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Shares of Duke Energy (DUK), the largest electric power holding company in the United States, have hardly moved after the company reported its first quarter results last week. The company, which delivers energy to more than 7 million consumers, has seen its shares already return some 15% this year as investors see the first benefits from the acquisition of Progress and are looking for dividend payments in this low interest rate environment.

First Quarter Results

Duke Energy generated first quarter revenues of $5.90 billion, up 62.5% on the year before. Growth was driven by the acquisition of Progress Energy which was completed in July of 2012. Revenues came in ahead of consensus estimates of $5.74 billion.

Adjusted diluted earnings per share came in at $1.02 for the first quarter of 2013, down from $1.13 a year ago. Net earnings rose from $0.66 to $0.89 per share. Adjusted earnings fell as a result of the dilutive effect of the Progress deal, as well as less favorable results from the commercial power and international operations.

Favorable weather conditions and revised rates for Carolina could not offset these headwinds. On average analysts and investors were looking for adjusted earnings of $1.04 per share.

Chairman and CEO Jim Rogers commented on the developments in the first quarter, "Our first quarter earnings were consistent with our internal plan and we are affirming our 2013 earning guidance range. Our operational performance was strong, as highlighted by our 97.1 percent nuclear capacity factor, reflecting our continuing focus on optimizing the performance of our nuclear fleet."

Looking Into The Results

The US Franchised Electric and Gas division reported operating income of $656 million, up from $344 million last year. The $0.44 per share profit increase was driven by the acquisition of Progress, with operations in Carolina and Florida, which added $0.35 per share in earnings. Good weather conditions added another $0.10 per share in earnings. Duke was able to raise rates in Caroline which boosted profits, but the State Attorney General asked a regulatory panel to abandon higher rates until the effects on customers are well considered.

The international energy business reported profits of $97 million, compared to $142 million last year. The results were impacted by higher purchased power costs in Brazil as the rainy season was delayed, as well as unfavorable exchange rate moves.

The commercial power business reported a mere $6 million in income, compared to $30 million last year. Lower coal and gas generation, driven by lower PJM capacity revenues were to blame. Wholesale operations suffered as capacity payments fell due to excess capacity in national grids.

Valuation

Duke Energy ended its first quarter with $1.58 billion in cash, equivalents and short term investments. The company operates with $40.1 billion in short and long term debt, for a large net debt position of around $38.5 billion.

At this rate the company is on track to generate annual revenues of $25 billion for the year of 2013, on which the company could report net earnings of around $3 billion as the company reiterated its full year earnings guidance of $4.20 to $4.45 per share.

Trading around $75 per share, the market values Duke Energy at $53 billion. This values the company at 2.1 times annual revenues and 17-18 times annual earnings.

Despite the large debt position, Duke pays out a quarterly dividend of $0.76 per share, for an annual dividend yield of 4.1%.

Some Historical Perspective

Shares of Duke have roughly doubled after hitting lows of $35 during the financial crisis of 2009. Currently exchanging hands around $75 per share, prices are at the highest levels since 2006 but remain far removed from all time highs around $140 set back in 2001.

Between 2009 and 2012, Duke managed to increase revenues from $12.7 billion towards $19.6 billion. Net earnings advanced from $1.06 billion to $1.73 billion in the meantime, while earnings per share grew much slower as the shareholder base diluted by roughly a third over the time period. 2013s revenues and earnings are expected to grow as a result of the acquisition of Progress which was closed 10 months ago.

Investment Thesis

Shares of Duke Energy have already risen some 15% year to date as the cold winter would boost results for the first quarter. Investors are furthermore beginning to see the benefits from the massive $32 billion acquisition of Progress which was announced in January of 2011, but was only closed last summer. The whole deal was a bit messy to say the least, given the delay in the closure of the deal and the resignation of Bill Johnson, former CEO of Progress following the closure of the deal.

Investors are seeing the first benefits of the acquisition thanks to cheaper debt financing and costs savings. For the first quarter, Duke paid $367 million in interest on its massive debt balances, suggesting an effective interest rate of 3.6%. The company expected $600 to $800 million in fuel and dispatch savings in the first five years following the closure of the deal. At the presentation of the first quarter results, Duke announced that it achieved some $37 million in fuel and joint dispatch savings following the deal, which compares to $52 million in the second half of 2012.

The company is experiencing short term dilution as Duke financed the deal roughly half-half in debt and debt equity. The contribution from Progress is rapidly making up for the dilution of the deal. In the first quarter the acquired activities added $0.35 per share in earnings, offsetting 80% of the dilution following the deal.

Still a 17-18 times earnings valuation is pretty steep based on valuation metrics. Valuations of utilities have been driven up as a result of relative high dividend yields, especially in light of this low interest rate environment. Earnings growth is expected to be modest, Duke guides for 4-6% earnings growth in the coming years. Investors are comforted by management comments that it targets a 65-70% net payout target ratio.

While the current yield looks really attractive, and Duke is committed and able to continue to pay out a steady dividend, the valuation multiples are bid up too high.

I remain on the sidelines.

Source: Duke Energy - As Interest Rates Keep Falling, Investors Keep Looking For Yield