Friday, September 06, 2013

Duke Energy Makes Progress

Royalty in the nuclear energy development consortium NuStart Energy is represented by Duke Energy (DUK:  NYSE) .  The group had its sights on getting a nuclear power plant construction and operating license from the Nuclear Regulatory Commission (NRC).  Duke on the other hand has had its sights on Progress Energy.  The two merged in July 2012, creating one of the largest fully integrated energy companies in the U.S.

Duke management was after better access to capital that typically accrues to the kind of bulked-up, diversified operation the Duke-Progress combination represents.  The combination delivered $23.6 billion in total sales in the twelve months ending June 2013, providing $2.0 billion in net income or $2.83 per share.  Cash flow from the combined operations totaled $6.1 billion, representing a cash conversion rate of 25.9%.   

Along with the scale that Progress brought to the combination, Duke had to accept the nuclear plant problems.  Extended outages at unit three of the Crystal River Nuclear Station has meant that Progress has had to purchase power for the past three years.  The Crystal River reactor was taken off-line 2009 for a refueling and 20% upgrade. Unfortunately, during the upgrade workers discovered a gap in the concrete containment dome.  After a series of setbacks in finding a solution, Duke Energy announced the nuclear plant at Crystal River would be shut down permanently. 

Like many energy companies Duke and Progress have been by-passing problems with nuclear by sourcing more environmentally friendly power from combined cycle natural gas plants.  As the name suggests, combined cycle plants match gas and steam technologies into one unit, yielding significant improvements in thermal efficiency over a conventional steam plant. A gas turbine generator generates electricity and waste heat is used to make steam to generate additional electricity via a steam turbine.  Combined cycle plants are not as capital hungry as nuclear power plants.  What is more they are more flexible in operation, a feature that is vital in the rapidly changing power distribution environment.  Last year Duke commissioned a 618 megawatt integrated gasification combined cycle plant at the existing Edwardsport Generation Station in Indiana.

The Indiana plant is not a signal Duke has abandoned nuclear power.  The company has three nuclear power projects in the pipeline.  In 2008, the old Progress Energy filed a license application with the Nuclear Regulatory Commission (NRC) for two Westinghouse Electric Advanced Passive AP1000 reactors to expand the Shearon Harris Nuclear Power Station. 

In 2008 Progress also filed for a license for a new nuclear plant in Florida to be called the Levy Nuclear Station.  The plant was also to feature the Westinghouse AP1000.  Unfortunately, a series of delays has caused cooler heads at Duke Energy to cancel the engineering and construction contract for Levy in August 2013.  The application with the NRC is still in the works in case economic circumstances improve.

Duke had earlier filed its own nuclear license application for a proposed nuclear power plant in South Carolina to be called the William States Lee III Nuclear Station.  With two Westinghouse AP1000 nuclear reactors, the plant would have generating capacity of 1,117 megawatts.  

Duke Energy is trading at 23.4 times trailing earnings, a discount to the average price-earnings multiple of the regulated utilities as a group.  However, in terms of sales and cash flows Duke is trading at a premium to the group.  The anomaly is probably due to Duke relatively higher profit margins compared to the group.  Accordingly, it is not a surprise that the consensus rating for DUK is a hold.  Just the same, the twenty or so analysts participating in the consensus view on DUK have an average $75.00 price target on the shares, representing 15% upside potential from the current price.  Coupled with a dividend yield of 3.0% at the current price level, even that modest return potential has an appeal.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.


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