Exelon Corp. (NYSE: EXC) and raising our target price to $45 from $42. We are encouraged by the company’s strong 3Q results. We also expect EXC shares to benefit from low interest rates.
Along with its substantial regulated utility business, Exelon is a competitive energy provider, with operations in the U.S. and Canada. The company’s energy supply assets skew towards nuclear, with 86% of FY19 supply coming from nuclear generation. This allows Exelon to be a leader in zero-carbon generation.
We see the defensive characteristics of utilities such as Exelon as particularly attractive during periods of low interest rates.
Exelon recently reported third-quarter earnings that exceeded analysts’ expectations. On November 3, Exelon posted 3Q20 non-GAAP earnings of $1.02 billion or $1.04 per share, up from $900 million or $0.92 per share in 3Q19. The results reflected regulatory rate increases at BGE and PHI, favorable weather conditions at PECO, and higher Generation earnings due to greater capacity revenues. Adjusted EPS came in above management’s guidance range of $0.80-0.90 and the $0.87 consensus forecast. Revenue declined 1% to $8.85 billion.
The company works with regulators to set rates and returns. On September 30, 2020, PECO Pennsylvania Natural Gas Distribution filed a request with the Pennsylvania Public Utility Commission asking for a $69 million increase in natural gas distribution rates with an ROE of 10.95%. A decision is expected in 2Q21. On October 26, 2020, Pepco filed a request with the Maryland Public Service Commission requesting an ROE of 10.2%. A decision is also expected in 2Q21.
In August 2020, the company announced plans to retire four generating facilities in New England. As a result, the company incurred a $500 million impairment charge and a $260 million one-time noncash charge in 3Q20.
Along with the 3Q report, management raised its 2020 adjusted EPS guidance to $3.00-$3.20 from $2.80-$3.10. The revised midpoint of $3.10 implies a decline of 3.4% from the $3.22 earned in FY19, reflecting lower usage due to the pandemic. It also projects 7.3% compound annual rate base growth and 6%-8% EPS growth through 2023.
EARNINGS & GROWTH ANALYSIS
The company organizes its business into five segments: Generation, ComEd, PECO, BGE, and PHI. The ‘other’ segment, which includes corporate operations, had costs equal to 4% of sales. Third-quarter results for Exelon’s operating segments are summarized below.
The Generation segment consists of owned and contracted electric generating facilities and the wholesale and retail supply of electric and natural gas products and services. The segment earned $456 million on a non-GAAP basis in 3Q20, up from $352 million in 3Q19. The increase reflected higher capacity revenues and lower O&M expense, partially offset by a reduction in load due to lower commercial and industrial usage.
ComEd, which consists of electricity transmission and distribution operations in northern Illinois, reported 3Q20 non-GAAP earnings of $197 million, down slightly from $200 million in 3Q19. Revenue in this segment is decoupled, so earnings are not affected by weather or customer usage patterns.
BGE, which consists of electricity transmission and distribution operations and retail natural gas distribution operations in central Maryland, reported 3Q20 non-GAAP operating earnings of $54 million, down from $56 million in 3Q19 as rate increases were outweighed by higher expenses. Revenue in this segment is decoupled, so earnings are not affected by weather or customer usage patterns.
PHI consists of electric transmission and distribution operations in the District of Columbia, parts of Maryland, Delaware and New Jersey; and natural gas distribution in northern Delaware. PHI reported 3Q non-GAAP operating earnings of $220 million, up from $209 million a year earlier. The higher earnings reflected the impact of rate increases, partially offset by storm costs.
In the past, management has signaled that it intends to realign its portfolio so that regulated utilities comprise 70% of earnings. The company plans to allocate 80% of capital spending to regulated businesses. The realignment should result in more stable earnings as the company scales back its competitive power generation business.
FINANCIAL STRENGTH & DIVIDEND
For the trailing 12 months, EBITDA covered interest expense by a factor of 5.9.
Cash flow from operations for the nine-month period came to $4.22 billion and covered 75% of capital expenditures, compared to $5.40 billion.
MANAGEMENT & RISKS
The CEO of Exelon is Chris Crane. Prior to becoming CEO in 2012, he served as the company’s president and COO.
Risks facing Exelon shares include cooler-than-normal conditions during the summer air-conditioning season or warmer-than-normal temperatures during the winter heating season. It is possible that the state regulatory commissions in Exelon’s service territories (primarily Pennsylvania and Illinois) will lower the company’s allowed return on common equity. Additionally, operating income is more volatile in the higher-risk, nonregulated electric generating operations than on the regulated side. Finally, an unplanned nuclear outage or a nuclear refueling that goes beyond the forecast time could put pressure on operating income.
Exelon Corp. is a leading competitive energy provider, with operations and business activities in the U.S. and Canada and headquarters in Chicago. The company has more than 31,000 megawatts of owned capacity, comprising one of the nation’s cleanest and lowest-cost power generation fleets.
On December 10, BUY-rated EXC closed at $41.20, up $0.11.