TOP CONTRIBUTORS

Vincent McPhillip

Avinash Gandhi

Isaac Middendorf

EXC AT A GLANCE

P/E ► 11.3 AVG EV/EBITDA ► 6.13 AVG ROA ► 7.6% AVG ROE ► 23.5% HIGH Debt to Equity ► 2.96 AVG Current Ratio ► 1.33 AVG Interest Coverage Ratio ► 6.93 AVG

 

 

 

 

 

 

Exelon Corp. is one of the nation's largest electrical utilities, with over 5.4 million retail customers and over 33,000 Megawatts in energy capacity (1 MW can power approximately 500 homes; for example, a city the size of Seattle can consume 1,100 MW at any given moment in time.) In the third quarter of 2009 Exelon reported operating revenues of $4.36B and operating income of $757 M and in 2008 operating revenues and operating income were $18.9B and $5.3B, respectively. Exelon delivers energy to millions of retail customers in Pennsylvania and Illinois and generates energy for wholesale delivery to retail suppliers throughout the nation.^[1]

PECO and ComEd comprise Exelon's retail utility segment. PECO delivers electricity and gas to almost 2 million customers in the southeastern portion of Pennsylvania, including the city of Philadelphia. ComEd delivers electricity to 3.7 million customers in northern Illinois. The future success of both subsidiaries depends largely on U.S. Energy Regulations and their respective regulatory environments. ComEd, in particular, faces some uncertainty as Illinois nears the end of a 10 year legislative rate freeze on energy prices. If Illinois moves from government regulated prices to market based pricing, ComEd could see a significant boost to earnings. On the other hand, continuation of rate freeze legislation could pose a serious threat to the company.

Exelon also operates a wide array of nuclear energy, fossil fuel, hydroelectric and renewable energy plants. Exelon's energy portfolio is concentrated in nuclear energy, with nuclear energy generation representing almost two thirds of total energy production. Exelon's nuclear fleet represents 3% of total US energy production. Exelon's nuclear focus will allow it to benefit from a variety of trends including rising worldwide demand for energy, resulting rising fossil fuel prices, global warming concerns and a favorable US legislative environment.

Corporate Overview

Exelon was formed through the merger of two energy utilities, Unicom and PECO, in 2000. The merger was part of an overall wave of consolidation that occurred in the wake of the deregulation of the utility industry. Exelon manages its broad interests through two business segments: Delivery and Power Generation. Generation processes raw fuel to generate energy in an array of fossil, hydroelectric and nuclear power plants. Exelon delivery focuses on maintaining the power lines and other infrastructure necessary for delivering energy to millions of customers in Illinois and Pennsylvania. Delivery operates through two subsidiaries: Commonwealth Edison (ComEd) which operates in Illinois and PECO which operates in the Philadelphia region of Pennsylvania. Power Generation is also subdivided into three business segments: Power, Nuclear and Powerteam.

In the third quarter of 2009 revenue was $4.36 billion, down 15% as compared to the same period in 2008. Excluding charges, profit was $757 million. Multiple factors impacted revenues including decreases in consumption due to energy efficiency programs and a decrease in customer base. Exelon's Commonwealth Edison utility had its customer base drop by 0.5 percent as compared to the third quarter of 2008. Additionally, the customer base for Exelon's PECO utility in Philadelphia was down 0.4 percent. Demand was also affected by weather in the Chicago area. The region experienced its coolest summer in 17 years contributing to a 9.8 percent decrease in energy usage as compared to the second quarter of 2009.^[5]

For the second quarter of 2009 net income was down 12% as compared to the same period in 2008. This was due primarily to lower energy margins at generation, higher nuclear costs and increased depreciation due to capital expenditures across the operating companies.^[6]

Net income rose more than 12% from 2007 to 2008 despite stagnant revenue growth, because of higher power generation margins.^[2] However, as electricity prices begin to adjust to lower fuel prices, margins are likely to return to previous levels.

Business Segments

ComEd

Commonwealth Edison, or ComEd, is responsible for servicing and maintaining the over 78,000 miles of powerlines that provide Chicago and northern Illinois with electric energy. ComEd does not engage in the production of energy. Instead, it purchases energy from third party providers and focuses on servicing and delivering this energy to customers. ComEd currently has a customer base of over 3.7 million and has approximately 6000 employees. In FY 2007, ComEd earned $6.104B in revenues, with $512 million in operating income. In June 2007, the Federal Energy Regulatory Commission raised ComEd's customer's rates by about 1%, in response to a request by ComEd.

PECO

PECO engages in the distribution and delivery of electricity and natural gas in the southeastern region of Pennsylvania. Like ComEd, PECO does not engage in the production of energy; it purchases energy from Exelon Power Generation and other third party providers. PECO focuses primarily on servicing and maintaining a web of substations, power lines and gas mains to deliver this electricity to 1.5 million customers and gas to another 460,000 in the Philadelphia region. Recently, PECO finished installing $12 million worth of upgrades to one of its Pennsylvania natural gas distribution systems, ensuring that it will be able to deliver to customers over the winter as temperatures fall and heat demand rises. The segment also announced that in 2007, it was able to cut the number of power outages that affected customers by 23% through increased spending on maintenance and upgrades. In FY 2007, PECO reported revenues of $5.613 billion and a net profit of $947 million.

The Pennsylvania Energy Independence Initiative, which is planned to help cut carbon emissions in the state by advancing conservation and raising fossil fuel taxes could benefit Exelon by pushing nuclear energy, but could hurt the company's fossil fuel power business. Currently, the company is working on lobbying the state legislature to make the Initiative more appealing for it.

Power Generation

Generation, Exelon's largest business segment, earned $10.749B in 2007 revenues, with $3.392B in operating income, making it Exelon's most profitable segment. Generation is divided into Nuclear, Power, and Powerteam.

Nuclear

Of these three segments, nuclear is by far the largest. Exelon's nuclear wing operates 10 nuclear plants with 17 reactors. Exelon's nuclear fleet is the largest in the nation and third largest in the world. In all, the plants represent 20% of US nuclear energy or 3% of total US energy production. Decades after nuclear accidents at Three Mile Island (Three Mile Island - 1 was acquired by PECO in December of 1999) and Chernobyl stigmatized nuclear energy, rising fossil fuel prices are making people reconsider. Higher oil prices increase costs for fossil fuel plants and make nuclear energy more attractive. Increasing awareness of global climate change also makes nuclear energy more appealing, as nuclear plants have negligible greenhouse gas emissions compared to plants that burn fossil fuels (though construction of nuclear plants does cause some emissions). Exelon demonstrated its long term commitment to expanding its nuclear energy program when it tried to merge with PSEG in 2006. The merger would have given Exelon interest in four additional nuclear plants and boosted it to the world's number two in nuclear energy. Although the deal was scrapped due to high regulation hurdles, nuclear energy remains Exelon's crown jewel. The nuclear segment was one of the most successful nuclear power teams in the industry during 2007, with an average capacity factor (that is, percent of capital used) of 94.5% (compared to the industry average of 90%), and energy production growth of 955,000 megawatt hours^[8]. During the first quarter of 2008, however, the company started five refueling outages, completing four - over twice as many as occurred in the same period of 2007. Though these outages were necessary, they did reduce the company's production during the period. Exelon was able to complete these outages in an average of 25 days - compared to the industry average of 41 days.

Power

Exelon Power manages Exelon's portfolio of fossil, hydroelectric and alternative energy plants. These plants have the capacity to produce over 8000 Megawatts of energy. This capacity complements Exelon's nuclear production; when demand spikes, some of the excess burden can be shifted onto the fossil plants. Unlike Nuclear, the Power division is exposed to the risks associated with fossil fuels such as global warming and oil prices. In addition to fossil and hydroelectric plants, Exelon Power also operates several solar power facilities and several wind farms as the largest producer of wind power east of the Mississippi.

While the price of coal has been rising for some time, Exelon continues to expand its Power segment, albeit in creative ways. In 3Q07, the company purchased the output of State Line, a 515 MW coal power plant in Indiana, until 2012. Despite the rising cost of coal power production, Exelon expects after-tax income from the plant to be around $130 million in 4Q07, and then expects to lose $35 million per year until the end of the contract, when State Line will pay the company $233 million, creating immediate cash flow. It should be noted that the coal plant was not purchased as a strategic asset, but rather as an assured investment with dependable future income and no long-term financial repercussions.

Power's fossil fuel capital availability rate in 4Q07 was 83%, compared to 95.7% in 4Q06, because two plants went down in 4Q07. The company's hydro-facility availability rose for the same periods from 97.9% to 98.6%, though lower river flow resulted in lower power generation^[9].

PowerTeam

PowerTeam is responsible for marketing Exelon Nuclear and Power's products. PowerTeam delivers wholesale energy products to retail suppliers. They also design and package energy products and negotiate contracts with municipalities, utilities and institutional traders. Additionally, PowerTeam actively hedges Exelon Nuclear and Power's portfolio of energy assets. PowerTeam's hedging reduces Exelon's overall exposure to the risks of fluctuating energy prices.

NRG Acquisition Bid

Exelon made an unsolicited acquisition bid to NRG Energy in October 2008, worth $6.2 billion. If Exelon was successful in acquiring NRG it would have created the largest power company in the country (by asset value).^[10]

The initial offer of $6.2 billion was rejected by NRG management, so Exelon made an unsolicited bid directly to shareholders.^[11] By the end of June only about 12% of NRG's shares had been tendered under the offer, so Exelon moved to what was deemed by the company's chairman, John Rowe, to be "the best and final offer." That offer was roughly $7.5 billion an increase of 17% from its initial offer in 2008. Exelon increased the offer after it identified another $1.5 billion in cost savings through the combination of the two businesses and the added benefits of NRG's purchase of a retail business from Reliant Energy (RRI).^[12]

The hostile bid was met resistant from the NRG management board and Delaware’s Public Service Commission and its Department of Natural Resources submitted concerns over the bid to the Federal Energy Regulatory Commission.^[13] On July 21, 2009 Exelon officially terminated its offer to acquire all of the outstanding shares of NRG Energy. Exelon was unwilling to raise its price to what it considered would undermine its own value proposition and in light of a preliminary proxy vote of shareholders against the proposal.^[14]

Trends and Forces

Falling Fossil Fuel Prices Make Nuclear Uncompetitive

In the first quarter of 2009, oil prices have hovered around $40-$60 a barrel, too low to stimulate interest in nuclear energy.

The key difference between nuclear and fossil plants is the cost structure. Nuclear plants require very large capital investments (to construct the plant) but little expenditure for fuel because it takes relatively little uranium to power a plant. On the other hand, fossil fuel plants require relatively little capital investment but have high fuel costs because they require large amounts of coal, oil or gas. In the past, low fossil fuel prices gave given fossil fuel plants a cost advantage over nuclear plants. The cost advantage, compounded by the stigmas of nuclear energy (the Not In My Back Yard (NIMBY) phenomenon) has prevented new nuclear construction for almost 30 years. Record fossil fuel prices after 2007 reversed this trend. Nuclear utilities such as Exelon and Entergy began filing for permits for construction of new nuclear plants, with some heralding the arrival of a "nuclear renaissance." With oil prices down more than $100 a barrel from mid-2008 to early 2009, making a profit after spending the massive amounts of money required to build nuclear plants has become more difficult.

Global Warming and Environmentalism

Over the past few years, global warming has moved from the fringes to become one of the single greatest challenges facing the world today. A growing body of scientific evidence ties carbon dioxide emissions to rising temperatures. As a result of growing popular awareness of the risks of global warming, many large corporations have stepped up their efforts to project greener images. Additionally, many expect the U.S. government to enact more stringent legislation limiting carbon emissions. Environmental awareness is another key trend driving the renaissance of nuclear energy. Compared to their fossil fuel peers, nuclear energy plants have negligible emissions. Again, although Exelon also operates fossil fuel plants, the majority of its energy comes from nuclear plants. Additionally, Exelon operates many hydroelectric, alternative and renewable energy plants. In all, Exelon stands to benefit from a shift to nuclear energy due to global warming concerns, a fact that has not been lost on the company. The company recently began to push for higher efficiency standards and other environmentally friendly state policies in the areas it operates, probably hoping that a paradigm shift will facilitate a shift towards renewable energy, ultimately benefiting the company.

In its second quarter 2008 conference call, Exelon detailed a program, Exelon 2020: A Low-Carbon Road Map, with a goal of offsetting 15 million metric tons of greenhouse gas emissions by 2020. The company plans on spending 10 billion over the next 12 years, 80-85% of which will go to upgrading nuclear plants, implementing renewable energy generation, and building efficient natural gas plants. The rest will go to carbon offsets and customer education programs.^[15]

Nuclear Power Is Still Highly Controversial

Nuclear power plants are run to precise, extremely high standards in order to ensure that the power-generating processes do not go awry. This is because nuclear energy is generated by dealing with the most basic and yet most powerful forces in the universe: the quantity of energy released by fission reactions in a single power plant, though enough to power 800,000 people, is enormous enough to melt a hole deep into the planet. Furthermore, an uncontrolled reaction could release enough radiation to make the state of Pennsylvania unlivable. These threats to the environment and human life have many people who would otherwise support nuclear energy in the fight against climate change turning to other energy sources like wind and solar, though the fact that Exelon can generate a kilowatt-hour of energy for only 1.8 cents versus an average of 4 cents for wind energy could have average consumers leaning toward nuclear as an easy climate change solution. Ultimately, the question of the success of nuclear energy will come down to what people fear more: the threat of climate change with its unknown effects or the risk of a cataclysm whose effects are known ([www.wikipedia.com/chernobyl see: Chernobyl]).

Weather

Weather can have a material impact on Exelon's business. Warmer than expected winters can lead to lower demand for heating energy, whereas a cooler than expected summer can lead to lower energy demand for cooling. The 4th quarter of 2006 for instance was cooler than the 4th quarter of 2005 resulting in a 1% decrease in Kilowatt deliveries when compared to 2005. Storms can also cost the company millions of dollars, as in June 2008 when a storm knocked out power for 152,000 PECO customers, forcing the company to put crews to work around the clock to restore power.^[16]

Government Regulation and Legislation

The U.S. government plays a critical role in the financial performance of the highly regulated energy sector. Each of Exlon's utility businesses face a variety of challenges and potential benefits that may arise from changes in legislation and regulatory schemes:

ComEd

ComEd in particular is at a crucial juncture in terms of U.S. Energy Regulations . In 1997, the state of Illinois enacted legislation that split the generation and delivery segments of energy companies, lowered rates by 20% and, most importantly, froze rates at that level for 10 years. Unless new legislation is enacted, 2007 will see the transition from artificial, regulated pricing to market rate pricing. Unless rate freeze legislation is reenacted, ComEd predicts an average 22% increase in rates in Illinois. In this way, the transition to market based rates should provide a significant boost to earnings in the coming years. On the other hand, the CEO of ComEd has been quoted saying that another rate freeze may push ComEd toward insolvency. This outcome is unlikely, however, as 75% of the company's 1Q08 rate hike requests were granted, indicating a close relationship between the company and its regulators.

Generation

In all, the legislative environment is favorable for Exelon Generation. Increasing concern over global warming makes US carbon emission legislation likely in the short to midterm. Because Exelon's portfolio is concentrated in nuclear energy any legislation based on carbon trading markets will allow Exelon to offset emissions at its carbon based plants with carbon credits from its renewable and nuclear plants. Additionally, the 2005 federal energy bill provided many government incentives for the continued expansion of the US nuclear fleet. Exelon Generation should benefit from this favorable environment moving forward.

Competitors

Although wide variation in their operations makes direct comparison difficult, it is clear that Exelon has been a top performer among utility companies. Exelon is considerably larger than its closest competitors. Its scale provides more leverage when negotiating energy contracts with retail energy suppliers. Another key attraction of Exelon is the high concentration of its energy portfolio in Nuclear Energy. In all, nuclear energy represents almost two thirds of Exelon's energy generation. ‎This high concentration in nuclear energy is a key advantage. While nuclear plants require large initial investments, low fuel costs allow for lower marginal costs. These lower marginal costs have helped Exelon maintain a much higher profit margin than its peers. It is important to note that, while these metrics are useful in highlighting various advantages of each utility, none of these company's utility operations are in direct competition. Each utility operates in a geographical monopoly.

References

1. ↑ ^{1.0 1.1} "UPDATE 1-Exelon revenues slide, trims forecast," Reuters.com, October 23, 2009
2. ↑ ^{2.0 2.1} Exelon 10K 2008, Item 6,Page 73
3. ↑ Exelon 10Q 2009 Pg. 5
4. ↑ Exelon 2Q- 10Q 2009 Pg.136
5. ↑ Williams, Mark, "Fewer, more efficient customers cut Exelon profits - October 25," Associated Press, October 25, 2009
6. ↑ Exelon 2Q-10Q 2009 Pg. 124
7. ↑ EXC 2008 10-K, Item 1,Page 14
8. ↑ EXC Q4 2007 Earnings Conference Call, http://seekingalpha.com/article/61310-exelon-corp-q4-2007-earnings-call-transcript?page=4
9. ↑ EXC Q4 and FY 2007 Results Release, http://library.corporate-ir.net/library/12/124/124298/items/276359/exc_4Q07_ER.pdf
10. ↑ New York Times: "Exelon’s $6.2 Billion Bid for NRG Would Create Largest Power Utility in U.S."
11. ↑ Financial Times: Exelon Stalks NRG
12. ↑ MacIntosh, Julie and McNulty, Sheila, "Exelon sets out ‘final’ bid for NRG" FT.com, July 2, 2009
13. ↑ Reuters.com: Delaware regulators concerned about Exelon-NRG deal
14. ↑ Fleming, Monica, "NRG shareholders nix acquisition by Exelon," Coastal Point, July 31, 2009, Volume 6, No. 31
15. ↑ SeekingAlpha: "Exelon Corp. Q2 2008 Earnings Call Transcript"
16. ↑ MarketWatch: "Violent Summer Storm Caused Widespread Damage And Interrupts Electric Service To More Than 150,000 PECO Customers"