The Duke Energy Train Keeps Rolling Along
Summary Duke Energy’s second quarter 2015 EPS of $0.95 missed estimates by $0.04, while Revenue topped $5.2 billion. The company’s residential retail energy market declined as a result of more efficient energy practices and the company’s international business segment declined due to issues in Brazil. I believe Duke Energy’s stock presents a safe dividend play with opportunity for slow stock appreciation going forward. On August 6th, 2015, Duke Energy Corporation (NYSE: DUK ) reported second quarter of 2015 earnings results and provided an update on the company’s four financial objectives for 2015 and beyond-(1) current year earnings guidance, (2) long-term earnings growth, (3) dividend growth, and (4) balance sheet strength. In this article, I will review the company’s four financial objectives and analyze the company’s progress in obtaining them. The company reaffirmed its outlook in achieving 2015 earnings per share within guidance range of $4.55 and $4.75 The company expects to achieve this range despite capital expenditures estimated to fall within the range of $7.4 and $7.8 billion for the year. Through the first half of 2015, the company had $3.2 billion in capital expenditures putting the annualized projection to $6.4 billion. While the capital expenditures projection is lagging behind projections, management expects the economic development usage of the expenditures to result in almost 5,000 new jobs as the company makes commitments to pursue alternative energy generation sources. Retail load growth expectations of 0.5% to 1.0% for the year remain unchanged from the previous quarter. The company saw higher weather-normal retail volumes of 1.7% compared to 2014 and favorable weather driven by warmer than normal temperatures, primarily in the Carolinas. This weather favorability helped the residential market, which is experiencing lower usage due to changes in energy efficiency and conservation and higher use of multi-family housing. The company originally expected to have 700M average shares outstanding at 12/31/2015. However, in connection with the transaction to sell the Midwest Generation business to Dynegy, the company completed a $1.5 billion accelerated stock repurchase program. After this repurchase, the company’s weighted-average shares of Duke Energy common stock outstanding in 2015 is expected to be approximately 695 million instead. With the company not having any planned equity issuances through 2017, this will have a positive impact on the EPS for 2015. We saw $65 per barrel average Brent crude price for 2015. Oil price projections have remained consistent to projections as the expected Brent crude oil prices have increased from EIA’s May 2015 report of $61 to $57 in July 2015’s report . The joint venture, National Menthol Company (NMC), which runs through 2032, is 25% owned by Duke Energy. NMC’s earnings are positively correlated with crude oil prices and an approximate $10 per barrel change in the average annual price of Brent crude oil has roughly a $0.01 to $0.02 EPS impact annually. A dive in the price of Brent crude prices could present a short-term problem for Duke Energy. There was an exchange rate of approximately 2.85 BRL/US dollar. The exchange rate has increased above this expected rate to $3.48 on 8/20/2015 as the Brazilian economy struggles and the US economy rebounds. The continued drought conditions, struggling Brazilian economy, and weaker foreign currency exchange rates are the largest factors behind the $0.13 year-over-year quarterly earnings per share decline in the company’s international segment. The ongoing drought in the country has caused the company to dispatch higher cost thermal generation instead of the low cost hydro generation. Additionally, the struggling economy has caused the company to lower demand growth for 2015 between 0% and 2%, which is much lower than the greater than 3% seen over the past several years. Fortunately, the continued weakness in the company’s international business has been offset by the strength in the regulated utility business. Deliver earnings per share growth of 4% to 6% through 2017 To achieve this, management expects retail load growth of 1% going forward. The company has been consistent with a 0.6% retail load growth from 2012 and 2014. Given the lower usage being seen due to changes in energy efficiency and conservation and higher use of multi-family housing, I think it is going to be very difficult for the company to achieve a 1% growth going forward. I think it is going to be difficult to achieve because of the lower energy usages in homes. I don’t see this trend reversing and allowing this 1% growth rate to be achieved. I definitely see this being a negative for the company going forward as achieving this growth without favorable weather is going to be difficult. The company expects total wholesale net margin to increase due to the new 20-year contract with NCEMC at Duke Energy Progress (began in 2013) and 18-year contract with Central EMC at Duke Energy Carolinas growing to a load of 900MW in 2019 from 115MW in 2013. FY2015’s total wholesale net margin is expected to be approximately $1.1 billion with an anticipated 5% compound annual growth rate. Regulated earnings base growth is expected to follow the $2 billion growth trend in 2015 that was seen in 2014. Continue growing the dividend within a 65% to 70% target payout ratio On July 8th, 2015, Duke Energy declared a quarterly cash dividend of $0.825 per share, increase of 3.8% from the prior dividend of $0.795. Management expects the dividend to continue to rise in the future. This 3.8% increase was higher than the 2% increase year-over-year expected. With the Company achieving a payout ratio close to 70% and management’s commitment to paying out a quarterly dividend to investors, I do not see the company’s current 4.5% dividend yield to be at risk. Management has paid 89 consecutive years of dividends with increases coming the past 7 years. This is largely possible due to the Company’s strong balance sheet and no planned equity issuances through 2017. In addition, the company announced a strategically tax-efficient way to repatriate $2.7 billion back to the U.S. during the fourth quarter 2014 earnings call, which will help fuel the dividend increases going forward. Maintain strong, investment-grade credit ratings. While the company’s credit rating was recently upgraded by S&P, I believe there are three risks for the company going forward. The exposure to Brazil is a significant risk for the company’s future, which was seen in the 2014 and early 2015 financial results. In these releases, there was a decrease in sales volume as well as higher purchased power costs due to the interruptions in the hydrology production. Per the earning’s call, they are assuming normal hydrology despite the rainy season starting slowly. Brazil is a major story to follow for Duke Energy in 2015 and beyond as the Company is predicting EPS growth from this business segment despite recent downward trends in profits there as well as the Brazilian economy. I think the company will have difficulty increasing the retail load growth to 1% given the increased technologies and social initiatives to decrease electric use. Oil prices will continue to be a wild card going forward. Forecasting a price on such a volatile asset is a difficult task. If oil prices continue to fluctuate widely, it will significantly impact the company’s bottom line. Conclusion: Duke Energy Corporation faces some difficult obstacles including a slowing Brazilian economy, lower residential energy usage, and volatile oil prices; however, I believe that the company gave conservative and very obtainable estimates in each of the key assumptions used to allow the company to meet its financial objectives for FY 2015 and beyond. While I don’t see Duke Energy being a rapid growth story going forward which can be seen in the lagging capital expenditures, I do believe they have the ability to present slow stock appreciation with the safety of a consistent dividend. 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.