Buy The Progress Energy Merger - Duke's Bigger And More Stable With A Good Dividend

| About: Duke Energy (DUK)

The Duke Energy (DUK) merger with Progress Energy is now complete (as of Monday July 2, 2012). This makes the combined company, Duke Energy Corporation, the biggest utility in the US with 7.1 million customers across 6 states. The most significant news for investors is that the earnings per share guidance Of Duke Energy from before the merger has been reiterated. In other words the EPS estimate for FY2012 is now $4.20-$4.35. This is effectively the same as the $1.40-$1.45 guidance before the reverse 3 for 1 stock reverse split due to the merger. The company is still forecasting 4% to 6% annual growth in EPS. The dividend policy remains unchanged. DUK is still targeting a payout ratio of 65% to 70% of adjusted diluted EPS. Consistent with this plan DUK recently announced a 2% increase to its quarterly dividend payable in September 2012.

The new company has approximately $49B in market cap and total assets of more than $100B. It operates in the Carolinas, Florida, Indiana, Kentucky, and Ohio. It has a higher regulated percentage at approximately 85% versus DUK's prior 75%. This is a good thing in these troubled world economic times. Regulated utilities are generally allowed to recover costs for new, repaired, or replacement infrastructure through specific regulatory agency approved fees. There is a standard application and approval process for this that usually works well. The profits are usually limited by regulation too, but they are still substantial (generally ROE's are slightly greater than 10.0%). The user base is relatively captive. This is good news for DUK's investors.

The only negative fallout from the merger has been the near immediate action of Standard & Poor's Financial Services to put Duke Energy on a negative credit watch for a possible downgrade of it's A- credit rating. Apparently S&P didn't like the abrupt change in leadership from Bill Johnson to Jim Rodgers. Progress Energy CEO, Bill Johnson, who had been tabbed to lead the combined company, resigned at the last moment. Now Jim Rodgers, the Duke Energy CEO, will lead the combined company. This actually makes more sense, as Duke Energy was the dominant company in the merger. This way the culture change will be lessened. This way the man, who has led Duke Energy to be one of the top performing US utilities, will continue to lead it going forward. S&P also revised the credit watch on Progress Energy's BBB+ rating from positive to developing. It seems most likely that Progress Energy's rating ultimately will get dragged up, and Duke Energy's rating will not get dragged down. On a good note, 30 lenders promised $6B in credit when the merger closed.

There remain a few problems to be solved. The top problem is the Crystal River nuclear plant in Florida (Progress Energy). This plant broke down during a maintenance and upgrade project. Specifically a 42 inch thick concrete reactor containment building cracked, and subsequent repair attempts have led to more cracks. The currently estimated costs for the further repairs and the purchase of replacement power while the plant sits idle exceed $2B. Some speculate that the "hiding" of these extra costs by Progress Energy led directly to Bill Johnson resigning. DUK will give a update on the repair status to the Florida Public Service Commission on Aug. 13, 2012. The main choices are to repair the plant or to decommission it. The probable outcome if it is decommissioned will be the proposal of a new natural gas powered plant to replace it. Customers would pay for this. This is no small matter after the recent Japanese disaster. DUK is letting itself in for huge future lawsuits if the Crystal River plant repairs are later found to be inadequate. With the history of failed repair attempts so far, DUK, from a strictly legal standpoint (and perhaps an environmental one too), should elect to replace the plant. DUK also has to decide whether go ahead with the $24B project for two future nuclear plants in Levy County. The price of natural gas and the recent Japanese disaster will likely play heavily in DUK's decision.

There will be some benefits to the merger. Roughly 1800 people are being laid off. This will save money. Plus the company thinks it will see synergy saving in three primary areas: fuel, joint dispatch (transmission assets, ancillary services, hedging, etc.), and O&M (Optimization & Management solutions). DUK expects to see significant fuel and joint dispatch saving. Plus it expects 5% to 7% savings on non-fuel O&M.

Since the merger, the price of the stock has fallen from a high of $69.84 to a recent low of $65.31. It closed Friday July 13, 2012 at $66.74. It may rebound from here. If you want to be truly safe, you might wait until after the Aug. 13, 2012 date to buy. Then you will at least be able to assess the impact of the Crystal River situation. However, this is one of the strongest utilities. It will not disappear due to Crystal River. It is even possible that some of DUK's excess generating capacity could be sent to its new Florida customers.

The two year chart of DUK gives some technical direction to this trade.

Click to enlarge

The slow stochastic sub chart shows that DUK is oversold. The main chart shows that DUK's price line is very near its lower Bollinger band (oversold). DUK may be due for a rebound from this oversold condition. With the plethora of investors looking for good dividend opportunities in historically strong stocks, any dip in a long term powerhouse like DUK may signal a buying opportunity. Still averaging in is a good strategy in this uncertain, economically troubled market.

DUK trades at a PE of 19.95 and an FPE of 14.95. It has a Beta of 0.19 and a dividend of 4.58%. These all seem attractive in these troubled times. Yes. There are a few problems ahead. However, the likely synergies are real, and they should produce real EPS gains. DUK still seems very much a buy.

If you are interested in other big, stable US utilities, you might consider such stalwarts as the Southern Company (SO) and Consolidated Edison (ED).

NOTE: Some of the fundamental financial information above came from Yahoo Finance.

Good Luck Trading.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in DUK over the next 72 hours.