Pull the Plug on Entergy

 | Dec 30, 2013 | 5:30 PM EST  | Comments
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Check to see if Entergy (ETR) is in your portfolio. If it is, consider selling it. While Entergy owns some terrific utility assets, it is facing headwinds that could hurt shareholders in 2014 and beyond.

The recent news is that Entergy's transmission-line deal with ITC Holdings (ITC) has fallen apart. State regulators failed to approve the arrangement that would allow Entergy to sell its transmission lines to ITC. After hearing the verdicts, Entergy pulled out of the deal.

Neither stock reacted to the news. For now, Entergy's shareholders have avoided a haircut. Year-over-year, Entergy's shareholders saw flat returns. Not considering its robust dividend, Entergy's stock is only down by less than 2%.

There is a reason not to consider dividends. Months ago, Entergy's management warned that they were considering right-sizing the dividend after the ITC deal closed. Even though the deal did not close, Entergy may continue looking at options to reduce dividends.

Entergy could be looking at Exelon's (EXC) right-sizing experience. Like Entergy, Exelon owns a large fleet of nuclear plants. Like Entergy, Exelon's plants have been struggling in deregulated power markets. Exelon saw its margins drop, believing that drop was systemic, management decided to reduce shareholders' dividends to maintain the company's investment grade. It appears Exelon's management was unpunished for its right-sizing decision.

Both Exelon and Entergy have had a problem with their merchant nuclear fleets. Exelon owns the nation's largest fleet. Entergy owns the second-largest fleet. Exelon previously announced plans to shutter Oyster Creek facility in New Jersey. Entergy announced plans to shutter its Vermont Yankee facility. If investors believe the Wall Street Journal, however, Entergy will be doing more than just closing a few plants. According to the Dec. 25 report, one analyst believes Entergy will shutter all its merchant nuclear units:

"At least 38 reactors in 23 states -- more than a third of the U.S. total -- face headwinds that put them at risk of early retirement, according to an analysis by the Vermont Law School's Institute for Energy and the Environment. Mark Cooper, the author of the study, said the most vulnerable reactors included Clinton in Illinois; Davis-Besse in Ohio; FitzPatrick, Ginna, Indian Point and Nine Mile Point plants in New York; Fort Calhoun in Nebraska; Millstone in Connecticut; Oyster Creek in New Jersey; Palisades in Michigan; and Pilgrim in Massachusetts."

All nuclear plants owned by Entergy's Wholesale Commodities (EWC) segment are on the WSJ list-- Palisades, FitzPatrick, Indian Point and Pilgrim are all there.

Is the WSJ analyst wrong? When it comes to Entergy's merchant nukes, apparently not. After checking with industry colleagues, they seem to agree that the nation's older and smaller nuclear plants could be at risk. Like the WSJ analyst, they thought some newer and larger plants could also be at risk. Dominion Resources' (D) Millstone units were a surprise, however.

Real Money subscribers were warned here about this problem in May. They were warned again here about Entergy's challenges with their Pilgrim and Palisades units.

If WSJ is correct, Entergy's merchant fleet of nuclear plants could be completely wiped out. As such, if measured today, the mark-to-market value of EWC's fleet would appear to be somewhere near zero (they own some non-nuclear assets).

If EWC is wiped out, here is the problem for investors: In its 2012 10-K filing, Entergy reported property, plant and equipment are stated at original cost less (straight-line) depreciation. Consequently, it reported EWC's net property, plant and equipment at $3.2 billion (p. 58). In their subsequent third-quarter filing, EWC wrote off $291.5 million for Vermont Yankee, which leaves about $2.9 billion.

It is possible Entergy could continue operating EWC's fleet. Power markets could improve. Federal, regional and state energy policies could change. Entergy may avoid early retirements for some, if not all, of its units. But if Entergy is forced to retire its merchant fleet, shareholders are looking at substantial impairment charges.

Entergy owns other nuclear units and seven separate utilities. For the most part, these assets operate under the economic protection of state regulators. They are not at risk.

Investors should see Entergy as a speculative and risky stock. Looking at 2014 and beyond, there is potential to lose principal and income. Before Entergy exits the merchant power industry, now is a good time for Real Money subscribers to exit the stock.

While I'm not recommending the stock today, Exelon might be a better bet. Yes, it will also consider retiring older and unprofitable units. But Exelon is ahead of the game and already shared its pain with shareholders. In addition, it's unlikely Exelon will wipe out its entire fleet. When it's over, the power markets will likely be stronger, and Exelon's fleet will be more profitable.

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