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SCANA Corporation: Is AP A-1?

October 31, 2011 | About:
Tarrington

Tarrington

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Value Thesis

SCANA Corporation (SCG) represents a compelling value proposition for investors because it has a long history of growing earnings, share price and dividends (the company has increased dividends nearly every single year for a half-century)and because it is building two new nuclear power plants which will permit it to continue and accelerate those three favorable trends well into the future.

Business

SCANA Corporation is the public utility holding company for the South Carolina Electric & Gas Company. The name “SCANA” is not an anagram for anything, but merely a contraction of the words “South Carolina.” SCANA Corporation trades on the New York Stock Exchange under the symbol SCG and is a member of the Fortune 500. The company was founded in 1984 and is headquartered in Cayce, S.C. The company provides electric service to 640,000 customers in South Carolina and provides gas service to 1,300,000 in the Carolinas and Georgia. SCANA has approximately 6,000 employees, $12 billion in assets and a market capitalization of about $5 billion.

ELECTRIC POWER GENERATION

Coal (6 plants) 45.9%

Natural Gas 26.6

Nuclear (1 plant) 15.1 (Once the two new nuclear plants are built this will be 55%)

Hydro (6 plants) 12.1

Oil 0.3

In addition to these electrical generation plants, the company owns 24,500 miles of electrical transmission lines and 15,700 miles of natural gas transmission pipelines.

History

SCANA Corporation began as a hydroelectric power company. A poor state like South Carolina needed electric power sources that did not require the purchase of expensive fuels from out-of-state. The original name of the company was the Lexington Water Power Company. Its first project was the Saluda Dam project on the Saluda River northwest of Columbia, S.C. Construction on the Saluda Dam began in 1927 and was completed in 1930.

The company had a couple of name changes going from the Lexington Water Power Company to the Broad River Power Company to the South Carolina Electric and Gas Company. Although the company still operates six hydroelectric plants, today it has as many coal plants and even more natural gas plants in addition to the one currently operating nuclear power plant.

The South Carolina Electric and Gas Company is a subsidiary of SCANA Corporation, but its assets and activities are the main part of the holding company. The main SCANA Corporation subsidiaries include the following:

South Carolina Electric & Gas Company (Electric Utility)

Carolina Gas Transmission (Interstate natural gas pipeline in South Carolina and Georgia)

PSNC Energy (Markets natural gas in North Carolina)

SCANA Energy Marketing Inc. (Markets natural gas in the Southeast – Parent of SCANA Energy)

SCANA Energy (Markets natural gas in Georgia)

SCANA Communications (Fiber optics networks)

During the hey-day of the Internet bubble, much was made over the SCANA communications fiber optics networks, but more recently analysts do not focus on it.

Management

The current CEO and Chairman William B. Timmerman is retiring but will remain on as a paid consultant to help the company through the transition to new management and to assist with the task of building two new nuclear power plants and bringing them online. His contract runs for five years, which should overlap the commissioning of the first plant. He will be succeeded by the current president and COO, Kevin B. Marsh.

Timmerman got his start as a certified public accountant with Arthur Anderson & Co. He entered the utilities industry with Carolina Energies Inc. He was a Senior Vice President for Finance and Administration when that firm merged with South Carolina Electric & Gas Co. in 1982 in a series of events which lead to the founding of SCANA two years later. He worked his way up through the ranks of the united companies, becoming a board member in 1991, president in 1995 and then chairman, president and CEO since 1997.

Marsh also began in public accounting with Deloitte & Touche. But he is a true company man, having served SCANA in many capacities including controller, vice president of finance and treasurer. He has also served as president of both the South Carolina Electric and Gas and PSNC Energy subsidiaries.

Market

SCANA serves North and South Carolina and Georgia. A breakdown of its electric revenue is as follows:

Residences: 43%

Businesses: 32

Industrial Plants: 17

Unclassified: 8

Competitors

Competitors are normally the critical element of any business analysis, but are less so in the case of a regulated public utility. Duke Energy is the big utility in the neighboring state of North Carolina. One of many legacies of the Duke family tobacco dynasty, this company has far less impact on the profitability of SCANA Corporation than the Public Service Company of South Carolina, their primary regulator. The Southern Company is another larger utility, mostly in Florida and Georgia. Interestingly, the Southern Company is also building AP 1,000 nuclear power plants as a part of President Obama’s “Nuclear Renaissance.”

Generally speaking, Duke Energy and The Southern Company are larger and considered safer than the upstart SCANA Corporation. SCANA pays out at a higher rate however, and is the slightly more risky/aggressive play in the Dixie electric utilities universe.

Regulatory Environment

The core electric utility business is a regulated public utility and rates must be approved by the Public Service Commission of South Carolina. The Public Service Commission has agreed to allow SCE&G to raise rates an average of 2% per year through 2019 to repay the financial costs of the nuclear reactors. These increases are separate from other increases the utility might seek. The company recently filed for and received other increases. The southeast in general and South Carolina in particular offer a pro-business economic climate.

SCANA Corporation is South Carolina’s only Fortune 500 company, and state level regulators are cognizant of its importance to the economy of the state.

In addition, SCANA has been enjoying a beneficial federal regulatory environment, particularly with respect to the licensing of its new power plants and the safety regulation of the existing nuclear plant. On the other hand, new regulation to reduce greenhouse gases may be expensive, although it is expected that the company will be allowed to recover them though their rates. Currently, 69% of SCANA’s coal capacity has scrubbers installed, but since the equipment was installed on their very best and most efficient coal plants, this coverage represents 80% of their coal-fired electric output. Note that SCANA generates almost 50% of its electricity from coal today, but that percentage will drop to 24% once the two additional nuclear plants are online.

Business Strategy

SCANA Corporation’s basis corporate strategy rests on three principles:

  • Provide energy in the most economical way.
  • Provide energy in the most reliable way.
  • Provide energy in the cleanest and safest way.
SCANA Corporation believes nuclear power is the best fit for all three principles. For instance, coal is economical and reliable but not clean. Solar and wind are clean but not economical or reliable. Oil is reliable but not clean or economical. Nuclear Energy, they believe, is economic and reliable, as well as clean and safe. Natural Gas is probably the next best choice, but it is not quite as economical, quite as reliable or quite as clean as nuclear. Hydo power is unreliable because you have to rely on the availability of development sites and those are few and far between and rarely located where needed.

SCANA Corporation is not known for making big acquisitions or pushing for rapid market growth. It is a tend-to-the-knitting kind of company which attempts to develop and preserve a sweet business.

Fundamental Metrics

SCANA Corp. (SCG) Duke Energy Company (DUK) The Southern (SO)





Dividend Rate 4.80% 5.00% 4.50%


PE Ratio 13.72 13.00 18.02


Revenues 4.64B 14.17B 18.02B


PEG 2.78 4.33 2.84


Growth Rate 6.50% 7.70 7.40


Return on Equity 10.34% 9.31% 11.51%


Debt/Equity 138.76% 83.67% 114.96%

Technical Metrics

As this is a Value Idea competition. Only secondary reliance is placed on favorable technical factors. Yet many fundamentalist investors want to check how a stock is trading before they will invest, no matter how much value they see, in order to avoid “Value Traps” and “Falling Knives.”

But SCANA Corporation common stock is trading above its 50-day and 200-day moving averages, so it is no falling knife. It has been showing relative strength against the Dow Jones Utility index since mid-September.

The stock is also trading near the higher Bollinger Band, which is considered by some technicians to be bullish.

Risks

Generally, regulated public utility companies are considered less risky than a typical publicly traded corporation. But if the net is spread widely, a list of possible adverse events can be drawn.

  • An adverse nuclear related incidence at a company plant.
  • A nuclear incident elsewhere, that increases costs and regulations on all operators.


  • But note – shutdowns of nuclear plants in Japan and Germany are helpful if this reduces the cost of uranium and other nuclear plant inputs.
Weak economic growth in the company’s North and South Carolina and Georgia Markets. A bull market in equities that favors growth companies over utilities.A negative state regulatory environment that disallows price increases.An adverse federal regulatory environment that increases safety and pollution control costs.Unfavorable tax policy.Poor relative performance compared to similar utilities – some building AP 1000 plants.Rising fuel costs for uranium, natural gas and coal that cannot be completely passed on.Unreasonable labor costs imposed by labor or the government.[/list]Note that in September Moody’s downgraded SCANA Corporation debt from Baa2 to Baa3, citing the expenses of nuclear plant development and the long lead time before offsetting electricity sales could be realized.

Primary Catalysts

SCANA currently owns and operates one nuclear power plant. This plant was evaluated after the Japanese nuclear disaster at Fukeshema, and no upgrades were required, although some additional evaluation and analysis is on-going. SCANA is in the process of building two additional nuclear power plants on the same site. These two plants are described as “on budget and on schedule.” However, the construction has barely begun (site work only until the permits were just recently received), so this may not be saying much. Nevertheless, the necessary permitting has been acquired, and this is a substantial accomplishment.

Total expected cost of the plants is expected to be $9.8 billion dollars — almost twice the company’s current market capitalization. SCANA Corporation’s SCE&G subsidiary will be a 55% owner of the completed plants at a cost of approximately $5.4 billion. The remaining 45% of the plants will be owned by Santee Cooper, a state owned electric and water utility. Completion of the two plants is expected in 2016 and 2019 respectively. Cost of the financing is expected to be kept low by Federal Government loan guarantees and by funding through immediate rate hikes. Details of government loan guarantees are still being worked out, but should amount to approximately $4 billion for SCE&G and eventual approval is expected. Also, the plant has been designed by Westinghouse to be economical to build.

Evaluation of the company’s prospects at this point becomes tricky, because it depends on the evaluation of the two AP 1000 nuclear reactors that the company is buying. Does the construction and operation of these two plants make economic sense — and so much economic sense that a good record of rising profits and dividends will become a great one? Also, are these plants safe? A Fukeshema style disaster at any of the three plants at Jenkinsville could lead to a complete loss of shareholder equity.

The two plants are a Westinghouse design. The name AP 1000 comes from term “Advanced Passive 1000 Megawatt” design. The design is called “Advanced Passive” because the plant is designed to operate safely in some emergency situations without active human intervention. It is interesting at this point to look at the picture of the proposed plant and observe that the containment structure does not look like a traditional nuclear power plant dome. It looks more like a block placed on top of a dome. That block is a water reservoir and because it is on top of the reactor, gravity will do much of the work in getting the cooling water to the reactor in the event of an emergency.

The “1000” represents the plant's approximate output. Actually, the plant should normally output more than 1154 megawatts, but the Westinghouse marketing department liked the sound of a nice round number better, and thus the name AP 1000 was born. The containment vessel is made entirely of metal, and not metal encased in cement as is the normal method. The reason is that metal is a much better conductor of heat than cement, and so hopefully it will be much more able to cool by simply radiating the heat off compared to traditional designs. Critics argue that an all metal containment building is likely to have issues with rusting.

Another interesting feature of the AP 1000 is that although it is called a “Generation III” plant, much of the design and equipment is adapted from existing models of nuclear power plant. This may be a considerable advantage, as much of the equipment is well-tested and familiar and has come down in price over the years. The recycling of tried and true technology helps to bring down costs and improve safety.

The designers of the AP 1000 also cut costs by simplifying the design. It has fewer moving parts and is much smaller in area. Reducing the size of the facility is a big money-saver, as this kind of construction is very expensive since it must be of great strength and durability. The following table from Wikipedia illustrates this point:

  • 50% fewer safety-related valves
  • 35% fewer pumps
  • 80% less safety related piping
  • 85% less control cable
  • 45% less seismic building volume
Few investors are qualified to evaluate a nuclear plant design, and we are therefore forced to rely on the fact that the plant design was approved by regulators. As an additional factor, the AP 1000 design is also a favorite of the Chinese government. China is planning on building one hundred AP 1000 plants. While the Chinese authorities are not necessarily to be taken more seriously than the more experienced United States regulators, they nevertheless represent a second vote of confidence in the safety and economics of the design. China would not build 100 such plants if they were not certain that the AP is indeed an A1 nuclear power plant design.

Note that China is ahead of SCANA in the construction of these plants, and the same engineering firms are involved. Therefore, SCANA will get the benefit of learning from the construction experience in China. As usual, the pioneer can be identified as the one with all the arrows in his back.

Secondary Catalysts

SCANA Corporation may see accelerated earnings growth in the natural gas distribution segment if the continued discovery and development of Shale Gas continues to keep natural gas supplies plentiful and prices low. This will particularly be the case if large truck fleets convert to natural gas, an idea that many believe is gaining traction. But note that benefits to SCANA depends both on truck fleets converting to natural gas and to the development of equipment that will allow gas stations to pull natural gas off of the SCANA pipeline network for compression and fueling of the natural gas fleet. Currently, the natural gas used by trucks is compressed at a centralized point and distributed as compressed gas.

Profits in the electrical segment could also be improved by any widespread adoption of electric cars.

In general, South Carolina is a business-friendly state, with many manufactures and other large power users re-locating to and expanding there. Recently The Boeing Corporation began investigating a manufacturing facility in South Carolina. Aircraft manufacture is notorious for high rates of electric consumption, and many early manufacturers started in the Pacific Northwest region specifically to take advantage of low-cost hydro-power then available there.

Takeover Rumors

There is occasional talk that SCANA Corporation is a takeover target, with a story surfacing as recently as July. One commenter contended that SCANA had advanced smart-grid technology that would be tempting to an acquirer. Others play a version of that old-time world domination board game stratego and attempt to determine which area electric utility needs SCANA to round out their grid.

One analyst has commented that he is familiar with SCANA management and has been made aware that they are not desirous of a buyout. The reason for recent buyout talk seems to be the need to facilitate the construction of the nuclear plants. The larger the company, the easier it is to finance these massive projects. It is easier and cheaper to borrow for a large company, and also the retained earnings will be much larger and much more adequate to finance big construction projects. But most likely SCANA will be able to finance the plants with Federal Government loan guarantees and rate increases. In that case, buyout talk will most likely die out quickly. Other companies will not want to buy the company in the middle of a tricky nuclear plant development.

But once the great challenge of constructing and commissioning those plants is complete, interest is likely to return.

AP1000 Resources on the Web

If you read this article carefully, you will realize that my value investing idea is actually not SCANA Corporation at all — it is the AP1000. SCANA Corporation is merely the investable vessel. In fact, although SCANA Corporation is a true dividend achiever, the principle reason SCANA was selected is because it is a little smaller than the other companies building nuclear plants. A successful AP1000 program is more likely to be a game changer for SCANA than it would be for one of the gigantic utilities.

The official AP1000 websites are probably the best place to start. They have excellent visual representations of what the finished plants will look like.

www.ap1000.westinghousenuclear.com

www.facebook.com/westinghouseap1000

www.ongo.wm/v/595238

Note that there is other substantial material on the AP1000 posted on the web, including excellent articles by critics who question the design over safety, economics, rusting, seismic safety and ability to withstand an aircraft impact. A serious investor will become familiar with all this material before making an evaluation.

Conclusion

SCANA Corporation is going to succeed in building and operating their two AP 1000 nuclear power plants, and the addition of these two new substantial assets will cause an already good financial record to become great. The returns to investors will be greater than average, while risks and volatility are lower than the general marker.

This article is for entertainment purposes only, and to stimulate public discussion of public policy and economics. It does not constitute investment advice. This article does not cover all pertinent facts and aspects of any investment, including some that could lead to a complete loss of the investment. Readers should not rely solely on this article to make any investment decision, and should complete their own due diligence. Do not make any investment before consulting with an investment advice professional. Facts presented in the article are believed to be accurate but no guarantee is made of their completeness, accuracy or timeliness.

Rating: 2.8/5 (9 votes)

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