Duke Energy Corp (NYSE:DUK) is one of the largest regulated electric utilities serving 7.1 million customers in Ohio, North Carolina, South Carolina, Indiana, Kentucky and Florida. The recent merger with Progress Energy in July 2012 has created a powerhouse with stable earnings, stable dividends and a stable balance sheet. However, there are several events creating investor uncertainty and an overhang on share prices.
In addition to serving one of the largest regulated populations, DUK also generates 58,000MW, of which 9,000MW are from nuclear plants. This makes DUK the third largest nuclear power generator in the US. Of its seven-nuke plants, six are operating with long-term licenses in place and the next renewal will be in 2034. However, problems at its seventh, the Crystal River 3 (CR3) plant in Florida, are causing consternation with investors.
In Sept 2009, delamination of the concrete containment dome was discovered. The plant was shut down, and is still inoperable as of today. By early next year, the company will decide either to make necessary repairs or to mothball CR3. Estimates are for a repair bill of between $1.5 billion and $2.5 billion (less an insurance settlement) and may take up to 5 years to complete. Also weighing on the decision is the current license of the plant, built in 1977, expires in 2016 and the delamination issue will put the plant under further intense scrutiny during the re-license process.
The dismissal of the post-merger CEO in July has created shareholder uncertainty, not from a performance viewpoint from a regulatory one. When approving a merger, the regulatory bodies also give their seal of approval to a specific management team. In the case of DUK, there was a shakeup of management personnel just weeks after the merger was complete. North Carolina regulators were not pleased with the quick exit of their approved management team and have ordered a full investigation by an outside law firm. This investigation will take a few more months and may result in an ugly period of headline news. The end result, however, will be much less draconian than headlines might suggest with a give-back of some of the $300 million in expected merger cost saving synergies to ratepayers, replacement of the current CEO by a Progress-legacy manager and appointment of additional Progress managers to the board. While threatening to reduce the allowed ROI in NC, it is anticipated that a give-back would cost the company less than an ROI haircut while allowing regulators their pound of flesh. However, there will be a rate increase request filed early next year that could prove to be problematic for the company with some calling for a reduction of the current allowable ROI from 10.4% to 9.4%.
The forward dividend of $3.04 a share creates a current yield of 4.7%. Part of the reason for the higher than average dividend yield is a lack of dividend growth over the near term. While the company has paid a dividend since 1926, and has a 5-year dividend growth rate of about 3.0%, management has tempered expectations by announcing a 2% growth rate until the payout ratio declines to 65%. This would equate to earnings of about $4.67 a share and may not be reached until 2014 or later.
The company is looking to retire about 3,050MW of generating capacity due to potential EPA regulations. However, it is also opening up several new gas-fired generating facilities along with buying 5% to 10% of the Summer, SC nuclear facility under construction and owned by SCANNA (NYSE:SCG) and South Carolina Public Service. DUK is pursuing licenses necessary to build two new reactors at their Lee nuclear facility. Overall, DUK is anticipated to spend about $4.0 to $4.5 billion a year on capital expenditures, of which about 81% is regulated asset based. However operating cash flows of $5.5 to $6.0 billion barely covers the cap ex budget and $2.1 billion in annual dividends. Investors should expect overall debt levels to increase modestly during the next few years.
Market Cap billion
Duke Energy Co.
In addition to its equity, which is available for Direct Purchase through the company's dividend reinvestment program, DUK also offers an interesting investment in its debt through the PremierNotes program. These floating rate notes are available for a minimum of a $1,000 investment and a maximum of $750,000, and currently pay 1.11% interest up to a balance of $10,000, 1.31% for balances between $10,000 and $50,000 and $1.51% for balances over $50,000. This product is targeted to those investors seeking money market alternatives in the current low rate environment. From their website:
Duke Energy PremierNotes earn interest at a floating rate per annum equal to the most recent seven-day average yield (non-compounded) for taxable money funds as reported weekly in the iMoneyNet Money Fund Average,™ plus at least 1/4 percent. Interest is compounded daily and posted to your investment monthly. An investment in PremierNotes allows individuals and institutions to benefit from the financial strength of Duke Energy Corporation. PremierNotes are not money market accounts, which are typically diversified funds consisting of short-term debt securities of many issuers, and therefore do not meet the diversification and investment quality standards set forth for money market funds by the Investment Company Act of 1940. Instead, PremierNotes are variable denomination, floating rate demand notes that are unsecured debt obligations of Duke Energy Corporation and are backed only by the assets of Duke Energy Corporation.
More information on PremiereNotes can be found here.
The latest investor's presentation dated Sept 5, 2012 can be found here (pdf).
It seems DUK is valued about the same as its peers, except for its dividend yield. After the above-mentioned issues are resolved, DUK should trade at a premium to its peers. This could make buying on dips for its juicy dividend worthwhile, as capital appreciation should kick in after 2014. Duke is a well-diversified regulated utility with jurisdictional advantages and a strong balance sheet. Large-cap utility investors who do not own DUK should give it a serious review.
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