the analysts’ ratings (discussed later). Therefore, I believe that investors are better off staying on the sidelines for the moment.


Quarterly Results
The company’s adjusted earnings rose 1.4% to $667 million, or $0.78 per share, from $658 million, or $0.77 per share, from the same quarter last year. The earnings were considerably above the market’s expectations of $0.66 per share. Similarly, while revenues dropped by 1.2% to $6.50 billion, but Exelon still delivered better results than market’s consensus estimate of $6.20 billion.


The fall in revenue growth can be attributed to lower sales from PECO Energy Company and Commonwealth Edison Company (ComEd), although to some extent, better performance from Baltimore Gas and Electric (BGE) and Generation did offset some of the revenue drop.

SEGMENTS Qtrly Revs. 2012 Qtrly Revs. 2013 Change
Generation $4,031M $4,255M +5.6%
ComEd $1,484M $1,156M -22.1%
PECO $806M $728M -9.7%
BGE $720M $737M +2.4%


On the bright side, Exelon’s purchase power and fuel expenses fell by 9.4%, while 20% decline was witnessed in operating and maintenance costs. Consequently, this drop in expenditure was able to completely offset the decline coming from operating revenues. As a result, the company’s operating income rose by a huge 108% to $1.3 billion.


Challenging Business Environment

Exelon has been struggling due to the lower natural gas prices and weakness in the forward power prices. Struggling with growth, the company started expanding in the retail power sector (through the $8 billion acquisition of Constellation Energy) and in the renewable energy sector (through its purchase of a 230MW solar farm). However, Exelon is still primarily about nuclear power. The company boasts of a massive nuclear fleet, which represents about one-fifth of America’s total nuclear power capacity.


As a result, Exelon has to endure serious oversight of the Nuclear Regulatory Commission (NRC). This makes it difficult for the company to reduce its Capex and operating and maintenance expenses (O&M). Moreover, the older a nuclear plant gets, the more O&M expenditure it requires. With a number of aging plants, this expense head will likely increase in the future.


According to data compiled by Bloomberg, in the last five years, Exelon has lost more than $30 billion of its market value on the back of falling power prices. Earlier this year, the company cut its dividend for the first time in a decade. Moreover, with the weakness in power prices and expiring long term contracts, the future isn’t looking any less challenging.


Like Exelon, other energy companies have also struggled due to flat demand and weakness in energy prices. In its latest integrated resource plan, Duke Energy (DUK) has delayed its estimates related to the construction of new power plants. In 2012, the company announced that the market would require a new 680MW plant in 2016 and an 840MW plant in 2018. However, the company has now delayed its projections by a year to 2017 and 2019. Similarly for 2028, Duke Energy has lowered its demand projections from 117,195 GWh to 113,769 GWh.


Similarly, The Southern Company (SO), the owner of Alabama Power, Georgia Power, Gulf Power, and Mississippi Power , and Southern Power, has also been struggling due to the weakness in power prices. In its recent quarterly results, the company missed both top and bottom line estimates. With soaring costs, delays on projects and a tough business environment, its short term outlook looks tough.


Future Outlook
For Exelon, the optimist investors are eyeing strong dividend growth in the coming years, following the dividend cut mentioned earlier. However, Goldman Sachs thinks otherwise. Not only has Goldman Sachs reduced Exelon’s EPS outlook for the next 3 years, but due to the weakness in pricing environment in its core operating regions, margin pressure and higher expenditure requirements, it believes that it is unlikely that the nuclear giant would go back to dividend growth in the near future.


Not surprisingly, Goldman Sachs has given a sell rating to Exelon’s stock while it has reduced the price target to $26 from $29. Similarly, Jefferies, which rates Exelon as underperform, has also lowered its price target to $24.50 from $29.


Exelon’s shares closed at $28.12 for the week ending November 15.


For the full year, Exelon has lowered its EPS guidance to between $2.40 and $2.60 per share, from the earlier estimated projection of between $2.35 per share and $2.65 per share.
Disclosure: This article was written by Sarfaraz A. Khan, with valuable contribution from Gohar Yousuf, research assistant at Half Bridge Business Review. Neither Sarfaraz A. Khan, nor Gohar Yousuf have any positions in the stock(s) mentioned in this article.

 



Stocks Discussed: EXC, DUK, SO,
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