Diversified electric utilities are proving their ability to grow earnings in a challenging environment, analysts say.
Vikas DwivediMorgan [email protected]
Sector Outlook: We continue to view our sector as fundamentally strong … Our view is driven by our bullish outlook on the five key sector drivers: commodity, capacity, climate change, capital expenditures at the utility and capital optimization.
In particular, we believe that merchant generators and diversified utilities will outperform their regulated peers due to their commodity and capacity price exposure. Diversified utilities with merchant nuclear exposure such as Exelon and Public Service Enterprise Group also have positive exposure to carbon market development and should benefit from higher off-peak power prices. We are less excited about the prospects for regulated utilities due to their heavy dependence on utility capex (and favorable ratemaking treatment) to grow earnings and their lack of exposure to commodity, capacity and carbon market development.
Favorite names include: American Electric Power (AEP), Exelon (EXC), Natural Resource Group (NRG), Public Service Enterprise Group (PEG) and Reliant Energy (RRI)
Greg Gordon, CFACiti Investment [email protected]
Outlook for Exelon (EXC): We expect EXC to grow earnings from $4.35/share in ’07 to $5.00/share in ’10 … However, between the earnings uplift potential when its Pennsylvania jurisdiction goes to market in ’11 and the potential earnings impact from the implementation of greenhouse gas caps circa ’12, we think earnings “power” could approach $8/share. Given the stock’s almost 15 percent decline from its 52 week high on 1/9/08, we think the stock is once again undervalued.
We have updated our “Open EBITDA” model taking in to account more robust assumptions regarding long-term power pricing and have updated our carbon model to reflect the most recent legislation advanced in Congress. Assuming a long-term natural gas price of $7.50/million British thermal unit (BTU) and $15-ton carbon pricing in 2012, EXC could be worth as much as $100/share longer term. Given the back-end loaded nature of the story and the high percentage of the value proposition associated with carbon leverage (over $15 share of potential net present value), we are maintaining our target price of $85/share.