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Meghan Schiller/ MEDILL

Net income took a hard hit in 2011 as natural gas prices plummeted in the market.


Climate changes for Exelon Corp.

by Meghan Schiller
Feb 28, 2012


Exelon2y

Meghan Schiller/MEDILL

The two-year activity of Exelon's stock shows its recent drop-off due to warm weather and low natural gas prices.

Exelon Corp. doesn’t just make power, it makes cheap power. The Walmart of utility companies, it provides energy to customers at competitively low prices. In addition to owning the largest fleet of low-cost nuclear power plants in the nation, it was ranked as the top U.S. utility company by Forbes Magazine for the second year in a row.

The utilities industry certainly isn’t high-drama, but Exelon higher-ups and analysts alike expect the company to stay in its leading role -- with the help of a few game-changing moves.

“We think Exelon will be a premier nuclear operator for many years,” said Travis Miller, an analyst with Morningstar Inc. “The company has a very good asset base and they invest heavily in maintaining the nuclear fleet.”

Exelon’s first scene change will be the completion of its ongoing merger with Constellation Energy Group Inc., a Baltimore-based utility company. That will be followed by CEO John Rowe’s retirement. But all the glitz and glam of a large merger pales in comparison with company’s lack luster fourth-quarter earnings thanks to mild-winter conditions.

Exelon, headquartered in Chicago, delivers electricity to 5.4 million customers. The company along with its subsidiaries, Commonwealth Edison Co. and PECO, serve customers in northern Illinois, southeastern Pennsylvania and the Philadelphia area.

Long-term investors don’t have much reason to celebrate.

Over the last five years, Exelon’s share price fell steeply from $90 in the middle of 2008 to the current price of about $39. For the past year, Exelon’s stock price has been trended downward since its mid-November high of $45.50.

The stock hit a 52-week low of $38.57 per share; its 52-week high was $45.45. Analysts surveyed by Yahoo Finance are expecting Exelon to earn 81 cents per share in the first quarter of 2012. The highest estimate is 93 cents.

Exelon’s success doesn’t hinge on its stock price, but on something the company can’t even control: the price of natural gas.

“Earnings depends on power prices in the market,” said Miller. “Power prices have been down substantially since 2008. People in the industry think they’ll stay depressed.”

Depressed natural gas prices limits Exelon’s pricing power because it cannot mark up the price of its cheap nuclear energy as much as when demand for fossil fuels was high. Due to the recent drop in energy demand, Exelon must chop its prices to compete with utilities that produce energy from inexpensive natural gas.

Because of this, the only foreseeable problems for Exelon would likely stem from a larger economic issue, Miller adds.

“They’d come into trouble if power demands drop or if we went into a new recessionary environment,” he said. Also, the downward trend of wholesale fuel costs will strain Exelon’s earnings by reducing its once-fat profit margins.

Utility companies benefit mostly from hot summers when people run their air conditioning. Cold winters are also good but recent months have consisted of just the opposite for most areas across the nation.

For local Chicago residents, a warmer than usual winter comes as a pleasant surprise, but for Exelon the financial repercussions of sunshine are not positive.

“It is a tough power market environment,” said Neil Kalton, Wells Fargo Securities analyst. “Power prices are going down so their earnings outlook is going down.”

In the fourth quarter, Exelon’s net income rose to $606 million, or 91 cents per diluted share, from $524 million, or 79 cents per diluted share, a 16 percent increase from the year-earlier quarter. Its subsidiary ComEd recorded net income of $121 million, up 33 percent compared with $91 million in the year-earlier quarter.

Even so, fourth quarter revenue dropped to $4.3 billion from $4.5 billion a year ago, a 5.4 percent decrease. The company said increased operating and maintenance costs in addition to warmer than usual weather weighed on results.

For full year 2011, the company’s profit dropped 2.7 percent to $2.5 billion, or $3.75 per diluted share, from $2.6 billion, or $3.87 per diluted share, in 2010. Annual revenue increased a modest 3 percent to $19.2 billion from $18.6 billion in 2010.

“Why should you avoid Exelon?” asks Jonathan Wolf, contributing writer with Seeking Alpha. First, if natural gas prices remain around $2.60 per million British thermal units there will be downward pressure on the company’s stock price, he said. Second is the company’s exposure to nuclear power, “which is always one accident away from bankrupting an organization that favors it so heavily,” Wolf warns.

On the flip side, “the company can basically create its own replacement energy without going into the open market to buy more,” said Wolf. “This is definitely a monopoly effect, so to speak.”

Exelon may be secure with its current method of energy generation, but what about “fracking?” The term, short for hydraulic fracturing, is a method for extracting oil and natural gas. After drilling a large hole into reservoir rock, highly pressurized fluid is injected to create new passageways in the rock to increase extraction rates for fossil fuels. For old-school utility companies that fear cheaper methods of extraction, the term sounds like a swear word.

“Sure they consider fracking a threat,” said Miller. “The significant amount of gas supply that the U.S. has developed recently is the key driver to why power prices are low right now.”

But despite the challenges, Exelon executives argue a strong future lies ahead. CEO John W. Rowe told analysts earlier this month that the company’s continued strength will come from continually evaluating power output, looking for ways to cut costs, and successfully completing the merger with Constellation Energy.

“We are uniquely positioned to capitalize on the value of our large, well-run nuclear fleet--virtually no emissions, low operating costs, running at a reliable 93 percent capacity factor and capable of significant economic up-rates,” said CEO John Rowe.

Company officials also presented the argument that the market is seeing a “bottoming process” in power prices. Even if prices do rebound, Exelon doesn’t plan to expand--at least in terms of building new plants for its nuclear fleet.

“Nuclear plants are just too expensive and take a long time to be approved,” said Kalton.

Miller agrees: “Utilities won’t invest that type of money if they think the return on that investment is too low.”

For example, a recent ComEd pamphlet shows that the company uses more coal than nuclear power to provide power to its customers. Some environmental advocates argue that coal-burning power is archaic, but Exelon continues to rely upon this traditional source.

So why doesn’t Exelon stray from coal and build more plants, especially since some have been around since the 1970s and are getting old?

“Its a common misconception that a 40-year-old plant is near the end of its life cycle,” said Miller. “The [Nuclear Regulatory Commission] will say ‘Here’s what you have to do to receive a licensing renewal for your plant to run safely for the next 20 years.’”

Simply put, Exelon doesn’t believe the demand is there.

“There will be ample opportunity to invest in new natural gas plants, but only when they are required to meet new demand,” said Exelon in a recent release.

If the economy continues recovering, consumer demand for energy will likely increase. That means Exelon may see more people willing to run their air conditioners, cutting down both the summer heat and stress for Exelon investors.