Last week, I announced my intention to create a portfolio composed of 10 companies that investors have unjustly cast aside. My goal in creating the One Person's Trash Is Another Person's Treasure portfolio is to highlight just how successful value investing and contrarian viewpoints can be, as well as uncover some great companies that have a good chance of turning their fortunes around. For a more thorough explanation of what I hope to accomplish and how I'll measure my success, I encourage you to visit my portfolio mission statement.
For today's inaugural pick, I've chosen electric utility giant Exelon (EXC -0.13%).
Why traders have given up on Exelon
It's been a year to forget for Exelon shareholders, with shares down 30% over the trailing 12 months. The primary reason Exelon has performed so poorly relates to its primary energy generation source: nuclear.
Nuclear energy is clean-burning, but it's extremely pricey relative to low natural gas prices and the sudden proliferation of wind and solar power. This has left Exelon in a precarious situation, since the costs of building additional nuclear plants are likely to outweigh their eventual benefits. To make matters worse, both Southern (SO 0.93%) and SCANA (SCG) received the OK from the Nuclear Regulatory Commission to build two new reactors apiece, only further glutting the market.
Exelon has also been slow to convert coal-fired plants to natural-gas-burning facilities, which left the company particularly exposed when coal prices and demand headed south thanks to an extremely warm winter.
Why investors should trust Exelon
Yet for all the reasons to run away from Exelon, there are plenty of other reasons that would suggest a turnaround is brewing.
To begin with, Exelon is addressing its reliance on coal by using more renewable energy resources. As I noted in September, Exelon signed a contract with U.S.-based First Solar (FSLR 0.17%) to complete a power-grid-attached photovoltaic-panel solar facility in Maryland in an effort to reduce its carbon footprint and lower long-term energy costs. As for wind, Exelon has 39 projects in 10 states currently capable of 922 MW of generation, with the bulk coming from Michigan, Missouri, and Texas.
Another factor that bodes well for Exelon is the U.S. government's push toward energy independence. President Obama has made it clear that he'd like to reduce the United States' reliance on foreign oil, which is going to begin at home. Part of that solution very well could be the building of more nuclear reactors with the possibility that these reactors would be subsidized. Keep in mind this is mere speculation on my part, but it seems a logical next step, given that nuclear energy is a clean and efficient energy source.
Finally, it's worth noting that despite its problems, Exelon still has strong pricing power. As coal and natural gas prices have rebounded, it's given Exelon more justification to raise electricity rates, which will ultimately boost its margin and give it the free cash needed to make further clean energy investments.
What you'd get here
For one thing, you get a megautility that isn't dealing with regulatory scrutiny, like Duke Energy (DUK 0.21%). Duke's merger with Progress Energy went sour when former Progress CEO Bill Johnson, who was supposed to act as the combined company's CEO, resigned just hours into his tenure.
With Exelon you get a solidly profitable electric utility servicing 6.6 million people throughout the U.S. that's averaged $2.2 billion in free cash flow over the past six years. Exelon is valued at less than 10 times forward earnings and roughly 3.5 times cash flow, and it pays out a delectable yield that's tickling the 7% range. It's a value play that's predominantly frowned upon because of its large reliance on nuclear energy, but in reality, it looks poised to pop in a big way if you attempt to look beyond one or two poor quarters of performance.
Check back next week, when I unveil the second in a series of 10 selections to the One Person's Trash Is Another Person's Treasure portfolio.