Despite offering high dividend yields and low betas, utilities still face significant uncertainty in the years ahead. From regulatory headwinds to margin challenges, value creation has several limitations. Accordingly, the Street is currently reserved about Exelon (EXC), NextEra (NEE), and PPL (PPL).
From a multiples perspective, PPL is the cheapest of the three and still rated a "hold" according to T1 Banker. It trades at a respective 10.9x and 11.6x past and forward earnings; Exelon trades at a respective 10.5x and 13.8x past and forward earnings; NextEra trades at a respective 13.1x and 12.1x past and forward earnings. To put this in greater context, consider that PPL is valued at only 69% of its historical 5-year average PE multiple versus 77% for Exelon and 96% for NextEra.
At its fourth-quarter earnings call, Exelon's management noted several challenges:
"Our fourth quarter operating earnings were $0.82 per share. While December was a little disappointing due mostly to weather, our full year 2011 operating earnings per share of $4.16 were within our final guidance range, better than our 2010 results and well above our original expectations for the year. Our leading drivers in '11 were the strong performance of the generation fleet, led, of course, by our ninth consecutive year of over 93% capacity factors in nuclear that's helped significantly by our Texas operations. Tax benefits helped us a great deal. The impact of the Illinois Energy Infrastructure Modernization Act was positive, as was our summer weather. The good news was partially offset by costly storms at both ComEd and PECO and lower than weather-normalized load at PECO. ComEd had a terrible July storm wise, which we soaked up successfully, and PECO had both a hurricane and a freak fall snowstorm".
The merger with Constellation (CEG) is estimated to close 2012 and, in my view, will be dilutive to value if secular trends are positive for gas. Moreover, it will be hard to unlock value anyway, given that management had to make concessions valued at around $1B, according to Morningstar. Exelon reported hedging against 34% of estimated 2014 production, on average, across its fleet. In this respect, Constellation may help expand margins by offering its own hedges. Aside from uncertainty over the Constellation merger, Exelon Generation has hindered value creation.
Consensus estimates for Exelon's EPS forecast that it will decline by 27.2% to $3.03 in 2012, and then by 6.6% and 1.4% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $2.78, the rough intrinsic value of the stock is $36.14, implying 7.8% downside.
NextEra posted fourth-quarter adjusted EPS of $0.93, up 16.3% from a year ago. Earnings were, overall, around the low side of past guidance, with particular weakness at Energy Resources. The company should consider hiking rates for its regulated utilities. Towards that end, management submitted a rate case that is likely to receive a judgment by 4Q12. When solar and wind projects start in 2013, growth is likely to kick in to maximize free cash flow. Having recently boosted the dividend yield by 9.1%, management has excited greater investor entry.
Consensus estimates for NextEra's EPS forecast that it will grow by 2.7% to $4.31 in 2012, and then by 10% and 3.8% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $4.92, the rough intrinsic value of the stock is $63.96, implying 6.3% upside.