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I am downgrading Duke Energy (NYSE:DUK) from 'buy' to 'hold' as the stock price has moved up significantly toward my price target of $70 (calculation shown below) and there is not much price appreciation left. Also, the stock has an expensive PEG of 4.2 compared with its competitors and analysts are expecting a next five years' growth rate of 3.7%, which is lower than the company's peers' average as shown below.

DUK is the leading electric utility company in the U.S. Its regulated utility operations serves approximately 7.1 million customers in six different states of the U.S. It owns a diverse generational portfolio. Following are the percentage of different generation sources:

Sources

Coal

Nuclear

Natural Gas & Oil

Renewable/Hydro

Percentage (%)

51%

29%

18%

2%

Source: Duke-energy.com

DUK has delivered strong financial results in the past and continues its efforts to further strengthen its performance. To expand and grow earnings, DUK merged with Progress Energy last year, 2012. The company is expected to enjoy synergies from the recent merger in the future. Non-fuel operating expenses are expected to go down by 5%-7%, and fuel-related synergies are expected to be $650 million over the next five years.

In last three years, DUK has increased its sales, earnings and dividends by 15%, 7% and 2.5% respectively. In 2012, DUK reported annual sales of $19.7 billion. According to the last earnings release for fiscal year 2012 and 4Q'12, the company was able to beat the analysts' earnings consensus. The following two tables show earnings stats for recent quarter and full-year 2012.

4Q'11

4Q'12

Earnings Surprise (%)

EPS

71 cents

70 cents

7%

2011

2012

Earnings Surprise (%)

EPS

$4.38

$4.32

5%

Source: Yahoo Finance

Earlier this month, DUK decided to retire its Crystal River Unit 3 instead of repairing it. This decision is likely to remove uncertainty for the shareholders regarding repairing cost and time for completion if the company had chosen to repair the plant.

Rate cases approval are important drivers for the company's earnings growth. Approval of requested rate cases means the company will be able to charge higher rates to its customers, translating into higher top and bottom lines. DUK has filed two rate cases in Ohio, two in North Carolina and one case is anticipated to be filed in ongoing first quarter of 2013 in South Carolina.

The company remains focused on achieving its financial objectives: long-term adjusted earnings per share growth of 4%-6%, target long-term payout ratio of 65%-70% and strengthen its balance sheet to maintain an investment grade credit rating.

The following table displays credit ratings assigned by three rating agencies to DUK and its subsidiary.
(click to enlarge)
Source : Investors Presentation

DUK currently has a debt-to-equity ratio of 98% and offers a dividend yield of 4.5%. Ongoing annualized dividend rate is $3.06, up from $2.76 in 2008. The tables below show annualized dividends, payout ratios and dividend coverage for the company for the past five years.
(click to enlarge)

2008

2009

2010

2011

2012

Annual Dividend per share

$2.76

$2.88

$2.94

$3

$3.06

Payout Ratio

89%

-

95%

75%

70%

Dividend Coverage

2.9x

2.85x

3.5x

2.7x

-

CAPEX as % of Sales

33%

33%

33.5%

30%

-

Source: Annual Financial Statements

Conclusion
The stock is up almost 6% YTD. I believe the stock is fairly valued at current valuations and there is not much price appreciation expected. I have a price target of $70 for the stock; calculated using utility sector forward P/E of 15.1x and DUK's 2014 EPS estimate of $4.61. Also, analysts are anticipating a growth rate of 3.7% per annum for the next five years for DUK, which is lower than its competitor's average. Moreover, at current valuations DUK has a PEG of 4.2, higher than its peers' average, which reflects the fact that the stock offers expensive growth as compared with peers. I think Southern Company (NYSE:SO) offers better investment opportunity than DUK at current valuations; therefore I am downgrading DUK from 'buy' to 'hold.'

DUK

SO

Wisconsin Energy Corp. (NYSE:WEC)

NextEra Energy, Inc. (NYSE:NEE)

Average

Forward P/E

15x

15.2x

15.5x

13.6x

14.8x

PEG

4.2

3.3

3

2.3

3.2

Five Years Growth Rate

3.7%

5%

5.5%

7%

5.3%

Source: Yahoo Finance

Source: Duke Energy: Why I've Downgraded From 'Buy' To 'Hold'