An Exelon Surprise

 | Nov 02, 2012 | 3:30 PM EDT
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Sell Exelon (EXC). Management is looking for a different type of shareholder as it expects speculators to replace traditional utility investors. 

How do we know?

Christopher Crane, Exelon's CEO, president, director and member of the Generation Oversight Committee, told investors in a conference Thursday that dividends are not his highest priority. 

"Our number-one priority is to remain investment grade across all our registrants. Our investment grade rating is fundamental to the business, given our sizable collateral requirements, our counterparty and customer relationships and our significant nuclear capital expenditure," he said. "Our next financial priority is returning value to the shareholders through our dividend. Our third priority is to invest in growth opportunities, smartly deploy growth capital to value -- to provide value to our shareholders."

Crane then described how Exelon was cutting capital expenditures and reconsidering dividends. Addressing capex, Crane argued, "In total, we removed roughly $2.3 billion of growth capital from 2012 to 2015 capital plans at Exelon Generation, which meaningfully improves our free cash flow over the period." 

While it may improve cash flow, reducing capex also slows growth.

Beneath the veneer of action-oriented buzzwords, there appears to be a frightened management team captured by the power markets. They cannot predict market outcomes and offer no options, except hope. They claim the average price of wholesale power needs to balloon $3 to $6 per megawatt-hour, or the company is in serious peril. That's where Exelon's dividend comes in.

Crane said, "We have had a lot of conversations with the board, and I said we wouldn't surprise anybody. As I said, we believe the market is going to come back. We believe the market has to come back. And so we're more on the side 'let's get the market back' than we are 'here's the date we would plan on cutting a dividend.'"

The conversation Exelon is having with shareholders sounds desperate. It's also a surprise. One year ago, the conversation was a lot different; it was about the tremendous benefits that shareholders would realize after Exelon acquired Constellation Energy. In light of today's message, it appears that merger may have been a bad idea. 

The other surprise is that Exelon suddenly finds itself in financial danger. Hinting that the dividend could be in jeopardy, sends chills throughout the marketplace.

From an investor's point of view, when a utility suspends its dividend, that changes everything. Income investors flee and shareholders' value tumbles. Only when the stock price reaches low enough levels, will speculators enter and replace income investors.

Walt Higgins, former president and CEO of Sierra Pacific Resources, was also facing a dividend problem in 2001. At the time, he said, "The dividend is vitally important in retaining investor confidence at a time when new energy infrastructure is so critical to protecting consumers. We recognize that the decision [to suspend dividends] is painful to shareholders who have already suffered an unprecedented drop in the value of their investment."

In a conference call, Exelon's management warned investors and offered their owners little upside. Believe them. With this management team, there is high risk that the dividend will be sacrificed and significant shareholder value may be lost. 

There are better-managed utilities. Dominion Resources (D) is one. Unlike Exelon, it plays offense. It shed underperforming assets and realigned its power portfolio. Dominion plans to sell three power plants: two in Illinois and one in Massachusetts. It already sold another plant in Massachusetts and plans to decommission a nuclear plant 21 years early in Wisconsin. 

Another top utility is Southern Co. (SO). It is fully regulated, has state-supported revenue and avoided investments in the deregulated power markets.

Duke Energy (DUK) needs a change in management, but it is operating in regulated states and, like Southern, is aggressive in developing clean-coal technologies.

NextEra Energy (NEE) is the nation's leader in renewable energy production, but it also owns underperforming nuclear assets in Wisconsin. It may find it in shareholders' interests and follow Dominion's lead by decommissioning its Point Beach Nuclear Plants in Wisconsin. Because it is small and old, decommissioning should not materially affect NextEra's balance sheet and it certainly will not affect earnings.

Exelon is a surprise and a disappointment. Shareholders have been warned; they should consider taking the nearest exit.

Those shareholders choosing to remain should understand they now own a speculative stock. They are speculating in Exelon's management team. They are speculating in the deregulated power markets. They are also speculating that Exelon's dividend will survive.

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