Duke's Credibility Gap

 | Feb 01, 2013 | 3:30 PM EST  | Comments
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Now is not the time to jump into Duke Energy (DUK). While some of Duke's issues have been flushed out, the utility company's future is uncertain.

Last year, Duke's management dug itself a deep hole. Senior executives and loyal members of the board of directors led the company in a bizarre direction and damaged the company's reputation with state regulators, consumers, shareholders, employees and the public. As a result, state regulators reminded Duke's management who controls the purse strings and demanded Duke change key executives, including CEO James Rogers, and specific members of the board. The regulators did not stop there. They insisted on economic penalties and insisted Duke make additional investments in community development projects.

For shareholders, the largest concern is rate relief. Regulators decide if the company can pass expenses on to consumers. If regulators remain upset, they may not allow Duke to pass on all of its costs. Duke agreed to the regulators' demands; it didn't have much of a choice. Though the company apologized, it delayed implementation. Duke's wounded CEO continues to lead the company, the board remains largely unchanged and the strategic vision of the company remains unchanged.

This should concern investors. Duke faces critical strategic decisions that will have long-term consequences. Any decisions should be addressed by the new management team, not the compromised team. Today, Duke is in desperate need of a new leader.

One urgent question is about the future of Duke's crippled nuclear plant in Florida. Crystal River was safely shut down for maintenance, but when repairs were under way, the facility's containment building was damaged. To fix it would require a substantial capital investment. Not to fix it would require retiring the facility early and force another investment (decommissioning).

Clearly, Florida needs more power plants. Duke and NextEra Energy (NEE) have been arguing that Florida should build four new reactors at two new sites. Retiring Crystal River early puts Florida and Duke in a difficult position.

Another urgent question is about new nuclear construction under way at SCANA's (SCG) Summer nuclear facility. SCANA and South Carolina's municipal utility is currently building two new nuclear reactors. The total cost of these units is something near $15 billion, which far exceeds SCANA's market capitalization of $6.2 billion.

South Carolina is asking Duke to consider investing in the project. Under the proposal, Duke would take an equity position in two AP1000 plants, the same type they planned to build in Florida. For Duke, South Carolina represents considerable risk. If it says yes to the proposal, Duke may find itself invested in a difficult project. If it says no, it may upset a regulator.

These are only two questions facing Duke's management team. There are more, and there is a need to repair the public's trust in the company's leadership. While Duke is a solid company and it has a bright future, its short-term prospects are uncertain. Investing in Duke today is speculation. For investors, Duke is in never-never land. For speculators, there are far better opportunities. For traditional utility investors, Duke poses serious questions.

But there are alternatives. Dominion Resources (D) has a solid management team and a focused strategy. Dominion has maintained the public's trust and confidence. In addition, it has the respect of state regulators. Southern Co. (SO) is another alternative. While it is challenged by a nuclear construction project, the company is largely hedged against construction risks. Like Dominion, Southern has maintained solid relations with state regulators. It also has maintained the public's trust and confidence.

Duke will survive. But it will take time to repair the damage caused to its relationship with the very party that control its revenues: the state regulators. Until a new management team arrives, give this company a wide berth.

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