Dividend Investors Were Burned By Exelon Last Year. Will 2014 be Different?

Exelon is attempting to reverse course after a challenging 2013, but investors may be better off picking a less-risky utility.

Jan 8, 2014 at 10:21AM

Electric utility Exelon (NYSE:EXC), the largest operator of nuclear fleets in the United States, took its investors on a roller-coaster ride last year. After it encountered difficulties due to extremely challenging power prices, Exelon took some drastic steps to engineer a turnaround. Mainly, the company cut its dividend after providing its fiscal 2012 fourth quarter results. This was not received well by investors, who typically buy utilities for their stable profits and reliable dividend payments.

However, as the saying goes, often the best time to buy a stock is when there's blood in the streets. Does the turnaround potential at Exelon have legs? Or would investors be foolish to take the risk?

Where Exelon currently stands
Exelon saw tough conditions for most of 2013, but to its credit, has seen business stabilize more recently. The company had a decent third-quarter that resulted in flat net income and diluted earnings per share versus the same quarter the year prior. That being said, Exelon still generated lower operating cash flow over the first nine months of fiscal 2013 as compared to the same period in 2012.

Other utilities simply haven't experienced the troubles that Exelon is encountering. Over the first nine months of 2013, Southern Company (NYSE:SO) generated adjusted earnings of $2.24 per share, down just slightly from $2.26 per share through the same period last year as a result of extremely heavy rainfall. Meanwhile, Consolidated Edison (NYSE:ED) actually grew its core operating profit by 3% in the third quarter and 2% over the first nine months of the year.

Balance sheet receives a much-needed cushion
After fourth quarter 2012 results, Exelon made the always-difficult decision to cut its dividend after its fiscal 2012 fourth-quarter profit fell a whopping 38%. It's especially troubling when a utility slashes its payout, since investors buy utilities largely for the hefty dividends. Unfortunately for shareholders, Exelon's deteriorating business conditions meant it simply couldn't afford its payout.

A decision had to be made as management was committed to keeping its credit rating out of junk level, which it was only two notches above at the time of the dividend cut. Exelon bought itself some much needed financial flexibility to keep investing in its business. Its new dividend payout will "save" the company approximately $740 million per year going forward.

In addition, Exelon recently sold $650 million in new bonds through its ComEd subsidiary. Amazingly, Exelon's new issues carry fairly low coupons, considering the company's less-than-stellar credit rating. Exelon sold $300 million in bonds maturing on January 15, 2019 that carry a 2.15% coupon. Exelon also issued $350 million in debt that matures on January 15, 2044 with a 4.7% coupon. These coupons are low enough to provide Exelon much-needed capital at a manageable cost.

Exelon's turnaround may happen—but why risk it?
While Exelon is confident in its turnaround prospects in the year ahead, it's no guarantee. Nuclear has proved to be an extremely difficult business from a pricing standpoint. While it's always tempting to pick a bottom among businesses encountering hard times, investors don't really need to gamble on Exelon's turnaround prospects. After all, it seems that low volatility and stable dividends are why investors flock to utilities in the first place.

After Exelon's dividend cut last year and corresponding stock sell-off, the stock now yields 4.7%. That's certainly a high yield that will provide meaningful downside protection while the company attempts to sort itself out. But again, higher-quality utilities are suitable alternatives. Consider that Southern Company current yields 5% and is still growing its dividend on an annual basis. Likewise, Consolidated Edison raised its dividend last year and yields 4.6% at recent prices. It's very unclear when Exelon will get back to dividend growth.

All eyes are now on Exelon's fiscal 2013 fourth quarter. It was the same fourth quarter in the previous fiscal year that resulted in Exelon's dividend cut, so investors will clearly need to see better performance this time around to justify buying in.

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Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Exelon and Southern Company. 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. The Motley Fool has a disclosure policy.

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