Avoided Nuclear Shutdowns, Higher Power Prices Make Exelon A Buy
Summary
- Exelon's Byron and Dresden nuclear plants got a last-minute reprieve with the Illinois government passing subsidies to keep these plants running.
- Market prices for power have increased substantially in the last few months, enabling the Generation spinoff to hedge out-year sales at higher prices.
- These developments reduce my earlier concerns about the value of the Generation division and make Exelon a buy ahead of the spinoff.
Scott Olson/Getty Images News
Last-Minute Reprieve For Nuclear
Exelon Corp. (NASDAQ:EXC) earlier this year announced plans to spin off its Generation division by the first quarter of 2022, leaving a pure-play regulated utility focused on the transmission and distribution of electricity and natural gas in Illinois and the mid-Atlantic states. The Generation division, until recently, has been a drag on the company with several issues including a large one-time cost from the outages incurred in the February 2021 Texas cold snap, stagnant power prices, and the impending shutdown of several of its nuclear facilities in Illinois which would be uneconomic to operate in the existing market.
Exelon was on the verge of closing its Byron and Dresden facilities in Illinois when the state government passed the Clean Energy Jobs Act which subsidizes Exelon to the tune of $700 million total over the next 5 years while phasing out coal and gas plants over the next 10 - 25 years. The law also offers state rebates on electric vehicle purchases and charging station installations. The company stated that the new law provides an opportunity to keep other plants running and has committed to spend $300 million in capex to overhaul Byron and Dresden. These actions will preserve Exelon Generation's status as by far the largest producer of zero carbon energy in the US as well as the lowest CO2 emissions per megawatt.
Exelon 4Q 2020 Earnings Slides
Power Prices On The Rise
Another development since my last analysis in May has been the rapid increase in power prices, which have followed the strengthening economy and the rise in natural gas prices. For example, the November 2021 PJM West Off-Peak futures have doubled to almost $50/MWh from under $25 this past spring.
This increase will not impact 2021 results significantly, as Exelon is nearly fully hedged at prices of $27/MWh in the Midwest. With the impending spinoff, the company is not disclosing how much output has already been hedged for 2022, but in prior years they were about 90% hedged by this point.
Exelon 2Q 2021 Earnings Slides
On the positive side, it is possible that Exelon has not yet hedged the 2022 output from Byron and Dresden as until recently they were expecting these plants to be shut down next year. (The company has not yet yet disclosed if it has hedged these plants or not.) These two plants make up about 4.1 GW of Exelon's 17.8 GW nuclear capacity, or about 23% of the total. If these plants were not hedged, it could provide substantial upside to the earnings of the Generation spinoff in 2022. Additionally, the higher forward futures curve will allow Exelon to hedge out-year production in 2023 and beyond at higher prices than we could have expected earlier this year.
Valuation
Not much has changed with respect to the outlook for the regulated utilities since my February article. EPS guidance is still $2.10 per share for 2021, increasing to $2.30 in 2022.
Exelon 4Q 2020 Earnings Slides
One small potential upside is that ComEd (the Illinois regulated utility) has an allowed return on equity in the rate formula that changes depending on US Treasury rates, at least through 2022. While this takes time to flow through to Exelon's earnings due to the annual true-up process, a rising interest rate environment will eventually help ComEd's earnings, partially offsetting the negative impact of higher interest rates on the stock market and utility sector in general. Beyond 2022, the ROE may no longer be tied to Treasury rates, but there is some speculation that the new ROE negotiated with the regulators will be higher than it is currently.
The 17 P/E that I used in February for the regulated utilities still seems valid based on peer companies, so the remaining part of Exelon post-spinoff would be valued at $39.10 based on 2022 earnings.
On the Generation side, the 2021 guidance midpoint remained at $0.70 (range of $0.55 to $0.85) in the last earnings release in August. This included $0.20 of net impact for the February outages from the Texas cold snap. So, for 2022, Exelon Generation would earn at least $0.90, assuming no improvement in realized (post-hedge) power prices. Since August, it has been announced that Byron and Dresden will continue operating and power prices have continued to increase. The latest prices for the PJM West Off-Peak forward strip from the CME on INO.com average around $39 for 2022 and $30 for 2023, compared to the $27 price Exelon has hedged for 2021.
Considering that Byron and Dresden (23% of Exelon's nuclear capacity) will now remain on line in 2022, as well as the increase in power pricing, I think 15% upside for Generation is reasonable in 2022, putting my earnings estimate at $1.04 per share. I will conservatively keep the same 10.5 P/E multiple I used in February, but it could increase if the market sees these rising power prices as something more than transitory. Nevertheless, based on the 10.5 P/E to 2022 earnings, the Generation spinoff is worth $10.92 per share.
That brings my total valuation for Exelon to $50. While this is only a small premium to the current price of $48.35 at the time of writing, the friendlier regulatory environment and higher power prices have significantly lowered the risk of holding the Generation spinoff. When the split was first announced in February, I was expecting no dividend from Generation. The improved power market could now enable the spinoff to initiate a dividend in its first year or at least allow it to pay down debt faster and bring forward the date for the first payout.
Conclusion
Despite the drama with Illinois regulators over the past year, the state ultimately approved subsidies that will keep Exelon's nuclear plants running. The company will also benefit from increasing prices in the power futures market as soon as existing hedges roll off. These developments make the upcoming Generation spinoff a more attractive company to own and I now expect to hold on to it or buy more depending on where it trades after the spin. I also consider Exelon a buy at this time to get the well-run regulated utilities company with 6%-8% EPS growth.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of EXC either through stock ownership, options, or other derivatives. 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.
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