Is Duke Energy Still A Buy?

| About: Duke Energy (DUK)

Duke Energy (NYSE:DUK) recently reported and improvement in its fourth quarter 2013results. Its adjusted diluted EPS was $1 which is 30 cents higher than the EPS of the same quarter of the previous year. For full year 2013 the company achieved adjusted diluted earnings per share of $4.35 compared to $4.32 in 2012.

During the quarter the company continued to drive efficiencies and achieve lower operating costs as a result of a merger with Progress Energy. In addition to the merger synergies the timely recovery of infrastructure costs through revised customer rates also helped the company to improve the bottom line. The segment wise earnings contribution can be seen below.

Going forward, the company expects a retail load growth of 0.5 percent. Similarly, the nuclear outage levelization will contribute to increasing earnings by $0.5 - $0.6 per share in 2014. Another factor that is worth mentioning here is that the company was able to keep operation and maintenance expenditures flat through 2014. So after considering these factors, the company expects its full year 2014 adjusted earnings guidance to remain in the range of $4.45 to $4.60 per share. However, in the long term, the earnings are expected to grow at a longer term annual growth of 4% to 6% through 2016.

In addition to the strong results the company announced the possible divesture of its Midwest generation assets. Throughout the rest of the article I will be discussing its possible impact on the company's earnings capacity.

Transition Towards Stable Earnings: Divesture of Merchant Business Assets

Duke Energy's Midwest generation assets are a part of the company's commercial power division and account for a bulk of the division's revenues and generation capacity. The Midwest generation business includes 13 power plants with a total capacity of 6,600 megawatts. The prices on the PJM Interconnection market, on which the Midwest assets sell their electricity, have been quite volatile. Moreover, after Ohio regulators denied Duke's request to collect a capacity charge of around $768 million the company started to divest these assets. In addition, due to weaker anticipated industrial demand as well as rising gas prices the company has initiated a strategic process to exit ownership interests in 13 natural gas, coal, and oil fired power plants.

The management recently observed, "Our merchant power plants have delivered volatile returns in the challenging competitive market in the Midwest. This earnings profile is not a strategic fit for Duke Energy and we have begun a process to exit the business". However, the company remained fully committed to the Duke Energy Ohio and Kentucky regulated utilities as these utilities are not a part of this strategic process.

What Difference Will it Make?

As a result of this announcement the company will take an estimated pre-tax impairment charge of $1 to $2 billion in the first quarter of 2014. This impairment will be treated as a special item and excluded from Duke Energy's adjusted diluted earnings per share results.

After the successful divesture of the assets the commercial power division will consist of solar and wind generation assets. The sale is expected to be completed within the next 18 months and is expected to generate sale proceeds amounting to $2 billion. The sale proceeds can be used to pay debt, acquire utility assets, or make investments in solar and other renewable generation sources that generate predictable returns.

The divesture of assets will ensure more stability in the earnings which bodes well for the stock price as utility investors prefer companies with lower earnings volatility.

Increased Dividends

In the recent past, the company declared a quarterly cash dividend of $0.78 per share which will be paid on the 17th of March 2014. This marks the 88th consecutive quarter that the company has declared and paid dividends to its common stock holders. For the full year 2013, the company increased dividends by 2 percent. With the current dividends the stock price is now trading at a dividend yield of 4.36%.

For 2014, the company anticipates it will achieve a 65- 70 percent payout and I believe that the company will be able to achieve the target. Going forward, with the successful sale of its merchant assets, the bottom line of the company will become more stable and this will further ensure the company's ability to pay dividends. However, investors need to take a closer look at the possible reinvestment of sale proceeds that will further improve its earning potential as well as its dividends.

Concluding Remarks

The company continues to impress investors with improved fourth quarter results primarily due to increased rates. Going forward, in 2014, the company will be experiencing full year rate increases. Moreover, the company intends to divest its Midwest assets as it seeks to reduce its exposure to the volatile wholesale electricity market. The divesture will bring greater earnings stability as well as the possibility of better margins ahead. However, a lot is dependent upon the realized price of the divesting assets but the company expects the reinvestment of the sale proceeds will be profitable for its earnings.

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.