Exelon Corporation (EXC) is one of the largest electric utilities within the S&P 500 and is the largest provider of nuclear power in the United States. Through the last year, this large-cap utility has underperformed the utilities sector and broader market, declining by about 20 percent, and appears to be undervalued.
Exelon has not increased its dividend since November of 2008. Nonetheless, Exelon is now the highest yielding large cap utility, with a current annualized yield of around 5.92 percent. This compares to a 3.9 percent yield on Utilities Select Sector SPDR ETF (XLU), which is made up of the 31 energy utilities in the S&P 500. Most of Exelon's utility peers, such as Dominion Resources (D), Duke Energy (DUK) and Southern Company (SO), yield below five percent. These three utilities and Exelon are also the four largest components of the XLU ETF.
Exelon has operations and business activities in 47 states, the District of Columbia and Canada. The utility has four primary segments: (1) Exelon Generation, which generates and supplies electricity; (2) Commonwealth Edison, serving Chicago and Northern Illinois; (3) PECO Energy, serving Philadelphia and Southeastern Pennsylvania; and (4) Baltimore Gas and Electric, serving Baltimore and Central Maryland.
In April of 2011, Exelon announced it was merging with Constellation Energy Group, and the merger likely accounts for some of its subsequent equity underperformance. At the time the deal was announced, the combined market capitalization of the two companies was $34 billion, with the company now having a market cap of about $30.3 billion. Baltimore Gas and Electric is essentially the Constellation unit of the new Exelon. At the time the deal was announced, Exelon claimed the merger would be accretive to earnings by more than 5 percent in 2013 and that the company would break-even in 2012.
The deal took longer to take than expected and regulators required some power generating sales, but the merger should end up being a source of revenue and earnings growth over time. During the second quarter of 2012, Exelon indicated the merger continued to work out reasonably well, and that the synergistic savings should be greater than expected. Because of the deal took time to get approved and forced Exelon to divest itself of some assets, it may take longer to be accretive than initially estimated.
Another reason Exelon has underperformed the broader utilities sector is because its geographic footprint is considered problematic. For example, states such as Illinois and Pennsylvania are not currently experiencing robust economic growth, and may undergo further contraction in the near future. Similarly, Baltimore and Central Maryland are considered potentially weak markets, though the region certainly benefits from its proximity to Washington DC. This region is also susceptible to storm outages, such as from Hurricane Sandy.
Despite this melancholy outlook for Exelon's core regions, the company should inevitably benefit from its broad geographic footprint. Exelon is still the largest competitive U.S. power generator, with approximately 35,000 megawatts of owned capacity, and it is also one of the nation's cleanest and lowest-cost power generation fleets. Exelon's energy is low cost and deemed clean is because of its nuclear generation. Though the company does generate substantial power with natural gas, it generated about 55 percent of its power through nuclear generation prior to the Constellation merger.
As the largest nuclear plant operator in the United States, Exelon produces less greenhouse gas emissions than many of its generating peers that have greater dependence upon fossil fuels. Recently, though, exceptionally cheap natural gas and heightened fears over nuclear generator safety have prompted many to deem Exelon's nuclear assets as a risk. Over time, such concerns should subside.
These issues have weighed on EXC shares in the recent past, but soon enough the ties will likely turn and the company is likely to recognize some benefits from these same characteristics that now hurt it. Moreover, any spiking of fossil fuel costs should be less problematic to Exelon than to its peers.
Yet another reason Exelon has been under pressure is because during the second quarter of 2012, the company reduced its full-year earnings guidance to between $2.55 and $2.85 due to low natural gas prices. Low natural gas hurts the price of nuclear power, and Exelon noted it nearly fully hedged-in recent prices for the coming quarters.
Despite the many issues that have hurt Exelon equity in the past year, the company continues to be one of the largest and most efficient utilities in the United States, as well as the highest yielding utility within the S&P 500. Though the company has not been able to raise its dividend for several years, the company should ultimately recognize a benefit from its strong market position, high mix of nuclear and natural gas power generation, growing demand for electricity and eventual price increases linked to inflation. Last week, the company reported its was maintaining its $0.525 per share quarterly dividend, which works out to about a 1.48 percent yield for the quarter.
At its current level, Exelon appears to represent lower potential risk and greater possible reward than the vast majority of its utility peers, or the broader market. If the Constellation deal becomes accretive in 2013, the company may be able to raise its dividend shortly thereafter. In the meantime, the company provides a substantial income stream in the form of its nearly six percent dividend, effectively paying investors to wait for its valuation and prospects to grow. Additionally, Exelon is scheduled to report its Q3 results on October 31, or this Wednesday.
Additional disclosure: A family member currently holds EXC shares. I a waiting to see EXC's Q3 results and whether Hurricane Sandy discounts the equity due to outages.