Exelon's 4.1% Yield Is Not Enough

| About: Exelon Corporation (EXC)

As usual within the utilities sector, Exelon Corporation (NYSE:EXC) offers an attractive dividend yield above 4%, which could represent a good opportunity for income investors. However, the company is riskier than many of its peers, and its yield should be higher than average. Exelon is one of the largest electric power companies in the U.S., and its main competitors are other large electric power companies, such as Duke Energy (NYSE:DUK), Southern Company (NYSE:SO), or American Electric Power (NYSE:AEP). It has a market capitalization of $25.8 billion and is listed on the New York Stock Exchange.

Company Background

Exelon has operations and business activities in 47 states, and the District of Columbia. The company is one of the largest U.S. power generators, with approximately 34,700 megawatts of owned capacity comprising one of the nation's cleanest and lowest-cost power generation fleets. It also provides energy products and services to approximately 100,000 business and public sector customers and approximately 1 million residential customers. Exelon's utilities deliver electricity and natural gas to more than 6.6 million customers in central Maryland, northern Illinois, and southeastern Pennsylvania, comprising the company's regulated activities. The company has also international activities in Canada, and has approximately 26,000 employees. Its merger with Constellation Energy completed in March, 2012, made the company the number one competitive energy provider in the United Sates.

In energy generation, Exelon is the largest owner and operator of nuclear plants in the United States and maintains a growing renewable energy development business. It has one of the nation's cleanest and lowest-cost power generation portfolios, with 55% nuclear, 28% natural gas, and 10% hydro, wind, solar and other clean generation Electric utility companies are under increasing legislative pressure to adopt cleaner electricity generation methods while maintaining competitive prices. This requires cleaner fuel sources, such as nuclear or wind power, instead of coal. Given that Exelon only generates about 7% of its energy using coal and oil, the company is very well placed to deal with "green legislation". This is a major advantage compared to some of its peers, like American Electric Power that relies on coal to produce about 65% of its energy.

In 2012, Exelon completed the merger with Constellation Energy increasing considerably its scale and markets, operating currently from a truly national footprint. Therefore, its financial results cannot be directly compared to 201, due to the addition of Constellation and BGE to Exelon's financial results in March of 2012. Nevertheless, Exelon achieved about $23.5 billion in operating revenues during the past year. Its operating income was almost $2.4 billion, representing an operating margin of 10%. Its net income stood at $1.1 billion and its earnings-per-share [EPS] were $1.42, a strong drop from the $3.76 per share achieved in 2011. This overall decrease is justified by lower power prices, given that both natural gas and power prices were at or near its 10-year lows during 2012. This weak pricing environment was only partially offset by merger synergies and increased operating efficiency. Exelon expects to achieve $550 million of merger synergies by 2014, which should boost the company's profitability.

Regarding its recent earnings, Exelon delivered in the second quarter EPS of $0.53 which was in-line with its guidance. Going forward, as coal plants retire Exelon is very well positioned to benefit from increasing gas and power prices. However, the timing of such increases is naturally uncertain and current low prices may continue to negatively affect the company's earnings. Furthermore, although its hedging activities provide earnings stability they also reduce upside from higher gas and power prices in the short-term, so Exelon's earnings aren't expected to increase significantly over the next few years.


Regarding its dividend, Exelon's dividend track record is quite good given that it has paid dividends consecutively over the last few years. Its dividend payment frequency is quarterly, with payments usually in March, June, September, and December. The last quarterly payment was $0.31 per share, which represents an annual dividend of $1.24. At the current share price, this gives a dividend yield of about 4.10%. This yield is attractive for income investors, but it is lower than for some of its closest peers, such as Duke Energy which yields 4.65% or American Electric Power at 4.52%.

Moreover, Exelon recently cut its dividend. Its first quarter 2013 dividend was $0.525 per share but it also announced a revised dividend policy going forward. The first quarter dividend was based on its previous level of $2.10 per share on an annualized basis, while the new dividend contemplates a regular $0.31 per share quarterly dividend beginning in the second quarter of 2013 (or $1.24 per share on an annualized basis). This cut was justified by the company's prospects of long-term low energy prices, adjusting its shareholders distributions to a more sustainable level. Exelon intends to maintain the normal cadence of quarterly dividends going forward.

Its dividend payout ratio was almost 150% in 2012, taking into account GAAP earnings. Therefore, it is hardly surprising Exelon's dividend cut at the beginning of the year. For the next few years, the company expects to reach a dividend payout ration in line with other utilities, between 65% to 70% of its earnings. Based on the company's guidance for 2013 EPS of between $2.35 to $2.65, the dividend payout ratio should be about 40-50% of its earnings which is acceptable for a mature company.

In addition to the dividend cut, the company has recently re-ordered capital plans to manage cash and protect its balance sheet. Its capital expenditures should be about $3.3 billion in 2013, which are fully funded from cash flow from operations which should amount to $5.5 billion. It also covers Exelon's cash outflows to shareholders, which are expected to be $1.25 billion during the year. As the company enjoys a good cash flow generation capacity, the dividend seems to be much more sustainable after its cut to an annual $1.24 per share payment.


Exelon's business model is much more dependent on competitive markets than most of its peers, that rely more on regulated activities. This makes the company especially exposed to gas and power prices, which leads to higher earnings volatility in the long-term. For income investors this does not provide the usual safety pursued within the utilities sector. Therefore, Exelon's 4.1% yield seems to be not enough to compensate risk assumed by investors, and better value propositions are available elsewhere, like Duke Energy in the U.S. or Snam (OTCPK:SNMRY) in Europe, as I discussed in my previous articles researching the utilities sector.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.