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Exelon's Not-So-Excellent Outlook

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Typically when companies forecast lower sales or profits, their stocks usually take a hit. It's not always easy to tell whether it's having a fire sale or burning down its house. Maybe it's time to get out -- or maybe it's time to buy more!

After reporting fourth-quarter earnings that were below analyst estimates, slashing its dividend, and offering guidance below expectations, it's surprising that the nation's largest operator of nuclear power plants, Exelon (NYSE: EXC  ) , didn't suffer a meltdown. Although its stock did ease back a little, the shares remain in an upward trend, having risen almost 11% from the lows they hit last November.

Now don't blindly follow those selling (or buying) on this apparent bearish signal: You still need to dig further. We'll just use the announcement as a jumping-off point for additional research.

Like lemmings over the cliff
Probably more so than lowering guidance, cutting a dividend like Exelon did (the utility is slashing it 41% to $0.31 a share) will often cause a company's stock to tumble and its financial acumen to be called into question. It's one of the reasons companies are loath to do so and why they often resort to other financial gymnastics to preserve the payout.

Yet it's not as if Exelon didn't warn investors that it might have to cut the dividend -- it told them last November that if conditions didn't change, its payout might need to be trimmed. Still, a tactical retreat is oftentimes a smart decision, and analysts have uniformly praised Exelon's move because it's being done to preserve its investment-grade credit rating.

By lowering the dividend and maintaining its rating, the nuclear-plant operator asserts that it will be better able to invest in growth opportunities when they arise while still providing financial stability for the dividend that remains. Indeed, following the announcement, ratings agency Moody's reaffirmed its Baa2 rating. 

Grow up or grow out?
Yet after acquiring Constellation Energy last year, Exelon has deferred further growth spending because market conditions haven't been favorable. Its fourth-quarter earnings report was hit by lower energy prices as power companies are announcing that they've shut down or will shut down by 2015 some 19,000 coal-fired power plants. Typically, that would cause heat rates -- which, in turn, affect pricing -- to rise, but that's not happening at the moment. Exelon's prices in 2012 were at or lower than the levels seen in 2011 and 2010, hurting margins.

Exelon could take on new debt to support the dividend, but doing so would jeopardize its investment rating, and if it's to grow in the future, it can't have a balance sheet larded with debt. It wants to invest in initiatives that add to stable cash flows. Renewable energy also remains a top priority, such as its new 230-megawatt solar farm in California that First Solar (NASDAQ: FSLR  ) is building and its City Solar urban solar installation in Chicago that it partnered with Sunpower (NASDAQ: SPWR  ) on.

An alternative solution
As management notes, its competitive advantage arises from the broad scope of its operations up and down the energy value chain. And despite concerns about nuclear power, it remains a viable clean energy alternative to fossil fuels. Yet getting a new nuclear power plant approved is a long and arduous, not to mention expensive, task, so Exelon believes it can invest in nuclear uprates to grow its production. As the Fool's Matt DiLallo recently pointed out, if uprates are achieved across its entire portfolio, the plant operator can increase production as much as if it had built a new plant, and he points out that NextEra Energy (NYSE: NEE  ) is also investing $1.5 billion in an uprate program to add 400 megawatts of nuclear capacity.

As beneficial as that is for the operator, it's not a fait accompli to do so. Uprates refer to the maximum power level at which a commercial nuclear power plant may operate, and they're set at the time Exelon, NextEra, or Duke Energy gets its license. For a company to increase its uprate, it needs to apply to and get prior approval from the Nuclear Regulatory Commission.

Of course, the NRC has a history of approving uprate applications, so it's not so difficult as all that, and as of April 2011 -- the latest available data from the NRC -- 139 uprates have been approved since the 1970s, resulting in a gain of approximately 18,063 megawatts thermal or 6,020 megawatts electric at existing plants. That's the equivalent of six new power plants.

React to the situation
Nuclear power generation is on the rise again. According to data compiled by Bloomberg, after Duke returned its McGuire 1 to the grid at the end of January, national nuclear production increased 1% to 85,845 megawatts, or 84% of capacity, some 0.3% higher than a year ago. Exelon's also restored its Dresden 3 reactor to full power, and others have done the same with theirs.

While Exelon's decision to cut its dividend may have disappointed investors and its outlook for the year might not be a glowing endorsement of existing conditions, it's the longer-term opportunity investors really need to concentrate on, and the nuclear plant operator has shown itself to also be interested in more than short-term gains. That's the kind of management team an investor would want to align himself with.

Let me know in the comments box below whether you agree that Exelon remains an excellent choice to power your portfolio in the future.

Looking under rocks
As the nation moves increasingly toward clean energy, Exelon is perfectly positioned to capitalize on having the largest nuclear fleet in North America. Combine this strength with an increased focus on renewable energy, and Exelon's recent merger with Constellation places Exelon and its best-in-class dividend on a short list of top utilities. To determine if Exelon is a good long-term fit for your portfolio, you're invited to check out The Motley Fool's premium research report on the company. Simply click here now for instant access.

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9/27/2016 11:23 AM
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