With the S&P 500 index up nearly 70% from its March low, the number of companies coming up on my stock screens is dwindling. But one company that recently came up was nuclear power generator Exelon (NYSE:EXC). I like Exelon because it's a relatively low-risk company, has a huge cost advantage over most competitors, pays a stable 4.3% dividend, and is pretty cheap. Owning Exelon shares is also a free option on any climate-change legislation that introduces a cap-and-trade system.
Exelon is an electric utility company that operates the largest fleet of nuclear power plants in the United States. It has 20% of all nuclear power generating capacity in the United States. Exelon also operates natural gas, oil, coal, and hydro plants, but 75% of its output is nuclear. Nuclear power's advantage is that, along with hydro, it has the lowest operational cost, and it is used as base-load power. Combine a 90% plus utilization rate with low costs and you get high, predictable cash flows -- and who doesn't like cash? It's no accident that Warren Buffett's Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) has invested so much in its Mid-American subsidiary.
The nuclear advantage goes to companies that have existing plant capacity. No new nuclear plants have been started in the United States since the 1970s, although some were completed and brought online in the 1990s. Today, capital cost is the main reason why new plants have not been started. There are approved plans for new plants, but without significant government guarantees on debt, I think it will be some time before any are built in the United States. And even then, it will take years to complete them.
Exelon owns two public utility companies: Commonwealth Edison (ComEd) in Illinois and PECO in Pennsylvania. ComEd serves 3.8 million customers, and PECO 1.6 million electricity and 491,000 natural gas customers. Utilities are highly regulated, and profit margins are much lower than power generation; however, the profits are fairly consistent and could be boosted by lower price constraints.
The value in power
In any economic downturn, demand for power is reduced, and Exelon has accordingly experienced diminished demand. But this won't last forever, and of course, it brings the share price down to value territory. Opportunities for accelerated growth are limited barring acquisitions, but at less than $50 per share, the market is pricing in less than 2% growth. With an eventual rebound in the economy, I estimate mid- to low-single-digit organic growth over the next 10 years, which puts the value around $70.
Just as important to me is how management allocates its considerable cash flows. Over the last five years, dividends per share have grown annually at a 13.6% average pace. The next priority is growth opportunities, but management has demonstrated that it will only invest when it sees a good economic return. The company has shelved plans to build two new nuclear plants, based on cost and current demand.
Exelon will acquire significant power companies, but only if the price is right. Earlier this year, Exelon offered to buy NRG Energy (NYSE:NRG) but was rebuffed by NRG shareholders. Exelon management refused to raise its offer. Any cash that is in excess of investment is used to buy back shares, which at today's price is a good deal.
Foolish bottom line
Exelon affords good protection to the downside -- even in the March lows, the share price only dipped below $40 for two days. Exelon will never be a high-flying stock, but just like Icarus, highfliers can crash and burn. For 2010, the market is starting at a high altitude. You'll do much better to keep your feet on the ground with a potential 40% to 50% upside and a 4.2% dividend while you wait.
Which is the best stock for 2010? See all 13 candidates here.
