As the $7.9B merger between Exelon (NYSE:EXC) and Constellation (NYSE:CEG) nears, the former will have an opportunity to turnaround its image of having a poor takeover record. Unfortunately, based on where power prices are likely to go and regulatory concessions, I am bearish on the accretive value of the strategy. Analysts mostly concur with a negative outlook in utilities and rate the company a "hold" - the same rating assigned for NextEra (NYSE:NEE). Based on my multiples analysis and DCF model, I would recommend holding out.
From a multiples perspective, Exelon is the cheaper of the two. It trades at a respective 11x and 15.2x past and forward earnings while NextEra trades at a respective 16.4x and 13.1x past and forward earnings. In addition, Exelon also has a dividend yield that is roughly 160 bps greater at 5.3%. Both companies are 40% less volatile than the market, but carry more risk than this metric would suggest due to regulatory headwinds and speculation over alternative energy sources.
At the fourth quarter earnings call, NextEra's Chairman & CEO, Lew Hay, noted a solid finish to the year:
"NextEra Energy delivered strong performance in the fourth quarter and overall for 2011. At Florida Power & Light, earnings growth was driven by investments in the business, including new efficient power generation, that are helping to provide our customers with the lowest bills in the state and reliability that is among the best in the country. At NextEra Energy Resources, we signed nearly 2,200 megawatts of long-term wind and solar contracts in 2011, our most ever in a single year".
Unlike for its competitor, fourth quarter results were decent at an EPS of $0.93, which was a 16.3% y-o-y return. Solid investments in clean power and efficiency also paid off at FPL - driving an EPS of $0.51 in this segment. The $3B deployment on projects further showcased management's confidence in the long-term fundamentals of the business.
Consensus estimates for NextEra's EPS forecast that it will grow by 1.9% to $4.38 in 2011 and then by 4.1% and 9.2% more in the following two years. Modeling a CAGR of 5% for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $64.03, implying just 7.4% upside. This is not enough, in my view, to call the investment a "value play".
Ditto for Exelon, which is about to close its merger with Constellation. As I believe that power prices will increase, Constellation will be more dilutive to shareholder value than what Exelon anticipates. This is not even considering the roughly $1B worth of concessions that were made to regulators. If, however, power and gas prices remain low, the acquisition will be accretive to utilities. In any event, concerns loom about rate caps and with opex roughly fixed, power prices are the main determinant of margins. During the fourth quarter, EPS of $0.91 was 6 cents below consensus due to lower margins and the negative impact of poor weather. The company's 11 Midwest and mid-Atlantic plants generate about 17% of domestic nuclear power, but represent less than a quarter of that in total domestic energy consumption. With Exelon being the greatest nuclear generator, it has strong speculative value from a shift to cleaner energy.
Consensus estimates for Exelon's EPS forecast that it will decline by 26.9% to $3.04 in 2012, decline by 3.6% in 2013, and then grow by 6.8% in 2014. Assuming a multiple of 12.5x and a conservative 2013 EPS of $2.98, the rough intrinsic value of the stock is $37.25, implying downside.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.