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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.

Duke Energy: Ramping Up Its Solar Ambitions

Summary Duke Energy has acquired a majority stake in REC Solar, which should allow Duke Energy to stake a foothold in the promising distributed solar markets. Duke Energy and REC Solar make for an incredibly synergistic partnership, with Duke Energy providing for cheap capital and influence, and with REC Solar providing for its experience an talent. Because REC Solar’s business directly conflicts with Duke Energy’s centralized fossil fuels business, such an acquisition will only be worthwhile if distributed solar eventually becomes the dominant electricity generation model. Duke Energy is smart to expand its renewable energy profile, especially in light of solar’s continually increasing cost-effectiveness and its exponential growth path. The fight between utility companies and distributed solar companies have heated up markedly over the past year. Some major utilities have even started resorting to underhanded tactics , such as influencing congressmen to do their bidding. While most utilities are trying to quash distributed solar, the savvy utility companies are embracing the change. Duke Energy (NYSE: DUK ) has been one of the rare few utilities that have actually seen the rise of distributed solar as a huge opportunity. Duke Energy is currently the largest electricity holding company in the U.S., and has assets all over North and South America. While Duke Energy has a huge reliance on fossil fuels, which has been essential for the vast majority of the its business, the company is slowly making a transition to solar. Unlike most other utilities, Duke Energy is incorporating solar not as a means of meeting federal requirements, but to ensure the company’s survival in a rapidly changing energy landscape. In fact, Duke Energy already has more renewable assets than many of the top renewable companies, with a sizable renewables portfolio consisting of around 1.8 GW worth of solar and wind assets . There are few other fossil fuel based utilities doing the same, with NRG Energy (NYSE: NRG ) being almost the sole exception. Duke Energy has reaffirmed its commitment to solar by acquiring a majority state in REC Solar , which focuses on distributed commercial installations. Duke Energy is willing to invest up to $225M into REC, with the clear intentions of trying to stake a foothold in the commercial solar sector. REC Solar will operate under Duke Energy Renewables(which is the green arm of Duke Energy) and should benefit tremendously from Duke Energy’s financial clout and low costs of capital. As per Duke Energy CEO Allen Bucknam, “We plan to extend the benefits of clean, distributed energy solutions to previously underserved small and medium-sized businesses,” and that “The Duke Energy relationship realizes our strategy to be the one-stop shop for commercial solar by securing a predictable and streamlined customer financing process.” This is what a typical commercial REC Solar install looks like. (click to enlarge) Source: REC Solar The Importance of Maintaining an Early Foothold The utilities sector has seen little to no change in over a century, which means that sudden industry change likely seems extremely threatening, and even alien to most utilities. This could explain why the majority of utilities have been violently opposed to the proliferation of distributed solar companies such as SolarCity (NASDAQ: SCTY ). Instead of working with these companies, which would likely end up being better for everyone involved, most of these companies are fighting tooth and nail to resist change. Duke Solar is clearly an anomaly in this sense, not only accepting such change, but actually transitioning its business model to become more solar friendly. The company’s majority stake in REC Solar leaves no doubt about the company’s renewable ambitions. Not only does REC Solar’s business model come in direct conflict with that of Duke Energy’s, but it also represents an existential threat to the company’s centralized business model. Instead of combating such REC Solar, Duke Energy has gone the infinitely wiser route of acquiring it. By controlling REC Solar’s commercial solar operations, Duke Energy will have a foothold into the promising ditsributed solar sector . Because the vast majority of Duke Energy’s business is based upon centralized fossil fuel generation, the acquisition of a distributed solar company seems counterproductive at best. That is, for every distributed solar customer that Duke Energy signs up, that is one less customer for its main centralized business. While this is a no-win situation for Duke Energy, the company is looking at the long-term energy landscape, where distributed generation may very likely replace centralized generation. Without staking a foothold in the distributed solar sector now, Duke Energy may become obsolete later on. At the relatively small cost of $225M, Duke Energy is setting itself up for future success in an immensely promising market. While $225M is a sizable sum of money for the solar sector, it is merely pocket change for the $60B valuated Duke Energy. Incredible Synergy Duke Energy’s acquisition of REC Solar should amount to some incredibly synergistic effects, especially in financial and political matters. Despite all the talk about distributed solar’s coming dominance, this form of electricity generation currently only amounts to below 1% of total electricity generation, which unfortunately results in a lack of perceived credibility and influence. This is of course where Duke Energy can fill the void, and in return, Duke Energy gets REC Solar’s talent and years of solar industry experience. The distributed solar industry has traditionally suffered from high capital costs , largely due to solar PV’s relatively novel technology. While solar PV has been around for 40+ years, the technology has not seen statistically significant adoption until the last decade or so. Because finance companies have had so little to work on in terms of accessing solar PV’s stability/reliance, such high capital costs are not at all surprising. REC Solar’s capital costs have been no exception in this regard, which makes its Duke Energy partnership perfect for this situation. Duke Energy Renewables has billions on its balance sheet, which should drastically lower REC Solar’s capital costs. Instead of trying to find outside funding for its commercial projects, REC Energy could now go directly to Duke Energy. A lowered cost of capital means that REC Energy would be able to increase its profit margins, expand its commercial operations, or both. This, of course, also benefits Duke Energy. What makes Duke Energy’s acquisition of REC Solar particularly intriguing is if/how Duke Energy will be able to leverage its financial clout to influence politics. For instance, the company’s renewable arm has the majority of its solar assets in North Carolina, which unfortunately does not allow for solar leases/PPAs. While traditional distributed solar companies have nowhere near the political clout to significantly alter North Carolina’s state policies/laws, Duke Energy has more than enough influence to do so(especially considering the fact that the company is based out of North Carolina). If Duke Energy chose to support the legalization of leases/PPAs in the state, REC Solar would benefit tremendously, which would in turn benefit Duke Energy. With such a powerful utility heavyweight entering the distributed solar game, it will be interesting to see how Duke Energy deals with policies negatively impacting solar leasing/PPA. On one hand, these policies help Duke Energy’s core business of centralized fossil fuel generation, but on the other hand, they would severely limit its distributed REC Solar business. Given Duke Energy’s seemingly forward looking nature, it is likely that the company will aid in trying to eliminate such policies, at least in its home state of North Carolina. Risks and Obstacles As was previously stated, REC Energy’s business comes in directly conflict with Duke Energy’s main business of centralized generation. If distributed solar does end up dominating the electricity generation scene, this will prove to be an ingenious acquisition. If such a scenario does not play out though, REC Solar would likely just be taking revenue from Duke Energy’s main business, resulting in a zero-sum game. This could even turn out to be negative-sum game considering all the time and effort that would likely be put into REC Solar. In addition, REC Solar’s business primarily deals with the distributed commercial sector, which has struggled to grow over the past few years. Duke Energy may have a harder time than anticipated in growing REC Solar’s commercial business due to the numerous problems plaguing the commercial solar sector(i.e. lack of efficiency, standardization, etc). While such problems are possible to overcome, they will nevertheless represent daunting obstacles for Duke Energy’s REC Solar acquisition. Conclusion Duke Energy is one of the largest energy companies in the world, having over 7 million customers in North America alone. Despite making its fortune on fossil fuels, the company is smart enough to realize that centralized fossil fuel dominance will not last forever. The company’s transition into renewables, and more importantly, distributed solar, will prove to be key for the company’s future success. With a valuataion of $60B and a P/E ratio of 19 , the company still has upside due to its increasing involvement in the immensely promising solar market. Disclosure: The author is long SCTY. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.