Well, at least the company can say you were warned. Exelon (NYSE:EXC) finally ended months of speculation and announced that it will be cutting its dividend. Starting in the second quarter it'll be going from the current rate of $0.525 per share to $0.31 per share.
As a soon-to-be investor in Exelon I'm not exactly thrilled by the cut; I was looking forward to that nice chunk of quarterly cash flow. What's important to understand, though, is the reason behind the cut and if it makes sense. For Exelon, the idea behind the 41% haircut is so that it can maintain its investment grade credit rating, and invest the cash in growth projects. I can certainly understand the company wanting to maintain its credit rating. My question is: How does the company plan to grow?
As investors know well, Exelon owns the nation's largest fleet of nuclear power plants. However, given the shear cost involved to build a new plant, as well navigate the difficult regulatory environment, the company won't be building a new unit any time soon. Instead, the company is investing in nuclear uprates to grow its nuclear generation. This entails investing in the components necessary to increase the generating power of a reactor.
These are lower-risk, higher-return investments for the company. When executed across its portfolio, the uprates will increase Exelon's generation capacity to an output equivalent of adding a new unit. Even better, the uprates will be accomplished at a substantially reduced cost.
Exelon is not alone in using uprates to grow its nuclear capacity. Fellow clean energy generator, NextEra Energy (NYSE:NEE) is investing $1.5 billion on its own uprate program to add 400 MW of nuclear capacity. The company had filed to build two new 1,100-MW nuclear reactors, but no decision on the reactors is likely until 2014, for the $12 billion-$18 billion project is not likely to enter into service until at least 2022. As you can see, uprates have quite the return on investment.
Looking past uprates, Exelon is also investing in renewable energy to generate even more nuclear generation growth. One example is the company's new 230-MW solar farm in California that First Solar (NASDAQ:FSLR) is building. The $1.36 billion dollar project will include more than 3 million solar panels and will be operated by First Solar. The power has been contracted out to PG&E under a long-term contract.
These long-term power purchase agreements are important because they generate steady, predictable returns for the company. Not only that, but as Exelon CEO Christopher Crane noted: "[When] the balance sheet is tight like it is right now, you would want to make investments that have a short investment period ... wind and other smaller assets really do fit that profile. Within a year, you're getting a return."
That's likely why the company will continue spending a bulk of its growth capital on these quick-turnaround growth projects at the expense of its dividend. Essentially, management is saying that it believes it can earn its investors a greater return on their money by investing in these high-return, quick-payback projects than they could earn if the company kept up the payout. So, while no one likes to see a pay cut, this one shouldn't scare you.
Matt DiLallo has the following options: Short Apr 2013 $35 Puts on Exelon. The Motley Fool recommends Exelon. 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.