Exelon Corp. (EXC)

December 13, 2018

COMPANY DESCRIPTION

Exelon Corp. (EXC) is an electric and natural gas utility that operates four utilities in Illinois, Maryland, Pennsylvania, and Washington, DC and the largest deregulated nuclear fleet in the United States. The company’s regulated businesses consist of Commonwealth Edison Company (ComEd) in Illinois, PECO Energy Company (PECO) in Pennsylvania, PEPCO in Maryland and Washington, DC and Baltimore Gas & Electric in Maryland. Exelon Generation (ExGen) operates the largest nuclear fleet in the United States with plants in the Midwest and Mid-Atlantic regions.

INVESTMENT THESIS

We expect Exelon’s aggressive capital expenditures to boost earnings through additions to the rate base. In 2018, the company is adding transmission capabilities, with a new substation expected to be up and running in 2021. While we see relatively weak prices at Exelon’s wholesale power business we expect zero emission credits (ZEC) to negate this weakness. At ExGen, the company’s generation segment, we expect strong cash flow to enable its capital spending and debt reduction program. The shares pay an attractive 2.94% dividend.

RECENT DEVELOPMENTS

On November 2, Exelon reported 3Q18 adjusted earnings of $0.88 per share, up from $0.85 in 3Q17. Earnings were in line with the consensus forecast, but below our estimate of $0.90 prior to the earnings announcement. Results benefited from cuts in the corporate tax rate, ZEC, higher capacity pricing, offset in part by weaker market demand and more nuclear outages.  Drilling down, rate hikes, rate recovery (utilities are allowed to recoup investments through higher rates) and more favorable weather.

In the 3Q press release, management raised its 2018 adjusted EPS guidance to $3.00-$3.20 from $2.90-$3.20. EXC aims for $21.0 billion in capital expenditures through 2021, with $5.4 billion in 2018. It also projects 7.5% compound annual rate base growth through 2021. We view the latter target as achievable. Management plans to lower costs by 1.9% annually through 2021, primarily in the Generation unit.

EARNINGS & GROWTH ANALYSIS

Reflecting much better-than-expected first, second and third quarter earnings, we are leaving our 2018 EPS estimate at $3.16, above the midpoint of management’s guidance range, compared to $3.05 previously. For 2019, we are keeping our adjusted EPS estimate at $3.28, up 4% from our 2018 estimate.

RISKS

Risks include electricity price fluctuations, the ability to recover construction costs through rate increases, and potential environmental and safety lawsuits. In addition, the capital-intensive nature of the utility industry requires above-average debt levels. Income investors purchase utility stocks for their above-average dividends and an increase in interest rates could reduce the shares’ attractiveness.

VALUATION

Our price target of $57 implies a multiple of 17.4 times our 2019 EPS estimate. At recent prices, the shares are not cheap, but we believe Exelon’s steady growth, and improving finances warrant a premium valuation. At its current prices, our target, if achieved, offers investors the prospect of more than a 24% return, including the dividend!

Exelon Corp. (EXC)
Current Price: $46.87
Target Price: $57
Current Valuation: 14.3 times FY19 EPS
Target Valuation: 17.4 times FY19 EPS

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