Regulated utilities are low risk businesses that offer stable income and high dividend yields, which is why they have remained popular among income-seeking investors. U.S. utilities are scaling down their merchant power businesses due to a weakness in forward power prices. Duke Energy (DUK) is also among those utilities companies who plan to sell their merchant power business and strengthen their regulated operations. Already, 85% of DUK's operations are regulated. I reiterate my bullish stance on the stock, as the company has almost resolved all rate case proceedings (except Ohio) and is now focused on cost curtailment to support its earnings and strengthen its credit outlook. Also, the company offers a solid dividend yield of 4.3% and intends to strengthen its regulated operations further, which will provide further earnings stability and visibility.
Key Growth Drivers
Utility companies are struggling to maintain the profitability of their merchant power assets because of lower power prices. Capacity power prices for merchant assets have declined by more than half in the last five years because of weak natural gas prices and lower industrial demand. Consistent with the rest of the industry, DUK intends to sell off its merchant assets. Recently, DUK has started work to sell more than a dozen of its merchant power plants. The sale is not yet started and the bidding process is expected to begin in early 2014. The sale of the plants is expected to generate $1.5-$2 billion in proceeds, which I believe will be used by the company to strengthen its regulated operations and repay debt. As the company will scale down its merchant assets, it will have a positive impact on the company's future earnings.
The proceeds of the plants sales are likely to be directed towards low-risk and regulated operations. Also, the company has started to realize the threat that solar and other renewable power plants pose to the company and the industry, and encourages the adoption of renewable power plants. The company plans to strengthen its renewable portfolio in Florida and Carolina, in addition to the existing 2000MW of wind portfolio. As the company continues to make capital spending to expand its regulated operations, it will result in rate base growth and fuel long-term earnings growth.
Currently, the company has total debt-to-equity of 100% and holds investment grade credit rating assigned by different credit rating agencies. During the recent EEI conference, DUK announced to use $700 million of offshore cash to pay off debt. The repatriation of almost $700 million of offshore cash will be part of a one-time tax advantage structure. The repayment of debt will improve DUK's financial flexibility and strengthen the credit outlook. The following table shows the credit rating assigned to DUK by different credit rating agencies.
Also, the company has resolved almost all of its pending rate cases, except in Ohio, which provides more visibility and stability into the future's earnings. The company only has one major rate case pending in Ohio, in which the company has requested a rate increase of $729 million through May 2015. The outcome of the rate case is expected by the end of the year. If DUK gets the desired rate case approved, this will bode well for future earnings and increase investor confidence.
Moreover, as the company has no major pending rate cases in 2014 through 2016, it remained focused to reduce expenditures to fuel earnings growth. The company's management anticipates total operational and maintenance (O&M) expenses to remain flat through 2014, and expects to achieve its 5%-7% non-fuel saving target by 2016.
I reaffirm my 'buy' rating on the stock, as I believe the company is likely to benefit from the sale of its merchant assets and the expansion of its regulated operations. Also, the strengthening of renewable energy portfolio and cost containment efforts will bode well for the stock price in the long run. Moreover, DUK offers a solid dividend yield of 4.3%, backed by a strong operating cash flow yield of 13%, which makes it's a good investment prospect for income-seeking investors.