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Duke Energy Corp. (DUK)

Introduction

Duke Energy Corp. is switching from coal-based power generation to gas-based generation. This factor, coupled with favorable weather conditions in the U.S., warrant an increase in the company's profitability going forward.

DUK is trading at a cheaper P/E and offer the highest dividend yield among its peers. Therefore, we have a Positive stance on the stock.

Industry

Utilities are a regulated industry, and utilities businesses are low growth and low risk (defensive) in nature. Electric utilities engage in the generation, transmission and distribution of electricity to different consumer types.

Coal is the most widely used fuel for generation of electricity in the U.S. Even though the use of coal as a fuel has lost favor due to its non-friendly emissions, it still produced about 40% of the electricity in the U.S. in 2011, down from 52% in 1998. There are currently regulations being considered to reduce the carbon emissions from the use of coal in power generation in the U.S.

Natural gas prices have decreased drastically in the U.S. over the last few years, and dipped below the $2/mmbtu mark in April 2012. The decreasing natural gas prices have induced electric utilities to shift their power generation from coal-fired generators to those running on natural gas, due to the latter being a cheaper and more environmentally-friendly substitute.

Nuclear power generation is still a major contributor of electricity generation in the U.S., and has maintained its contribution in the national grid. In the wake of the nuclear crisis in Japan, there has been worldwide criticism and concern over the use of nuclear technology to produce electricity.

Company Overview

Founded in 1916 and based in Charlotte, North Carolina, Duke Energy Corp. , along with its subsidiaries, operates as an energy company in the U.S. and Latin America, and is primarily involved in the generation, distribution and sale of electricity. The company has three business segments, namely U.S. Franchised Electric and Gas, Commercial Power, and International Energy.

Financial Performance

The revenue contribution of the three business segments is 73% for U.S. Franchised Electric Operations, 17% for Commercial Power and 10% for International energy. About 90% of the revenue is being contributed by the U.S. operations, and 10% from operations in Latin America.

As can be seen in the table below, total revenue for 2011 increase by 2%, as compared to the previous year; mainly due to the increase in rate riders and retail rates in 2011, partially offset by decreased sales to retail customers due to less than favorable weather. Total revenues increased by 12% in 2010 as compared to 2009, mainly due to an increase in net retail pricing and rate riders, an increase in sales to retail customers due to favorable weather conditions, and an increase in fuel revenues.

The company's EPS increased 28% in 2011 as compared to the previous year, due to the favorable rates and volumes in Central America, improved results in Brazil due to higher average contract prices, better results in Peru due to additional capacity revenues, increased earnings from the National Methanol Company (NMC) and lower corporate governance costs.

Also, EPS had increased 20% in 2010 as compared to 2009, due to favorable weather, increased earnings from associated major construction projects, increased rates, and improved results from Midwest gas assets due to both volumes and price.

$ Millions

2011

2010

2009

Total Revenue

14,529

14,272

12,731

YoY % change

2%

12%

-

Diluted EPS

3.84

3.00

2.49

YoY % change

28%

20%

-

Cash Flow and Liquidity

As witnessed below, cash flow from operations decreased by 19% in 2011 due to increased working capital requirements, while the figure increased 30% in 2010 as compared to the previous year due to favorable working capital changes.

$ Millions

2011

2010

2009

Cash from Operating Activities

3,672.0

4,511.0

3,463.0

YoY % change

-19%

30%

-

Capital Expenditures

(4,363.0)

(4,803.0)

(4,296.0)

YoY % change

-9%

12%

-

Total Cash Dividends Paid

(1,329.0)

(1,284.0)

(1,222.0)

YoY % change

4%

5%

-

The CAPEX in 2011 showed a decrease of 9% as compared to the previous year, as the company had continued with its planned CAPEX. The figure increased by 12% in 2010 also, as compared to the previous year, due to the ongoing infrastructure modernization program.

The company intends to continue with its CAPEX going forward and the following is a breakup of the CAPEX

(click to enlarge)DUK has flexibility with regards to the $4.5 billion CAPEX budget, and can defer or eliminate certain spending, should economic or financing conditions deteriorate as per the annual report.

The company increased its dividend payout by 5% in 2011 and 4% in 2010.

Debt Structure and Maturity

Source: Reuters

The company has total outstanding debt of approximately $31 billion, and the chart given above shows the maturity of the debt.

Production Mix

As can be seen from the production mix chart, the generation of electricity from coal is decreasing, while the contribution of generation from natural gas is on the rise.

(click to enlarge)

Source: Company Presentation

Switch from Coal to Natural Gas

The company is in the process of shifting its production from coal-fired generators to gas-based generation. This will be favorable for DUK since it will reduce the working capital requirement, and improve the company's cash flow.

Rate Improvement Going Forward

DUK intends to file for distribution and gas rate cases in 2012 with the relevant authorities. These rate cases need to be approved for recovery of investments in DUK's capital and operating expenditure. A development on this front will drive the company's future profitability and long term growth.

Weather

The weather in the Midwest has been witnessing rising temperatures, and 2012 has been one of the hottest years in the U.S. This is expected to increase the demand for electricity, as people increase their usage of air conditioners. The favorable weather conditions will increase DUK's profitability in 2012.

Outlook

Duke Energy Corp. has a stable business model with promising growth. A shift from coal to natural gas, and a favorable decision on the rate cases to be submitted in 2012, will be positive for the profitability of the company in the future.

The company's cash flow situation is expected to improve, as DUK's profitability and working capital improves.

DUK is trading at a cheaper P/E ratio of 15.6x compared to its peers, and offers a dividend yield of 4.61%, the highest among its peers. Therefore, we have a Positive stance on the stock.

Name

Ticker

Est. PE

EPS

DPS

Div. Yld (%)

ROE (%)

P/B

P/S

Duke Energy Corp

DUK

15.61

3.84

3.06

4.61

7.53

2.05

3.21

Southern Co

(SO)

18

2.55

1.96

4.11

12.62

2.22

2.35

Wisconsin Energy Corp

(WEC)

17.99

2.18

1.2

2.94

13.1

2.36

2.1

Public Service Enterprise Group Inc

(PEG)

13.58

2.78

1.42

4.36

14.14

1.61

1.49

Edison International

(EIX)

18.84

-0.1

1.3

2.85

0.22

1.34

1.17

Sector average (Mean)

--

17.06

2.29

1.61

4.06

9.5

1.69

1.55

Source: Duke Energy's Cheaper P/E, Highest Dividend Yield Among Peers, Make It A Buy