Seeking Alpha
Long/short equity, deep value, value, special situations
Profile| Send Message|
( followers)  

We think Exelon Corporation's (NYSE:EXC) Chief lobbyist Elizabeth Moler said it best when she said that Exelon is "The President's Utility." Exelon reminds us of President Barack Obama in that both were the hottest and most popular figure in each figure's respective field of endeavors back in the summer of 2008. Obama was the most popular political figure in our lifetime during the summer of 2008 and Exelon's stock had reached a peak of $92.13 in July of 2008. Both have been supporters of making energy costs skyrocket, both have generated mediocre performance since 2008 and both offer excuses instead of accountability for their failure to generate performance. In our critically acclaimed August 13th report evaluating Exelon's Q2 2012 performance, we were amused at the alliterative alphabet soup of adjustments (EXC's Q2 2012 adjustment letter footnotes" went up to "J") in Exelon's Q2 2012 results. Despite the fact that Natural Gas Prices have skyrocketed from $1.89/MCF in April to $3.29 as of the end of 2012, Exelon served up another steaming hot bowl of excuses to investors with regards to its financial performance. At least EXC's management decided to skip the alphabet soup coding of adjustments and use numbers (29 adjustments duly noted in its earnings report). At least EXC's share price has bounced back by over 25% in the wake of its 40% dividend cut.

Source: Morningstar Direct

Despite the fact that the number of natural gas drilling rigs declined by 40% year-over-year and has steadily declined since October 2011, natural gas production has held up pretty steady. Exelon bulls could point to the fact that monthly natural gas production declined by 1.2% in January 2013 versus January 2012. We would like to remind Exelon bulls that monthly natural gas production had registered a year-over-year increase for 30 straight months before its 1.2% dip in January 2013 and this was in spite of a steady reduction in the number of natural gas drilling rigs. We're surprised that Exelon's projected adjusted EPS for 2013 ($2.35-$2.65) is below its $2.85 in adjusted EPS in 2012 even with the recent run-up in gas prices. All of EXC's business units are expected to see declines in the applicable business unit net income. Although natural gas drilling rigs have declined by 40%, oil drilling rigs have increased by 4% and crude oil production has increased by 12.5% year-over-year in the first two months of 2013.

Source: US Energy Information Administration

We are glad that Exelon's Cover Slide did not include the words "Performance that Drives Progress" in its financial presentation supplement documents since we see a company with a long and proud track record of underperformance and its 2012 adjusted EPS regressed back to 2004 levels. We're surprised that EXC is proud of its performance because although its 2012 adjusted EPS was at the high end of its June 2012 guidance, its adjusted EPS still declined by over 31% even though natural gas prices have almost doubled in the last six months and that provides positive incremental revenue to EXC's wholesale power generation subsidiary Exelon Generation. EXC's management is entitled to its own opinion, not its own facts. Although Exelon's management and its stockholders insist that Exelon is different than typical regulated utilities, EXC cut its dividend so that it would be within the 65-70% payout ratio that regulated utilities typically pay. We can't help but laugh at that considering that Wisconsin Energy (NYSE:WEC) is 90 miles north of Exelon and it is increasing its dividend to converge with the 65%-70% that typical regulated utilities pay.

Source: Morningstar Direct

Evaluation of Exelon Generation LLC (Power Generation Subsidiary)

We were disappointed but not surprised that Exelon did not report pro forma results for Exelon Generation. That didn't really matter because we can rely on it to generate mediocre performance. Despite bulking up the division with the acquisition of Constellation NewEnergy, ExGen's adjusted net income declined by 21.1% year-over-year in Q4 2012. Exelon's bulls have continually brayed "Wait until natural gas prices rise". Despite the fact that Henry Hub Natural Gas prices have risen by over 80% from the end of April 2012 to the end of December 2012 (plus another 30% during the first four months of 2013) and despite the inclusion of NewEnergy's operations in the income statement, ExGen's year-over-year adjusted net income declined by 27.7% ($2B in FY 2011 to $1.55B in FY 2012). Unfortunately ExGen had $986M in "non-recurring charges" FY 2012 versus $231M in FY 2011.

ExGen's adjusted net income declined due to higher nuclear fuel costs, lower realized market prices for the sale of energy and a lower capacity utilization factor on a year-over-year basis. ExGen achieved a 92.7% capacity factor in 2012 versus 93.3% in 2011. We believe that EXC's management should be pleased that the Net Average Realized Margin/MWH sold increased on a linked quarter basis since natural gas prices have been rapidly rising since April. We were surprised that natural gas prices have continued to rise so rapidly because we don't see any rational and fundamental reason for gas prices to keep up the rapid increase since April. The reason why we think natural gas prices have no fundamental reason to rise is because of the following reasons:

  • The US is facing an economic slowdown thanks to the tax hikes passed earlier in 2013
  • ObamaCare is scheduled to be implemented in 2014 (eight months away),
  • The European debt crisis is still a nagging concern and
  • Hydraulic fracturing serving as a supply and demand changer for natural gas.

Source: Exelon's Last Eight Earnings Releases

Evaluation of Utility Subsidiaries

Commonwealth Edison's Revenue declined by 5.36% during Q4 2012 versus prior year levels; however, the majority of the revenue decline was offset by sharply reduced purchased power expenses. ComEd's operating income actually increased by 6.32% year-over-year even with a 32.6% increase in operating and maintenance expenses during the period. ComEd's depreciation and amortization expense saw an increase of over 2% during Q4 2012 versus Q4 2011. FY 2012 adjusted net income has declined by 5.46% versus FY 2011. Although the Illinois Commerce Commission had agreed to reopen ComEd's formula rate case; the results were unfavorable to ComEd. As a result of the unfavorable ruling, ComEd has deferred $450 million of capital expenditures from 2012-2014 to 2015 and beyond. ComEd filed a notice of appeal to challenge the interest rate used on reconciliation balances.

PECO's adjusted Net income increased by 9.46% in Q4 2012 versus Q4 2011 and increased by 78bp in FY 2012. Operating revenues increased by 1.54% for Q4 2012 versus Q4 2011 levels but decreased by 14.35% for FY 2012 versus FY 2011. PECO's operating revenues were nearly offset by reduced excise taxes and purchased power and fueling costs. PECO's gross margin declined by 2.4% year-over-year in FY 2012 versus the FY 2011 period. PECO's performance was also influenced by unfavorable weather trends in its Southeastern Pennsylvania service area, most notably the Hurricane Sandy super storm.

Baltimore Gas and Electric actually saw its revenues increase in Q4 2012 versus Q4 2011 even with the lower cost for purchased power and other fuel expenses. However, its year-over-year performance for the full FY 2012 versus FY 2011 was not as encouraging. BGE's revenue declined by 10.9% year-over-year in 2012 versus 2011 and its gross margin declined by 7.4% due to lower prices on the electricity and gas sold. BGE's weaker gross margin was compounded by higher maintenance and operations costs, higher depreciation expenses and slightly higher property and excise tax expenses. BGE's operating income declined by 58% year-over-year and it lost $9M during the year. Excluding the preferred stock dividends, BGE made a whopping $4M profit for FY 2012.

We'd also like to point out that Wisconsin Energy is 90 miles north of Exelon and its oldest operating subsidiary ComEd. Wisconsin Energy generated a higher level of net income during the year than ComEd and BGE combined as well as PECO and BGE combined. Wisconsin Energy's Net Income was within 71.5% of the combined net income of Exelon's three utility subsidiaries, despite having one-third the total revenue of Exelon's collective utility subsidiaries and a metropolitan service area (Milwaukee) that has maybe 8% of the total population of the metro areas of Exelon's three utility subsidiaries.

Source: Wisconsin Energy and Exelon Q4 Earnings Releases

Exelon's management forecasted that its FY 2013 adjusted EPS would range from $2.35-$2.65, which was below the $2.85 achieved in 2012. Considering that it is a wide range, we think that's a pretty easy goal to meet. Wisconsin Energy only has a $0.10 range ($2.38-$2.48). Another thing we don't like about Exelon is all the "non-recurring charges that it takes." Of the $1.55B in "adjusted net income," $986M represents "non-recurring charges" that reduce reported EPS. Wisconsin Energy didn't report any "non-recurring charges" this period. Then again, Wisconsin Energy is the Midwest's leading utility company and as such, it doesn't have to Alibi Ike its earnings with "non-recurring charges."

ExGen accounted for nearly all of the "non-recurring charges" and with $986M of "non-recurring net charges" this accounted for 64% of its "adjusted segment net income." Plant divestitures required in order to satisfy regulatory approvals of the Constellation acquisition accounted for $236M in realized losses on the sale of the plants in Q3 2012. Constellation merger and integration costs accounted for $189M in non-recurring costs, amortization of commodity contract intangibles accounted for $758M in non-recurring costs and other non-recurring gains and losses accounted for a net benefit of $197M. The good news is that Exelon's management thoughtfully put a number explaining each adjustment to net income in 2011 and 2012. The bad news is that the "adjustment number footnotes" went up to "29" in this quarter. Even with the lack of adjustments, Wisconsin Energy's actual profit margin was comparable to PECO's adjusted profit margin. WEC's actual profit margin exceeded the adjusted profit margin of the rest of Exelon's subsidiaries, including the highly-vaunted Exelon Generation wholesale merchant power generation subsidiary.

Source: Wisconsin Energy and Exelon Q4 Earnings Releases

Conclusion

In conclusion, we believe that if one is looking for a high-quality utility to invest in, we don't recommend investing in Exelon. While the bounce back in natural gas prices will help keep profits at Exelon and its flagship subsidiary ExGen from collapsing further, we are still not impressed with Exelon's operations, assets or its management. Even with natural gas prices in Q4 2012 exceeding the levels seen in H2 2011, EXC's adjusted EPS declined by 31.5%. Exelon's bulls were braying about EXC's 6% dividend yield last year, but then EXC ended up cutting its dividend by over 40% earlier this year. We think Exelon's ticker EXC is short for "EXCuses," since the company seems to have those in spades. Considering that natural gas prices are more than double the lows last achieved in April 2012, we think it is inexcusable for Exelon to project adjusted EPS in 2013 ($2.35-$2.65) than were lower than the $2.85 achieved in 2012.

Source: EIA Natural Gas Pricing Data

Disclosure: I am long WEC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.

Source: Exelon: The President's Utility Continues Its Record Of Futility