The Power of Exelon in Your Portfolio

Last week I made a pledge to turn away from shiny objects and other distractions and dig into five stocks that look attractive to me. The goal -- besides providing Foolish readers with a more in-depth view of these companies -- is to pick a stock to elevate to the top of my own buy list. Though I didn't manage to dig into all five companies last week, I'm charging ahead with the project this week.

Today, I'm turning my attention to electric utility and nuclear power giant Exelon (NYSE: EXC  ) to see whether it can be a contender for my next buy.

The business
It makes sense to start with a brief overview of the business. Exelon is an electric utility that has two broad businesses: electric generation and regulated retail power.

Electric generation is just like it sounds -- the company owns power plants that generate electricity and the company sells that electricity on both a wholesale and retail basis. What's particularly interesting about Exelon's generating assets is that they're heavily weighted toward nuclear. Of the 25,619 megawatts of owned generating capacity at the end of last year, two-thirds was nuclear. The remaining generating capacity is largely fossil-fuel based, but also includes a significant dose of renewable energy -- a large part of which came from acquiring Deere's renewable energy segment.

The other part of Exelon's business consists of (1) ComEd, which serves northern Illinois, including Chicago,  and (2) PECO, which serves southeastern Pennsylvania, including Philadelphia. These businesses buy and sell electricity and provide transmission of that electricity on a government-regulated basis. This side of the business is similar to more traditional electric utility companies like Southern Co. (NYSE: SO  ) and PG&E (NYSE: PCG  ) .

These businesses could be joined by newcomers to the family if Exelon gets approval for the takeover of Constellation Energy (NYSE: CEG  ) that it proposed earlier this year. In some ways, this would be a good deal for Exelon and its shareholders, and in some ways it wouldn't. We'll talk more about that in a moment.

What I like
To provide for easy digestion, I've boiled my research down to four primary reasons why I like Exelon as an investment.

  • Product. The electric industry is not without its peaks, dips, and wiggles, particularly when it comes to unregulated generation. However, as far as products go, there is a steady demand for electricity and I'm extremely confident that in a decade that won't change.

  • Dividend. What can I say? I like dividends. Since Exelon hasn't raised its dividend payout in the past couple of years, I can't call it an "ideal" dividend payer, but the stock currently yields a healthy 5% and there seems little reason the company would have to cut its payout. With a wild stock market and 10-year Treasuries that yield 2.3%, a 5% dividend can go a long way.

  • Valuation. I don't expect Exelon will grow very quickly (on an organic basis at least), nor do I expect that it will be able to grow its dividend very fast, if it even starts growing it again at all. But with the stock trading at just 10.7 times trailing earnings, investors shouldn't need scorching growth to score attractive returns.

  • Constellation deal. The Constellation deal will match Exelon's generating assets with the customer access that Constellation has. That could be a big long-term positive for the development of Exelon's business and reduce some of the volatility that comes with wholesale generation.

What I don't like
Before we get too excited about Exelon, there are a few things that throw cold water on my interest.

  • Electric utility industry. When I wrote about ArcelorMittal, I noted that I'm not an expert in the steel industry and that I'd have a lot of getting-up-to-speed research ahead of me if I wanted to buy shares. The same holds for Exelon and the electric utility industry. Utility stocks have marketed themselves well as simple investments that are perfect for the widow and orphan crowd -- or anyone else who wants an easy dividend-paying stock. Beneath that simple-looking exterior, though, lie companies that operate in a variety of different geographic markets with a vast web of government regulations. There would be a lot for me to get up to speed on here.

  • Constellation deal. Though there are definite advantages of the combination of Constellation and Exelon, it seriously irks me that Exelon would finance this multibillion-dollar acquisition entirely through stock. Not only am I generally against companies making massive, all-stock acquisitions, but I'm even less excited when a company does it while its stock looks undervalued. Financing a deal with an undervalued stock makes that deal much, much more expensive for shareholders. So why would management do this? Perhaps the stock isn't undervalued and they know it, perhaps the stock is undervalued and they don't know it, or maybe they just don't care. I don't like any of those potential answers.

  • Nuclear. There is a lot to like about the fact that Exelon's generation capacity is largely nuclear. Nuclear is a comparatively clean power source and it's an inexpensive -- and therefore more profitable -- way to generate electricity. On the flip side, nuclear is, well, nuclear, and while Exelon may have safety completely under wraps, when something goes wrong with a nuclear plant, it could be a big, big deal. But of course something doesn't even have to happen -- public perception and government receptivity to the real or perceived risks of nuclear power could change and cause problems for Exelon.

My bottom line
After taking a closer look, Exelon is a company that I want to like more than I actually like. My biggest holdup? Management's decision to dilute shareholders with the acquisition of Constellation. The strategic rationale may be sound, but the extent to which it benefits -- or harms! -- shareholders also depends on the financing of the deal, and I'm unconvinced that using shares is the right way to go.

I'm not completely knocking Exelon from consideration yet, but I think some of the other companies I've looked at seem like better opportunities.

But when it comes to your own portfolio, you obviously make the final call. As you digest this and dig into the numbers yourself, you should go ahead and add Exelon to your watchlist to keep up with what's going on at the company in the meantime. Don't have a watchlist? You're in luck; you can start one for free by clicking here.

Motley Fool newsletter services have recommended buying shares of Southern and Exelon. Motley Fool newsletter services have recommended creating a covered strangle position in Exelon. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer does not have a financial interest in any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.


Read/Post Comments (5) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 30, 2011, at 6:10 PM, Fool wrote:

    I have to agree that I'm not thrilled about the dilution from an all-stock deal.

    But, long-term, Exelon will now be in the top 2 companies in electricity generation and in customer base. Seems like a stream of steady, predictable profits for decades to come.

  • Report this Comment On August 31, 2011, at 1:15 PM, financeguy85 wrote:

    Matt,

    I've owned EXC for a couple years. However, can you provide any reason for why the company hasn't raised its dividend in 3 years? It appears that their free cash flow production provides more than enough cushion to raise the payout. If competitors like AEP and SO can raise the dividends on an annual basis, why can't EXC?

  • Report this Comment On September 01, 2011, at 11:45 AM, TMFKopp wrote:

    @financeguy85

    In my research I didn't happen on any statement from the company specifically stating why it wasn't raising. My best guess would be simple conservatism. EXC's large generation arm makes a little more vulnerable in a recession than AEP or SO.

    Also, it's notable that EXC's simple free cash flow (cash flow from operations - capex) is often less than net income, so the payout ratio on that basis can be a little higher than the "normal" calc.

    I prefer that a company keep a good track record of consistently raising its dividend, but with EXC's yield already at 5%, I guess I'm no too turned off by the idea of them playing a little defense. (though that acquisition was hardly defensive...)

    Matt

  • Report this Comment On September 01, 2011, at 12:46 PM, Eerkes wrote:

    as an owner of this company, i have done fairly well selling covered calls on exc just out of the money, usually at 43. occasionally i have lost my shares, but have gotten plenty of opportunities to buy back at 41 or under. Not too happy about the constellation deal, might just sell my calls a little closer to the money and not buy back in next time they float away

  • Report this Comment On September 02, 2011, at 1:26 PM, financeguy85 wrote:

    Matt,

    Thanks very much for your insights. I agree that the current yield of 5% is nothing to sneeze at, but I also own SO. In a few years, SO's dividend growth will make my yield on cost much higher than 5%, so EXC won't look so great in comparison. Keep up the good work sir.

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Related Tickers

10/24/2014 4:02 PM
EXC $35.73 Up +0.85 +2.44%
Exelon CAPS Rating: ****
CEG.DL2 $0.00 Down +0.00 +0.00%
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PCG $47.17 Up +0.98 +2.12%
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SO $47.41 Up +0.20 +0.42%
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