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Duke Energy Corporation
Duke Energy Financials

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By mjuarez
July 28, 2003

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I've been following this board for a couple of weeks now, and I'm seeing more and more to like about this company, mostly from reading BMW's posts. I'm seriously considering it for a small part of my portfolio, mostly for that juicy 6% dividend.

So, I downloaded the annual report for 2002 and started poking around. Since I'm looking at it as a possible investment, I tried to play devil's advocate and see what might be wrong with the company. Here's an initial overview of what I found.

A major acquisition, WestCoast Energy, was completed last year. This brought along $4.7B in debt, with interest rates as high as 15%. As of December 31st 2002, the company had more than $20B in long-term debt, plus other $20B in short-term liabilities and other contingencies. The $20B in long-term debt is not so significant, considering the company has more than $15B of yearly revenues, but still, it is worth noting that the company is significantly leveraged. I may add that, from what I've seen, this is "normal" in this business, mostly due to the huge capital expenditures needed for the building of plants and pipelines.

The company is issuing out more commercial paper, and shares of stock, than ever. Just last year, more than $5B was offered in debt, which helped pay for the difference in cash inflows vs. capex [capital expenditures.] On top of this, more than $1B worth of stock was sold to the public. The end result is that, in just one year, investors saw their stake in the company diminish by almost 15%. Subtracting the 50M shares of stock issued for the Westcoast Energy purchase, it still leaves 68M shares of stock, which diluted the ownership of shareholders by about 10%. A 10% dilution rate would be OK if the company was a startup on its way to profitability, but IMHO, is inexcusable for a company with the size and reputation of Duke-Energy.

At year-end 2002 the company had more than 30M stock options outstanding. With a float of about 900M shares, the ESOs are approximately 3.5% of outstanding shares, which is not that high. However, couple this 3.5% with the above 10%, and you get a pretty nasty 13.5% ownership dilution in just one year. The sad part is, this only seems to be increasing through the last years, instead of decreasing.

Cash flow looks nice at more than $4B per year, until you check capex, which stood at almost $5B. The company is actually spending more on building and/or expanding facilities than the total cash it receives per year. The difference was paid for with additional debt and issue of common stock. I have no idea what Duke Energy is building or expanding, but spending more cash than is coming in is usually not good for the long-term business owners.

In the end, that juicy 6% dividend only transforms itself in a not-so-nice 7% ownership dilution. Not a good first impression. I still have to take a long hard look at other aspects of the business. One of the things which intrigues me is that maybe all that debt is being used to significantly prop up revenues and profits in the medium-term future, and in that case, today's spending and dilution might not look so bad.

But I'll have to get back to you on that later.

Marcos


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