The energy grid needs serious repair. Decarbonization, decentralization, and electrification are key catalysts for a major investment into domestic transmission lines around the country. Let's take a step back, though. Today's energy market - namely how power is generated, distributed, and consumed - looks much different from just a decade ago.
It used to be such a straightforward process. A local power plant, perhaps a coal, nuclear, or natural gas-fired facility, generated enough electricity to power its community. A vertically-integrated construct, the utility would simply purchase enough fuel to run the generators it operated and provide enough power to heat and cool the city and keep the lights on. Then came regulation around and following the late 1990s and early 2000s Enron debacle and major public scandals of that era. There was a desire to bring together various parts of the country after a period of deregulation.
The Federal Energy Regulatory Commission (FERC) issued Order 2000 to build upon what was known as the "ISO" (independent service operator) concept. ISOs are like regional energy markets where power plants can produce energy, and long transmission lines can distribute that power to where it is needed most - dictated by price. Order 2000 created more structured Regional Transmission Organizations (RTOs). After more than 20 years of RTO growth and development, there's still a major push to integrate more areas of the electricity market.
Recall the Texas Freezeout of February 2021. Many retail customers were unable to get heat, and some lives were lost. There were massive power bills, too, as a result of the ERCOT RTO's construct of being less connected to other RTOs. Also, many natural gas-fired plants were unable to acquire fuel or simply could not operate due to poor winterization methods at the time in that area. What power was available was constrained by transmission lines that could not handle such high demand. Couple that situation with what's happening in Europe, and I expect major investment, particularly in the U.S., to help bolster the grid in order to save lives and reduce the effects of an ever-growing number of major weather-related disasters.
Getting back to RTOs, the regional and price-led market helps bring down costs for retail customers since all generators can produce energy and send it thousands of miles across the grid to whatever location needs it most. In general, if you send, say, 100 MW of power 1,000 miles, you might lose just 5 or 10 MW, so it is an efficient process versus limiting one city to just one or two local power providers. Moreover, RTOs help spread costs and increase competition. The downside is that plants that are costly to operate - like coal and nuclear - have often been priced out of the market, so we have seen a wave of retirements among those power plant types. Natural gas is generally the marginal energy source. Tax incentives and production credits for wind and solar generation also throw a bit of a wrench in the competitive markets.
That's a great 101 on the background of the domestic power markets. But what's the investment here? I assert that the market continues to shift quickly and in a big way. We need more transmission lines that are capable of efficiently delivering power to where it is needed most. Transmission providers, those owning important lines, and companies that can create ways to get power from low-cost areas (like a wind farm in Iowa) to high-priced areas (a major demand area like Dallas, TX on a cold January morning) could reap major rewards from a grid overhaul.
According to Bank of America Global Research, Exelon Corp. (NASDAQ:EXC) is a predominately transmission & distribution (T&D) electric utility (85%) operating in Illinois, Pennsylvania, Maryland, Washington DC, New Jersey, and Delaware. Primary utilities include Commonwealth Edison (ComEd) in IL, PECO Energy Company (PECO) in PA, PEPCO in MD/DC, Baltimore Gas & Electric (BGE) in MD, Atlantic City Electric (ACE) in NJ, and Delmarva Power (DPL) in DE/MD. Exelon is the largest public regulated utility by customers.
Morningstar notes that EXC is "now a pure-play electric and gas transmission and distribution utility providing investors a more stable earnings profile. We viewed the separation positively for shareholders. A standalone regulated utility strengthens Exelon's narrow moat and lowers the company's cost of capital."
I like EXC because its business is focused on T&D. Constellation Energy (CEG) spun off EXC, and now CEG is essentially a generation company and EXC is the T&D company. The $45.5 billion market cap Chicago-based electric utilities industry firm trades at an attractive 16.9 trailing 12-month price-to-earnings ratio and sports a dividend yield of 2.9% - nearly twice that of the S&P 500.
Exelon trades at a very attractive valuation when using forward estimates. According to YCharts data, EXC's forward price-to-earnings/growth (PEG) ratio is cheap at just 0.68.
Compare that PEG to the Utilities sector valuation multiple of 3.1.
Another visual I like to use is the PEG heat map. While the numbers differ a bit due to P/E and growth estimate differences, the relative valuation tells the same story: EXC's PEG is cheap versus the sector. Remarkably, it is among the few stocks in the Utilities sector with a PEG ratio under 1.5.
Earnings growth is seen as strong for EXC through 2024, according to BofA. Consider too that this Utilities sector stock should feature lower overall risk versus the broader market. Dividends are also expected to increase through 2024, so investors are paid well to hold EXC. The company currently trades at a slight discount to its peers; there's the chance of a bullish relative revaluation as the market discovers that EXC is positioned well for future T&D investment.
The major potential downside for a company operating in a regulated environment like the Utilities sector is regulatory change. We saw a big rally following the Inflation Reduction Act (IRA) among many utilities and renewable energy firms. EXC must pounce on the chance to own important transmission lines that could be affected. Regulatory, political, and adverse legislation is something the bulls must monitor. Also consider that high-impact storms can take out big transmission lines and result in costly repairs, so increasing weather-related natural disasters could hurt the company. Change in tax rates and interest rates provides another layer of uncertainty.
The management team must also stay on the side of shareholders. Heavy equity issuance would dilute current owners. Management must also execute well amid an inflation environment where capital costs run higher - capex decisions become all the more important.
Exelon split off Constellation back in February, so the chart is not particularly useful from a technical perspective. Still, EXC has outperformed the broader market in that time. The stock is currently consolidating and is near an important zone. If it cracks above the mid-$40s, its April high is certainly in play. Moreover, a move above $51 would clear the space for much more upside in the years ahead. There's support in the $42.50 to $43.50 zone.
Looking ahead, data from Wall Street Horizon shows a quiet corporate event calendar until its Q3 reporting date of Wednesday, November 2.
Exelon looks well-positioned to benefit from a growing need to revamp the energy grid, with a focus on beefing up transmission and distribution. Getting power from cheap areas to expensive spots is becoming more valuable. More intense climate disasters only make the need that much greater, though that does come with risk for transmission owners. Exelon has an attractive current valuation given robust growth prospects. While some investors might shoot for major home runs, I assert that EXC will be a steady grower with a solid dividend yield to weather any macro volatility.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.