Seeking Alpha
Profile| Send Message| ()  

Introduction

The utilities market in U.S. is home to some very large and pivotal companies which meet the requirements of power generation. In recent time, there has been a lot of focus on producing clean and green energy in an attempt to please the Environment Protection Agency's demands. By doing so, the use of coal to generate energy has more or less been outlawed, and power generation is now being focused more towards natural gas and oil. I take a look at Duke Energy (DUK), Southern Co. (SO) and American Electric Power (AEP) and aim to find out the best addition to your portfolio.

Financial and Market Snapshot

In the comparison ahead, while there will be direct metric analysis, I would also like to justify the criteria on which I base my decision in regards to utilities stock. Companies which have reliance on coal-fired power plants will have a clear cut disadvantage since they have no concrete source of revenue generation in the future. Furthermore, I understand that a lot of companies are using coal-fired power plants at the moment with plans to switch soon - in this case, nothing speaks louder and clearer than the amount of money being invested in setting up new power plants.

Indicator

Duke Energy

Southern Co.

American Electric Power

Price/Earnings ttm

21.9

16.6

15.2

Price/Book

1.2

2.0

1.4

EPS Growth

(3 Year Avg.)

6.2

4.3

5.5

Dividend Yield, %

4.44

4.41

4.14

Debt/Equity

0.9

1.0

1.0

Return on Equity

5.1

12.0

10.3

Current Price

$68.83

$44.43

$45.36

Estimated Fair Value Range

$46-$104

$34-$56

$36-$68

Current Stock Valuation

Fairly Valued

Fairly Valued

Fairly Valued

Data from Morningstar and Financial Visualizations on February 22, 2013

Duke Energy is the nation's largest electric company after merging with Progress Energy in July 2012. Its fourth-quarter earnings soared 51% and beat analyst expectations due to the acquisition. The company has spent $7 billion in retiring 3,800 MW of coal capacity while buying three new North Carolina power plants which were planned to come online by the end of 2012. By 2015, the company aims to retire 6,800 MW of coal power plants and replace them with either clean renewable energy farms i.e. wind and solar, or gas fired power plants. Over the next decade, the company plans to spend $5-6 billion for compliance with stricter air emissions regulation. On the financial side, Duke has not had spectacular cash flow for all of 2012 and an increased debt load only makes matters worse. The company's debt/equity ratio is almost one, which makes it a huge concern for investors, even though the average debt/equity ratio for utilities industry is one itself. The company's EPS can only hope to get better with the induction of new power plants which will help reduce cost in the long run which will also help with ROE. Furthermore, the dividend yield of about 5% has historically been higher - while a higher dividend yield should not be expected for the time being, it is still a massive percentage for investors to contemplate.

Southern Co. improved its EPS by 5% in Q4 2012, succeeded in expanding its margins and offers a high dividend of 4.41%; the annualized dividend paid is $1.96 per share, in quarterly installments. The company is building a coal-gasification plant in Mississippi and a nuclear plant in Georgia; however, both are more expensive to build than traditional gas-fired power plants. With a P/E of 16.6, it is one of the least valuable stocks amongst this comparison, outdone only by Duke Energy. The company's fourth-quarter profit rose by 44% as operating and maintenance costs were curbed and the demand for energy increased due to colder weather. The positive Q4 margins and performance allowed SO to have a relatively high ROE of 12%. The company's debt/equity reading is below market average and increasing debt should be expected due to the expansionary strategy taken up by the company.

American Electric Power beat analyst estimates for its EPS of Q4 2012 by announcing operating earnings of 50 cents per share but had to report registered earnings of only 5 cents because of Ohio Plant's impairment charges and restructuring programs. While the company may have performed well in the last quarter, its heavy dependence on coal for power generation worries for its future prospects. Stricter environmental regulations are forcing the company to retire 5,400MW of coal power generation by 2016. Unlike its peers who are shifting from coal power plants altogether, AEP is planning to spend $4-5 billion to make its coal plants compliant with the new regulations while shifting some of its power plants to gas fired plants. Up to 65% of the company's power generation comes from coal which is why it continues to capitalize on this mode of production. AEP's ROE is matched and outperformed by the majority of its competitors and adopting more efficient gas fired power plants may be a smarter option for the future. The company offers a yield of 4.14% which is lowest amongst the competitors in question but may be justified due to the stock price being cheaper as well. Furthermore, the company needs to improve its earnings consistently to be more competitive in the eyes of investors which have better options in the utilities market.

Make or Break for Investors

It's apparent that all of the power producers are in the midst of a transition from coal to gas-fired power plants. But some started early in their transformation and others are starting just now, which gives investors a distinct choice for their decision. With natural gas being used in such large quantities, is it safe to assume that gas prices will rise quite considerably and lower producer margins? If this holds to be true, then Duke Energy holds advantage in the utility market as it is way ahead of its competitors in completing its transition to gas-fired power plants. The company has the opportunity to take advantage of low gas prices, excused production cost and the largest utility company in the U.S. to stamp its authority.

Morningstar provides the following ratings for the above noted stocks: DUK - 3/5 buy, 1/5 hold, 1/5 outperform. SO - 1/5 buy, 2/5 hold, 1/5 underperform. AEP - 5/5 hold.

Bottom Line

While Southern and American Electric Power are undoubtedly expanding and outperforming stocks on their own, their routes towards having an environmentally sustainable business are beaten by Duke. SO has a difficult and expensive road ahead in its coal-gasification and nuclear plant construction, while AEP is way too dependent on coal in my opinion. DUK on the other hand, has reacted positively to the Environment Protection Agency's restrictions and its massive change towards gas will allow it to reap benefits in the future.

Source: Utilities: Many Bargains But Duke Is The 1 And Only Winner