PPL Corp. – Early Birds Catch The Worm
PPL has changed their business strategy to focus on a niche market. It is now a regulated utility focused on transmission and distribution assets. The company’s risk profile has been reduced. PPL could become a takeover target. PPL Corp. (NYSE: PPL ) is beginning to look attractive. In early June, PPL spun off their fleet of merchant power plants to a new company called Talen Energy (Pending: TLN ). By spinning off one part of their business, PPL changed its profile from a hybrid to a niche utility. The new PPL is a regulated utility. It is no longer exposed to the volatility associated with nation’s new deregulated power markets. It is no longer exposed to financial and political risks associated with U.S. Environmental Protection Agency or Nuclear Regulatory Commission actions. Instead, most of their revenues will be regulated and their earnings will become stable. PPL’s potential value is understood in the context of industry trends. Until recently, large utilities hedged their bets by spreading their positions along the utility value chain. Most wanted to diversify their portfolio of assets by owning power plants, transmission lines, pipelines, distribution wires, metering systems and energy service companies. They wanted to own regulated assets. They also wanted to own deregulated assets. For those utilities who tried owning everything, it did not work out well. Some were burned by the market. Others were overwhelmed with indirect expenses. A few saw their bond ratings limited as investors assessed their risks. Today, utilities are adopting a new strategy. One by one, the nation’s largest utilities are shifting their portfolios. One example is Duke Energy (NYSE: DUK ). Last April, Duke sold two deregulated businesses to Dynegy (NYSE: DYN ) for $2.8 billion in cash. One business was Duke’s fleet of deregulated power plants. The other was their deregulated energy services business. Today, most of Duke’s assets are regulated. Another example is Dominion Resources (NYSE: D ). Dominion sold a fleet of deregulated power plants and prematurely retired a nuclear plant. They also sold their deregulated energy services business to NRG Energy (NYSE: NRG ). While they still own a merchant nuclear facility, most of Dominion’s assets are regulated. Some utilities are unable to sell disaffected assets. Instead, they decided to do the next best thing. They decided to change the percentage of assets within their portfolio. To change their portfolio to more favorable emphases, they buy more of one asset and reduce numbers of other assets. Today, two large utilities are attempting to change their portfolios by acquiring distribution-only utilities. One example is NextEra Energy (NYSE: NEE ). NextEra is attempting to acquire Hawaiian Electric Industries’ (NYSE: HE ) utility. They are also attempting to acquire OnCore Electric Delivery (the Texas-based electric distribution utility owned by bankrupt Energy Future Holdings Corp.). By acquiring more distribution utilities, NextEra increases their footprint, reduces their reliance on one state’s regulator and de-emphasizes their generating profile. Another is example Exelon (NYSE: EXC ). They cannot easily sell their huge fleet of merchant power plants, which is mostly nuclear. They can adjust their profile by acquiring a wires-only utility, which is one reason why they are in the process of acquiring Pepco Holdings (NYSE: POM ). Pepco is mostly a regulated wires-only utility. If Exelon’s acquisition is successful, Exelon will become more of a regulated utility and less of a merchant utility. As a result, their access to capital is improved and their cost of capital is reduced. These examples are relevant to the new PPL. Now that PPL is mostly a wires-only utility, the company has become a niche player. This change in strategy should be attractive to investors. It could also be attractive to other utilities who might want to expand their footprint or alter their profiles. To be clear, the new PPL could be an attractive takeover target. If another utility attempts to buy PPL, shareholders could be rewarded. It may take time. It may not happen overnight. However, PPL is paying a stock dividend. That dividend could help buy shareholder patience. However, investors should be careful. There is a reason PPL’s dividend is attractive. It is possible PPL’s management could lower the dividend. The possibility seems remote. In their February conference call , PPL’s chairman and CEO addressed the complany’s dividend plans: But as we’ve said, post spin, our intent is to continue to maintain the same level of dividend prior to the spin. And we’ll look at opportunities where appropriate to grow it if we can. So that’s kind of still the game plan going forward. There appears to be equivocation. We can see why in their May conference call . In that call, PPL’s CFO addressed the dividend issue again: We recognize that the domestic payout ratio to fund our dividend was over 100% beginning in 2016. With our ability to dividend between $300 million and $500 million a year from WPD over the next few years, we would target to get the domestic payout ratio back under 100% for 2016 and continue to lower that domestic payout ratio in 2017 and 2018. Today, forward ratios appear to support PPL’s dividend goals. If everything goes as planned, the dividend should remain intact and possibly grow. However, PPL owns WPD utility system. WPD serves end-users in Wales and England. It has several subsidiaries operating in Wales and England. Over 40% of PPL’s assets are owned by their WPD subsidiaries. Approximately 33% of PPL’s forward revenues are derived from WPD subsidiaries. With billions of dollars in another country, PPL is exposed to United Kingdom’s economy and currency. They are also exposed to U.S. taxes on repatriated funds. If any unforeseen event takes place, there is risk PPL’s dividend may require adjustment. As a reminder, Exelon surprised their shareholders by cutting their dividend . Prior to acquiring Constellation Energy, Exelon’s management suggested dividends could be maintained. A few months after they completed their Constellation acquisition, Exelon’s dividends were cut. The stock tumbled. For PPL investors, the challenge is the company’s fundamentals. It is difficult to reference a baseline when the baseline suddenly shifts. In PPL’s case, when they spun off their generating company, it became difficult to reference past performance. As a result, it may take several quarters for investors to digest the full effects PPL’s spin-off. Nevertheless, speculators may want to accept management’s guidance and jump in. As uncertain as they may be, some ratios look attractive. PPL’s current yield is about 5%. Its price/earnings ratio is below 11, its forward earnings appear healthy, and its risk/reward suggests buying now — even if some critical facts are largely unknown. Fundamental investors may want to wait. PPL’s management has aggressive capex plans. They may attempt to buy a competitor and expand their wires business. There could be some dilution. Ratios could be adjusted. Then again, a hungry utility may want to jump in, pay a premium and buy PPL. In that case, ratios and earnings estimates are largely academic. Those who bought early may catch the worm. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
