Joining the 40-Plus Club

 | Apr 30, 2012 | 5:30 PM EDT
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Last summer, I mentioned five top-tier utilities that were operating in a league of their own. I called this group the "40-Plus Club." and as of today, they still are in a league of their own because each has an enterprise value of more than $45 billion:

•          Southern Co. (SO), $60 billion

•          Dominion Resources (D), $51 billion

•          NextEra Energy (NEE), $49 billion

•          Duke Energy (DUK), $47 billion

•          Exelon (EXC), $45.6 billion (includes the acquisition of Constellation Energy)

The closest utilities seeking admission into this club are billions of dollars behind. The top three are American Electric Power (AEP) at $36.3 billion, PG&E Corp. (PCG) at $32.1 billion and Progress Energy (PGN) at $29.1 billion. But Progress Energy may be taken out in a proposed merger with Duke this summer, making Duke's enterprise value about even with Southern's.

Since the 40-plus-club article came out last August, all of the group's enterprise values have increased by an average of $6 billion. Dominion had a 9% increase and all others had double-digit growth. Of course, Exelon's growth came from the acquisition of Constellation Energy, without which its enterprise growth would have declined.

Investors saw boosts in the value of all but one stock, Exelon. With the Dow up 9% over the same period, Southern is up 16.6%plus dividends. NextEra is up more than 16% plus dividends. Duke is up more than 14% plus dividends. Dominion is up more than 7% plus dividends. And Exelon is down 12.6% plus dividends.

Remember, the 40-plus club members are large because they participate in more elements of the utility value chain than their deregulated counterparts do. They all own generating assets, transmission lines and distribution systems. Deregulated utilities like Consolidated Edison (ED) and Northeast Utilities (NU) are wire-only companies and any generating assets they may own do not have a guaranteed return from state utility commissions (NU owns some regulated generators).

There's a lot more road ahead for the 40-plus club, but it will be bumpy. One bump is Duke. If Duke is successful in acquiring Progress, there will be an automatic boost in Duke's enterprise value.

But what's troubling investors is Duke's proposed merger is not a slam-dunk. Duke is facing stubborn opposition from municipal utilities in Duke's native territories. That opposition is before the Federal Energy Regulatory Commission, which is a final regulatory barrier for merger approval. Twice Duke attempted to resolve the utilities' concerns, and each time came up short.

Another bump affecting all utilities is the five new regulations in various stages at the Environmental Protection Agency. I will write more on this later, but these regulations are focused on coal and other hydrocarbons, and they will affect each member of the 40-plus club in different ways.

The effects are not all negative. For example, NextEra does not rely on coal to produce power. Less than 4% of its power comes from coal. Because of NextEra's unique position in carbonless power, the potential for it to grow is among the highest of the 40-plus club (excluding mergers).

Another beneficiary is Exelon. Less than 8% of its fleet uses coal. In addition, after Exelon completes expensing its merger costs, the enterprise multiple may become so attractive that the stock may begin to recover. Right now, Exelon's price-to-earnings ratio is 10.37, which is at the very bottom of the club. After Exelon reports its third quarter, investors may see some recovery.

Dominion plans to reduce exposure to the EPA by retiring or converting several older coal-fired plants. Dominion is carefully positioning itself for the long-term by seeking innovative ways to reduce its carbon footprint while maintaining diversity in its generating portfolio. In addition, Dominion owns an impressive portfolio of natural gas assets. With a PE ratio of 29.71, investors love Dominion.

Beware of Southern. Its PE of 18 may be driven by the fact that it's the nation's first utility to receive a Nuclear Regulatory Commission license to build a new nuclear power plant. But the problem is the Energy Department is having difficulties delivering the promised federal loan guarantee.

Southern's other problem is the EPA. With 58% of their power coming from coal and more than 80% coming from hydrocarbons, Southern is facing a challenge with the EPA. With a growing exposure to federal regulators and guarantors, Southern may lose its leadership position within the 40-plus club.

Nevertheless, the 40-plus club as a portfolio is performing well. They are a unique class of utilities. They are stable companies with strong leadership. They also represent the nation's largest fleet of safe, economic and reliable sources of power.

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