Is Exelon On The Right Track?

Apr. 6.14 | About: Exelon Corporation (EXC)


Exelon is considering closing some of its nuclear power plants.

Exelon’s dividend profile is highly volatile and the recent reduction may take time to recover.

Natural gas power generation is a gateway for Exelon’s future growth.

Exelon Corporation (NYSE:EXC) has an extensive business network in 47 states, the District of Columbia, and Canada. The company is one of the largest competitive U.S. power generators with approximately 34,700 megawatts of owned capacity. Its Constellation business unit 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.

Exelon, the largest owner and operator of nuclear-power plants in the U.S., acquired Constellation energy group in an $8 billion deal during 2012 that added a growing retail power business in states such as Texas, New Jersey, and Pennsylvania. The company heavily depends on nuclear plants for its total generation capacity as the 55% of power generation comes from nuclear plants.

Exelon's Struggle Continues

The highly competitive environment and low natural gas prices were strong headwinds. The company's wholesale business has continued to struggle as power prices have remained low for a prolonged period and demand has been flat. This poor performance is reflected in the financial results as in the latest quarter the company's generating segment's adjusted earnings declined by 35% due to lower realized market prices, increased depreciation, and amortization expense and weaker margins.

The energy consumption trend is changing due to environmental impacts. According to the report by the Energy Information Administration (EIA) over a decade the nuclear power generation proportion has remained at 19% from 2000 to 2012. This proportion is likely to decline to 16% by the end of 2040 due to alternate cheaper and cleaner energy resources. Exelon's heavy dependence on nuclear generation is a major concern for the future growth of the company. In 2012, the company announced it would cancel the construction of a new nuclear power plant for the Victoria Country Station. Exelon stated that the economic and market conditions, especially the low natural gas prices, made the construction of new merchant power plants in the competitive markets uneconomical now and for the foreseeable future.

Excessive Dependence on Nuclear Power is a hit to Growth

Electric generation from the nuclear power plants will grow at a steady pace of 5% from 769 million kWh in 2012 to 811 million kWh in 2040. The nuclear generation capacity is likely to decline from 102 GW in 2012 to 98 GW in 2020. The new construction will add 5.5 GW and the upgrading of existing plants will add 0.7 GW. However the increased retirements in several regions due to challenging economic conditions will offset the improved capacity by greater numbers and the overall capacity will be reduced. On the other hand, Exelon's six nuclear power plants in Illinois have failed to turn a profit over the last five years and the company is considering closing some of its nuclear power plants because they have become unprofitable and the company will close its Oyster Creek unit in 2019. Despite the fact that Exelon achieved its highest ever level of generation in 2013 with many of its units located in the Midwest, Exelon faces fierce competition from the wind industry. The production tax credit (PTC) that Exelon has long fought hard against has allowed the wind industry to rapidly expand in states like Iowa. Although wind will only make up an estimated 4.2% of the U.S. electricity supply in 2014 it competes in the same markets as nuclear. The nuclear industry is not really on firm ground due to government support for renewable energy resources. This puts Exelon in an untenable position.

Exelon is over Optimistic about Nuclear Power Plants

Exelon operates 17 nuclear reactors at 10 power plant sites around the country and is the largest operator of nuclear power plants in the U.S. Exelon estimates that the U.S. will need at least 25-30 new nuclear reactors by the end of 2030. This estimation is quite optimistic based on the statistics. According to a report by the World Nuclear Association following a 30-year period in which few new reactors were built it is expected that six new units may come on line by 2020 and four of those resulting from 16 license applications made since mid-2007 to build 24 new nuclear reactors.

Natural Gas is a Way out from Troubles

Natural gas is a better and faster growing energy resource. Over a decade, natural gas consumption to generate electricity increased from 16% in 2000 to 30% in 2012 and this proportion will increase to 35% by the end of 2040. According to the estimates by the EIA, in the first few years of the projected period electricity powered by natural gas will slightly grow because of higher natural gas prices for the coming period. During that time period Exelon can benefit from the high prices and profitability that cheap nuclear power may improve to some extent. However, by 2017 natural gas generation will be high and the difference will continue to grow. Additionally the retirement of coal and nuclear power plants may result in new capacity. This is a pretty good opportunity for Exelon to penetrate into natural gas-fired plants because they are cheaper to build than coal and nuclear power plants. Currently in Exelon's portfolio the fossil power generation is 12,165 MW or 27% to total power portfolio. The fossil generation is comprised of oil and gas, coal and natural gas but natural gas generation is higher amongst those resources. In 2020, natural gas generation will be 7% higher than in 2013 and it will expand to 16% by the end of 2040.

Source: EIA


Exelon's total return in terms of price appreciation and dividends remained very low over twelve months. In fact its 0.02% total return has underperformed the 21.95% of the S&P and the 26.79% of Dominion Resources (NYSE:D).

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Source: ycharts

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Source: dividata

The volatile dividends history of Exelon might be a concern for dividend investors. The company's dividend growth is very unpredictable. A few quarters ago the quarterly dividend was slashed to $0.31 per share from $0.525 per share. The financial position of the company is also quite weak. By the end of 2013 Exelon's cash balance was $1.5 billion compared to $1.4 billion whereas the free cash flows stood at just $948 million. This is a significant drop and from the graph it is clear that it took time to recover the dividends after the big slash. Looking at these factors it is highly unlikely that the company will boost the dividends soon.

Exelon's heavy dependence and over optimistic approach concerning nuclear power generation seems unjustified because the company itself is considering closing its nuclear power plants. Exelon's estimated growth for the next five years is -4.80% whereas nuclear power generation will grow by 5%. Even if Exelon changes its power generation mix it will take a considerable amount of time and it is less likely that company will gain considerable growth soon. Given the situation investors should consider other energy stocks.

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

Business relationship disclosure: The article has been written by a Gemstone Equity Research research analyst. Gemstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Gemstone Equity Research has no business relationship with any company whose stock is mentioned in this article.