- Duke’s international business is viewed as a growth area for the firm given that U.S. load growth is expected to be sluggish going forward
- International business margins are high (42% EBITDA compared to around 30% for U.S. business), but revenue growth will be a key catalyst for Duke’s stock price
- Brazilian operations account for nearly half of Duke’s international generation assets
- Brazil’s electricity market looks promising due to high rates (double U.S. rates ) and low per-capita consumption (one-fifth of U.S. consumption)
Duke Energy’s (NYSE:DUK) international energy business is viewed as a cornerstone of the companies growth strategy given its access to the energy hungry Latin American market. The division owns and operates electricity generation capacity and sells and markets electricity and natural gas in Latin America. Here we take a look at Duke’s Brazilian operations which account for a bulk of its Latin American assets.
Overview Of Brazilian And International Operations
Duke owns around 2.1 GW of power generation capacity in Brazil all of which is hydro-electric. The division accounts for nearly 45% of the firm’s international generation capacity. The international business unlike the U.S. Franchised Electricity and Gas (USFE&G) business does not own transmission and distribution assets to serve end users. Instead, it sells power to customers like retail distributors and electric utility firms. Rates, which are higher than the U.S., still vary based on the competition from other generators. The margins for the international business are higher compared to Duke’s U.S. operations. In 2012, the USFE&G business had EBITDA margins of around 32% whereas the international business margins were around 42%.
Why Is The International Energy Business Important To Duke?
Duke’s international assets presently account for just about 7% of the company’s sales and around 10% of the firm’s Trefis price estimate. However, they are becoming increasingly important for the company’s long term growth since most of the companies revenues (more than 90%) currently come from the U.S. market, which is expected to witness sluggish demand growth (around 1%) going forward due to slowing customer additions and also due to an increasing awareness on energy conservation. The demand from the industrial and commercial sector is also likely to remain tepid due to the tough economy. While there is some room to improve profitability in the U.S. through better efficiencies and cost control, it is unlikely to have a significant impact on the firm’s valuation. We believe that progress in the international markets will be a key catalyst for the firms stock.
Factors That Will Drive Performance In Brazil.
Brazil is Latin America’s largest economy and holds nearly a third of the region’s population. While the economy had expanded rapidly in the past, GDP growth has moderated of late, and is expected to be around 3.2% this year.  Despite the moderate economic growth, we believe that the electricity sector in the country remains attractive due to the currently low per-capita consumption and high retail prices.
Low Electricity Consumption: Electricity consumption in the region is still very low and there is potential for significant growth. Annual per-capita electricity consumption in Brazil is around 2,384 KWh while it is around 13,394 kWh in the United States.  However, the consumption growth is expected to be strong and the country’s state run Energy Research Corporation expects annual growth to be around 4.5% over the next decade, which would require generation capacity to grow by around 56% in that period.  A large portion of this growth is expected to come from the commercial sector.
High Electricity Prices, But Rate Cuts Pose A Threat: Retail electricity rates (paid by the end consumer) in Brazil are more than $0.12 per kilowatt hour (kWh) compared to around $0.06 per kWh in the United States.  Although a part of these high costs are due to the higher transmission losses, it is also because of the scarcity of supply and strong demand.
The Brazilian government has announced that it will reduce electricity rates by around and between 16% and 32% for industries and households in a move to help reign in inflation and stimulate the economy.  However, the short term impact of these cuts is expected to be negligible since most of Duke’s power sales have been contracted through 2014, and partially committed till 2016.
Low Rainfall Could Drive Up Costs: Duke’s Brazilian operations rely on hydroelectric power assets and of late the country has been experiencing low rainfall. If these conditions continue to persist, it could drive up generation costs for the firm and subsequently impact profitability of the firm’s international business segment. (Seeking Alpha)
We have a price estimate of $67 for Duke Energy, which is around 5% below its current market prices.
Disclosure: No positions