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I have been a long time holder of Exelon (EXC) and have benefited greatly over the years from the utility company's larger than average dividend payout. Recently however, the company has posted less than blockbuster results. In the past three quarters the company's EPS has continued to fall short ($0.35, $0.33, & $0.28) of what the street had hoped for. In the company's most recent quarter Exelon was able to beat earnings estimates by $0.05 per share, while also increasing its guidance for the full year 2012 earnings. The range was increased from $2.55- $2.85 to $2.75 - $2.95. Unfortunately, due to several one-time write-downs/expenses the total EPS for the quarter actually came in at $0.35 per share. The stock in the past week has performed extremely poor selling off almost 13%.

Majority of this selling pressure is not the result of the one-time write downs, but rather because the company's CEO Christopher Crane announced during the earnings call that if current pricing conditions do not improve a dividend cut may be coming in the near future. This news came off of the prior quarter's earnings call (June 7th) where CEO Crane stated that he recommended buying the stock, which was trading for around $37.50 per share. Crane also mentioned on the June 7th call that the dividend was "robust and sustainable".

This type of reversal in messaging has not helped the stock's performance, even after a quarterly report that was not all that terrible. The main culprit for this potential dividend cut is directly related to market pricing of future energy prices in 2015 and 2016. Exelon like many utility companies engages in the hedging of power prices as a means to control costs and ideally increase margins. With future power prices at extremely low prices, currently around $42 per megawatt hour, the market has yet to get to a price point that makes financial sense for Exelon to begin hedging at prices that are not at extreme lows. If Exelon was forced to hedge at current prices the hit that the company would take would have a direct impact on the company's ability to pay the $2.10 per share dividend.

The company believes that a $3 - $6 per megawatt hour increase is due in the coming months, because of the retirement of over 40,000 gigawatts of coal power plant electric generation in the 2015 - 2016 timeframe. Unfortunately, those increases have yet to play out leaving Exelon hanging on and unable to lock in its hedges. Currently, Exelon has only hedged 60% of 2014 prices and 25% of 2015 power prices. Additionally, the company wants to maintain its current investment grade rating of BBB, so that it can maintain lower borrowing costs. Hedging at the current low prices and still paying out a $2.10 per share dividend would cause the company to be paying out roughly 90% of its cash flow, ultimately having a negative impact on the company's credit rating and borrowing costs.

Given all of this uncertainty it is easy to see how a lot of the lose hands are simply selling the stock and walking away from it. I on the other hand am looking at this massive sell off as a great opportunity to add more to my current position. Most might consider this type of approach as trying to catch a falling knife, but as regular readers of my articles know, I very rarely just buy a stock outright. Instead I would prefer to sell some cash secured puts on the company in the coming months.

Before looking at the put options market for potential strike prices to consider selling, I think trying to determine what a good entry price might be is the most important. To effectively do this there are several factors that I think need to be examined.

· In a worst case scenario of a dividend cut, assuming a 30% cut to the current $2.10 rate, the new rate would be $1.47 per share. At that new rate in order to maintain a 4.5% - 5% dividend rate (the industry average) the stock will need to be bought between $29.40 and $32.66 per share.

· Exelon currently has a P/E of 17.15. Exelon's competitors have the following P/E ratios.

Company

P/E

Market Cap

Dividend Rate

Exelon

17.15

$27.40 B

6.54%

Ameren Corp (AEE)

66.28

$7.83 B

4.90%

PPL Corp (PPL)

9.85

$16.79 B

4.90%

Southern Co. (SO)

18.00

$39.10 B

4.38%

Duke Energy (DUK)

19.06

$45.11 B

4.70%

Industry

13.9

$9.69 B

4.70%

· Future earnings are something that can never be 100% determined, but based on the fact that Exelon has just increased guidance for the year, originally $2.70 per share up to $2.85 per share. I think it is important to examine how that change might affect the stock price. Originally the company was providing guidance of roughly $2.70 per share, which would put the year end P/E at 12, assuming the current market price of $32.50 per share. If the company is able to generate a year end EPS of $2.85 per share the new P/E would be 11.22.

At current prices the stock is trading at an incredible value and in my opinion is poised to pop as the market begins to further digest the firm's year end results. Given the above mentioned price range of $29.40 - $32.66, I would be a buyer of the stock at the lower end toward the $30 per share level. Rather than just waiting and hoping for the stock to further sell off toward the $30 per share level, I would prefer to be a seller of the April $30 Puts. I like the April puts because a lot of recent volatility is built into them along with the time value. Those factors together usually can create favorable premiums on the put option contacts. The April puts (at the writing of this article) were trading for around $1.25 per contract. That translates into a 4.16% discount for every contract that is sold, generating a real cost basis of ownership at $28.75 per share if the put option is eventually 'put' to the seller of the option(s).

Prior to just going out and selling these options to capitalize on this recent downswing in Exelon there are several factors that might continue to negatively affect the stock at least in the short term, pushing the premium for these option contracts up even further.

· As the election results finalize and the market determines what the year-end outcome will be for both capital gains and dividend tax rates, this might cause additional selling of the stock

· As the finalized damage costs get added up from hurricane Sandy additional selling pressure might be felt by Exelon shareholders as it is factored into the price

· Short sellers might continue to pile into this stock and play the momentum trade, pushing things even lower

Regardless of what happens in the short term I believe that Exelon at its current pricing is providing real opportunity for any value investor. The stock now trades at a price point that has not been seen since 2003. Once the short term tensions begin to calm I think that any investor that buys Exelon today will be handsomely rewarded in the coming months/year as Exelon gets through its current set back and gets back on track.

Source: Is Buying Exelon Really Like Catching A Falling Knife?