Summary Exelon is becoming attractive for traditional utility investors. Exelon is embracing regulation and withdrawing from nuclear power. Three new events are expected. Any single event could change the company. Two events take place within weeks. Management does not control the last event. Equity investments should be coordinated with announcements. Exelon (NYSE: EXC ) could become one of the nation’s most valuable utilities. It’s not there yet. Before jumping in, wait for some important announcements. After the market digests the news, consider adding Exelon to your portfolio. Exelon’s management is in the process of making significant changes to their company’s profile. If successful, Exelon’s revenues will become less volatile, their earnings more manageable and their debt more attractive. Exelon will be able to attract lower cost of capital to help them expand and grow. Today, Exelon is one of the nation’s largest utilities. With an enterprise value near $50 billion, only four investor-owned utilities are larger. Known by the investment community as a nuclear power producer that also owns a few local distribution utilities, their objective is to be known as a regulated utility that also owns some merchant power assets. To transform the company, Exelon wants to own more regulated assets and less nuclear. To accelerate those changes, Exelon will orchestrate three major events. Any single event could trigger a change in the company’s profile and valuation. In the end, management expects smoother revenues, cash flows and earnings. Event 1: Pepco Holdings Exelon currently owns three regulated utilities. The first is Commonwealth Edison Company (ComEd), which serves metropolitan Chicago. The second is PECO Energy Company (OTC: PECO ), which serves metropolitan Philadelphia. The third is Baltimore Gas & Electric (BGE), which serves metropolitan Chicago. Exelon is attempting to acquire their fourth. It is Pepco Holdings (NYSE: POM ), which in turn owns three regulated utilities. Pepco’s three utilities surround Exelon’s BGE and touches PECO. Pepco’s territory includes the District of Columbia, Maryland, Delaware and New Jersey. Before any merger can be completed, Exelon requires approval from those same states, the District of Columbia and other regulators. Exelon’s approvals are almost complete. They have won approval from all federal and state regulators except one. It is waiting for the District of Columbia. Within the District, several constituent groups support the merger while several vocal groups strongly oppose. The DC Commission must make a decision that could upset some groups. For Pepco’s shareholders, DC’s announcement will provide either relief or disappointment. While it is widely expected that DC will approve the merger, there is a small probability they will not. Should DC reject the deal, Exelon’s shareholders would face a bumpy road and Pepco Holding’s stock would likely tumble. DC’s decision is expected within days or weeks. A politically practical time for an announcement would be around September 4 (Labor Day weekend). Any merger would be completed a few days later. DC’s decision could alter Exelon’s other plans. Specifically, Exelon intends to alter their portfolio of nuclear power assets. Exelon plans a major announcement about those assets soon after the DC Commission releases their decision about Pepco (assuming that decision is forthcoming). Event 2: Exelon’s Nuclear Power Plants While Exelon was never a pure play on nuclear, its revenues and earnings were dominated by their massive financial position in the nation’s largest fleet of commercial nuclear power plants. According to reports published by Washington-based Nuclear Energy Institute, Exelon owns 20,791 megawatts, or slightly more than 21 percent of the nation’s nuclear capacity. It is the operator for 17,509 megawatts of nuclear capacity, including 1,126 megawatts owned by Public Service Enterprise Group (NYSE: PEG ) and 455 megawatts owned by MidAmerican Energy, a unit of Berkshire Hathaway (NYSE: BRK.A ). Exelon is considering the early retirement of up to seven nuclear power stations in three states. The combined capacity of the seven is approximately 6,380 megawatts (electric). If all seven were retired, Exelon would shrink their $52 billion worth of property, plant and equipment assets by about $10 billion to 15 billion and their operating assets by almost 45 percent. Two nuclear units are already gone. Exelon previously announced plans to retire their Oyster Creek facility in 2019, ten years early. Located in New Jersey, Oyster Creek is one of the nation’s oldest nuclear plants. At 615 megawatts, it is also one of the smallest. Another old and small unit operates in Upstate New York. Exelon’s R. E. Ginna Nuclear Power Plant is losing money. Because Ginna is an essential resource for grid reliability, Exelon sought and won temporary approval for a boost in revenues. In “CASE 14-E-0270 – Petition Requesting Initiation of a Proceeding to Examine a Proposal for Continued Operation of the R.E. Ginna Nuclear Power Plant, LLC” (August 13, 2015), New York’s Public Service Commission issued an order that approves temporary rates to fairly compensate the local utility, Rochester Gas and Electric, who in turn would pay Exelon. That order keeps Exelon’s 581-megawatt facility running until September 2018, with a possible extension to March 2020. By then, the Commission expects Rochester Gas and Electric will complete transmission and distribution system upgrades, access other sources of reliable power and disconnect from Ginna. On or about 2019, Ginna will likely join Oyster Creek and retire. The other five nuclear plants are seeking a similar deal. All five are located within the State of Illinois and the Midcontinent Independent System Operator’s territory (with limited access to PJM Interconnection). All five struggle for adequate revenues. Unless there is relief from the power markets or policymakers, Exelon needs to cut their costs. The best way to cut costs is to retire uneconomic assets and move on. For months, Exelon has been working with federal and state officials. They have been seeking a level playing field with other power producers. They want to be paid for their plants’ derivative products. Currently, the state takes those products without compensation. The issue is clean energy. According to DOE-funded NC Clean Energy Technology Center, the State of Illinois has 71 policies and incentives, which help the state’s power producers deliver clean energy. Not one of those programs include the state’s 11 nuclear power plants, which are carbon free, produce no air pollution and produce no water pollution. Unlike wind and solar – which offer important benefits to the state – nuclear power also offers the grid incredible levels of reliability. Nuclear power plants operate 24 hours a day, 7 days a week, rain or shine, day or night, cold or hot. Not only do nuclear plants produce clean energy with incredibly levels of reliability, nuclear plants also provide another valuable attribute. When nuclear power plants operate – which is about 90 percent of the time – inefficient and more costly plants need not operate and they are pushed out of the market. Inefficient plants usually pollute more than efficient plants. Consequently, nuclear power plants displace air-polluting power plants watt for watt. Most policymakers understand nuclear power plants produce clean energy. Not as many understand the consequences of removing existing nuclear power plants. It turns out; the consequences are severe. If existing nuclear units are removed from the grid, air-polluting power plants must replace lost capacity. If Illinois wants clean air and clean water, they will need to keep as much existing nuclear power as possible. The fate of Exelon’s five nuclear facilities will be announced in September. While the number of plants to be axed is unknown, a guess would be three out of the five. However, the decision could be dependent on the Pepco decision. For Exelon shareholders, early retirement means the company will ultimately write down nuclear assets. Depending on the plants involved, the write down could be $5 billion to $15 billion. As such, management’s announcement could affect the company’s valuation – at least for the short term. Event 3: Government Wakes Up The decks will be cleared after a favorable Pepco decision and after Exelon’s nuclear announcements. The market should absorb all the news and adjust the company’s forward earnings. For equity investors, this could be the time to jump in. It turns out; there is a little surprise. After the nuclear retirements have been announced, there is a likelihood the company could reverse course. If they do reverse course, the stock could slowly recover and grow. While Exelon expects to announce their nuclear strategy in September, they will not retire any unit for at least 18 months. As Exelon’s President, Chief Executive Officer disclosed in the last quarter’s conference call : “We have requirements around notification to PJM of our intent to retire units. It’s an 18-month notification. We also have commitments around when we have to notify of our availability for the 2018-2019 auction in participation on that. And very importantly, we have to order and design cores [for] the 2019-2020 auction. We’ve been in consultation with the Board and we’ll continue to consult with the Board, and where management’s made their decision we’ll pass that to the Board for the final approval in that timeframe, and continue with the outreach to our stakeholders.” Another executive repeated the CEO’s strategy. William Stoermer, Exelon’s senior communications manager explained : “Exelon will delay a decision “as long as we can see that the legislation is continuing to move forward,” Mr. Stoermer said. He warned, however, that if the legislation doesn’t advance and Exelon doesn’t “get through the auction process,” company officials will “have to make very difficult decisions,” including the potential of closing the plant in 2017.” So, there you have it. The big announcement to close is not really a firm announcement to close. Exelon plans to keep all five units running for a year or more. They may not retire them for decades. As such, it appears September’s nuclear announcement is aimed mostly at policymakers. This suggests that investors have some upside potential. If government policymakers hold to their position and allow perfectly good nuclear assets to retire, their decision is already baked into the price of Exelon’s stock. If, however, policymakers yield, the company’s revenues and earning improve and Exelon’s stock should respond. Of course, there are always risks. The future is not certain and Exelon’s management has a history of surprising shareholders. However, this time management appears to be signaling their intentions. While their signals are not aimed at shareholders, they are public and they appear to be consistent with keeping assets. Nevertheless, the third event not controlled by Exelon’s management. It is in the domain of government policymakers, who are saddled with several large challenges. For them, allowing solid nuclear plants to retire early resolves nothing and only adds to their woes. Let’s look at a few of their challenges. If Exelon closes one or more nuclear plants, the state’s consumers will incur higher electricity costs and more air pollution. This is because Exelon’s five nuclear plants are deregulated and they earn most of their revenues from the power markets. Within the power markets, when a lower cost producer is removed from the bidding, higher cost participants fill the void at higher costs. Higher costs means higher prices for consumers. It also means more pollution, because higher-cost producers are usually less efficient and less efficient plants pollute more. In addition, a loss of large nuclear plants means the state loses a large tax base and reduced economic activity. At the local level, retiring large nuclear facilities means permanent loss of thousands of high-paying jobs. It means a permanent loss a huge tax base that pays for local schools, fire, safety and infrastructure. It also means a loss to local businesses and real estate. Losses at the local level could be severe. Those losses will put pressure on political leaders, who in turn will likley seek relief at the state level. The worst case is if the state does nothing. It will hurt localcommunities. It will also hurt the state. However, it is not a terrible outcome for Exelon’s shareholders. Should three or five nuclear plants retire and decommission, the company’s revenues will decline. Ongoing expenses will decline at a faster rate. However, the company’s long-term cash flows and earnings should improve. Exelon operates 11 nuclear power plants within the state. Should Illinois decide to include nuclear in their clean energy portfolio, it would not only improve financial results for Exelon’s five underperforming units, it could boost results for all 11 nuclear units. To prepare, investors should consider two strategies. First, wait before buying additional shares of Exelon. Wait until after DC and Exelon announce their first and second events. After the news has been digested by the markets, watch the charts and consider strategic buys of the stock. Second, consider Exelon’s other equity unit (NYSE: EXCU). Technically, they are convertible notes (Fitch BBB-). They currently pay a 6.5 percent dividend. On some screens, they appear as an equity (without much description). During the last six months, EXCU’s market values have been roughly correlated to EXC. 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.
