U.S. Utilities Face Natural And Tax Disasters

Includes: DUK, EXC, FE, PPL, VPU, XLU
by: Peter Pham

The chief of Duke Energy (NYSE:DUK), Jim Rogers conveyed his congratulations to Pat McCrory on becoming the governor elect of North Carolina, as the latter not only served at Duke for 28 years but was also the mayor of Charlotte, Duke's hometown, between 1995 and 2009.

Meanwhile Duke recently acquired a small wind turbines maintenance service provider Outland Energy for an undisclosed sum as it aims to reduce its costs on maintenance of its turbines. Earlier this year, in July, Duke Energy acquired Progress Energy in a $26 billion deal that could create cost savings of $650 million and the merger also made Duke the largest American utility company surpassing Exelon Corp (EXC). Following the merger, in a controversial move which is still being looked into by North Carolina's regulators, Duke's new board ousted Progress's CEO Bill Johnson who was expected to take charge of the merged company and his place was taken by Rogers, originally slated to be chairman of the merged company.

Nevertheless, on the back of the merger, Duke Energy was able to increase its revenues and profits by 70% and 26% to $6.72 billion and $594 million respectively. However the company missed revenue estimates of $6.70 billion while the diluted EPS (excluding extraordinary items) fell by more than 20% to $0.84 due to the 57% increase in the number of shares. However, Rogers has reaffirmed that Duke will meet its annual EPS target of $4.20 -- $4.35.

But Duke wasn't alone in posting poor results as its rival FirstEnergy (NYSE:FE) posted a 13% and 20% drop in quarterly revenues and profits to $2.6 billion and $425 million respectively. The company also dropped its outlook from $3.30 -- $3.60 a share to $3.30 -- $3.40. FE's CEO believes that better results will come from cost cutting as the business plans to axe 400 jobs in the next four years. Similarly, PPL Corp (NYSE:PPL) and Exelon also reported a drop in profits.

















Although Duke's results looks promising it should be noted that a) a large part of these gains can be attributed to the merger and b) its EPS fell by 20% due to an increase in the number of outstanding shares.

On the other hand, Exelon witnessed a more than 50% drop in quarterly profits for its third quarter but this trend has been in place all year as Q1 and Q2 saw y-o-y income decreases of 70% and 54%. In that context, the 51% drop is actually an improvement. The company's poor performance is attributed to an increase in operational costs of nuclear plants coupled with falling electricity rates that have dropped by 35% in the previous four years.

Moreover, the company is also embroiled in a lawsuit related to its merger with Constellation Energy that violated court orders. The company will now pay $692,000 to the Justice Dept. and Maryland Public Service Commission for the violations. The merger had also increased the number of shares which diluted EPS. Amidst all the negative news surrounding Exelon, in early November, announced that it may reduce the dividends to maintain its already falling investment grade - BBB by S&P's and Baa2 by Moody's - which caused an even bigger fall of its stock.





Stock YTD






























Duke, Exelon, PPLand FirstEnergy were all hit by Hurricane Sandy as most of their customers are from states hit hardest by the storm, such as New Jersey, which forms 65% of Duke's customer base. Similarly for PPL, the super storm turned out to be the worst in the company's history as around half a million of its customers lost power. However, the businesses are more concerned about the persistent weak macroeconomic environment in the U.S which is hitting the entire utilities sector. The SPDR Utilities Select ETF (NYSEARCA:XLU) has been down 4.1% and the Vanguard Utilities ETF (NYSEARCA:VPU) has been down 3.6% since the beginning of the CY2012. In Exelon's case, the Fukushima disaster raised several question marks over its facilities as the company generates ~90% of its energy from coal-based nuclear plants.

One thing, however, that will not bear on their margins is the price of fuel. The price of Uraniam has dropped more than 35% since the disaster and is trading near 30-month lows. The futures curve, in particular, is very bearish out to 2015.

Moreover, with the reelection of President Obama, it is now all but confirmed that environmental friendly energy resources, particularly natural gas, are set to play an important role in the future. In his first post-election press conference, the President talked at length about the environment and said that he plans to work with "scientists, engineers and elected officials to find out what more we can do to make short-term progress in reducing carbons". This means that Exelon will have to make the transition from coal to natural gas quickly or face greater regulatory burdens which will drag on profits. The administration will continue its policy of subsidizing 'renewable' resources while demonizing the energy sources that reliably run the economy.

Moreover, high-yield utilities are particularly vulnerable because of the coming rise in capital gains and dividend tax rates regardless of what final deal is reached. Chasing yield in the U.S. is being actively discouraged by both fiscal and monetary policy and makes companies like these much worse investments going forward.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.