Utility stocks have remained a popular investment choice for dividend-hunting investors, as they offer attractive dividend yields. Duke Energy (DUK 0.07%) is a leading utility company in the U.S. and has a solid operational base. The company offers a solid dividend yield of 4.4% and its growth outlook remains impressive, as it is taking several initiatives to reduce earnings volatility and fuel earnings growth.
Ensuring earnings stability
Earnings of power producers like Duke, FirstEnergy (FE 0.70%) and American Electric Power (AEP 0.57%), with exposure to a competitive power market, stay volatile because of uncertainty of forward power prices, which are determined through auctions. Utility companies in the U.S. with exposure to competitive power generation are considering several options, including selling competitive generation assets and undertaking long term contracts, to ensure earnings stability.
Duke also has exposure to competitive power generation, and earnings of the segment remain weak and uncertain. Duke has planned to exit from the competitive power market by selling competitive generation assets in the Midwest. By the end of 2013, the book value of Duke's competitive assets was $3.5 billion. In the first quarter of 2014, the company took an impairment charge of $1.4 billion, which means that the fair market value of the assets is almost $2.1 billion. The first round of bids is expected in the ongoing second quarter, and a deal is expected to be finalized and closed by the first half of 2015. Duke could register more write-downs as a final bid takes place, if the company is unable to obtain the expected fair market value of the competitive assets in the Midwest.
The sale of competitive power assets will prove positive for Duke's future earnings and valuation, as it will eliminate commodity exposure and provide stability to bottom-line results. Also, Duke will be able to use the sale proceeds to reduce debt or buy back shares, which will prove accretive to EPS growth in the future.
Other companies including American Electric and FirstEnergy are also considering the option to reduce earnings volatility associated with competitive power operations; both companies are making efforts to introduce long term contracting to ensure rate and earnings certainty. American Electric continues to take initiatives to de-risk competitive operations through long term pricing contracts and productivity improvement. American Electric will want to get long term pricing contracts for its competitive Midwest assets, similar to the long-term contracts it has with municipalities.
If American Electric is successful with its plans to stabilize earnings through securing long-term contracts, then the company will keep its competitive Midwest assets operational; otherwise it will consider possible divestiture. The final decision on the Midwest assets is likely to be made by the end of this year or early 2015, and the company can opt for assets sale if its efforts to stabilize do not bring about the desired results.
Duke is also undertaking a strategic review of its international business segment to make optimal use of its employed capital. International business operations do provide Duke with operational diversification, but also add risk to its profile, as the segment is exposed to foreign government policies and regulatory risks, foreign exchange risk, and changing tax policy risk.
Impressive capital spending profile
Other than efforts to stabilize earnings, Duke's capital spending profile remains impressive. The company plans to accelerate its capital spending from 2015 through 2018, which will prove beneficial for its long-term rate base growth, as the capital spending incurred will be recovered through rate increases. Duke anticipates rate base growth to be 6% on average in the back half of the decade. Duke has planned to undertake new generation spending of $1.05 billion through 2016 and an additional $1.02 billion from 2017-2018 in Florida. Also, in the Carolinas, Duke has planned to undertake new generational investments of $2.25 billion and $1.95 billion through 2016 and from 2017-2018, respectively. These investments will be directed to regulated operations, which will strengthen Duke's regulated operations and provide earnings stability.
As competitive business environment remains challenging, FirstEnergy is also focused on increasing investments for its low-risk regulated business in the future, which will prove positive for its earnings stability and growth in the upcoming years. According to plans, FirstEnergy is expected to spend $4.2 billion over the next four years in regulated transmission assets. The planned capital spending will allow the company to reshape its business, focus more on regulated operations, and increase the predictable earnings base of the company.
Final thoughts
Duke has been taking the right initiatives to strengthen its business operations. Duke's plans to exit from the competitive Midwest market and a strategic review of its international business operations will increase earnings contribution of regulated business operations and provide earnings stability. Also, impressive planned capital spending, which the company plans to accelerate beginning in 2015, will provide earnings growth in the back half of the ongoing decade.
