Exelon: A Transmission Company Ready to Benefit from Grid Transformation (NASDAQ: EXC)

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The electrical network needs a serious repair. Decarbonization, decentralization and electrification are key enablers for major investment in national transmission lines across the country. However, let’s go back a bit. Today’s energy market – the way electricity is generated, distributed and consumed – is very different from what it was just ten years ago.

The old building

It used to be such a simple process. A local power plant, perhaps a coal, nuclear, or natural gas plant, produced enough electricity to power its community. A vertically integrated build, the utility would simply buy enough fuel to run the generators it operates and provide enough power to heat and cool the city and keep the lights on. Then came regulation around and after the Enron debacle of the late 1990s and early 2000s and the major public scandals of that time. There was a desire to bring different parts of the country together after a period of deregulation.

Main changes in the electricity market

The Federal Energy Regulatory Commission (FERC) issued the 2000 order to build on what was called the “ISO” (independent service operator) concept. ISOs are like regional energy markets where power plants can produce power, and long transmission lines can distribute that power to where it’s needed most – dictated by price. The 2000 ordinance created more structured Regional Transport Organizations (RTOs). After more than 20 years of growth and development of RTO, there is still a major effort to integrate more sectors of the electricity market.

Regional electricity markets

Regional electricity markets

FERC

Remember the February 2021 Texas Freezeout. Many retail customers were unable to get heat and lives were lost. There were also huge electricity bills, due to the design of the ERCOT RTO to be less connected to other RTOs. In addition, many natural gas power plants could not acquire fuel or simply could not operate due to poor wintering methods at the time in this region. The available power was limited by the transmission lines which could not meet such high demand. Add to this what is happening in Europe, and I expect major investments, particularly in the United States, to help strengthen the network in order to save lives and reduce the effects of an ever-increasing number major climate-related disasters.

Why RTOs Work: Economies of Scale and Transmission

Going back to RTOs, the regional and price-driven market helps reduce costs for retail customers since all generators can generate power and send it thousands of miles across the grid to the place that needs it most. Typically if you send, say, 100MW of power 1,000 miles, you might only lose 5 or 10MW, so it’s an efficient process compared to limiting a city to one or two suppliers local electricity. In addition, RTOs help spread costs and increase competition. The downside is that plants that are expensive to operate – like coal and nuclear – have often been squeezed out of the market, so we’ve seen a wave of retirements among these types of plants. Natural gas is generally the marginal energy source. Tax incentives and production credits for wind and solar generation also throw a bit of a punch in competitive markets.

RTOs make the most sense: network upgrades needed

Constructions of the electricity market

Clean Energy Buyers Association

Meeting today’s challenge: an aging transportation network

This is an excellent 101 in the context of national electricity markets. But what is the investment here? I say the market continues to change rapidly and dramatically. We need more transmission lines that can efficiently deliver electricity to where it’s needed most. Transmission providers, those who own major lines, and companies that can create ways to get electricity from low-cost areas (like a wind farm in Iowa) to high-priced areas (a major demand like Dallas, TX on a cold January morning) could reap major benefits from a network overhaul.

Enter: the new and improved Exelon

According to Bank of America Global Research, Exelon Corp. (NASDAQ: EXC) is a primarily transmission and distribution (85%) electric utility (T&D) operating in Illinois, Pennsylvania, Maryland, Washington DC, New Jersey and Delaware. Major utilities include Commonwealth Edison (ComEd) in Illinois, PECO Energy Company (PECO) in PA, PEPCO in MD/DC, Baltimore Gas & Electric (BGE) in MD, Atlantic City Electric (ACE) in NJ and Delmarva Power (DPL ) in DE/MD. Exelon is the largest customer-regulated utility.

the morning star notes that EXC is “now a pure gas and electricity transmission and distribution utility offering investors a more stable earnings profile. We have seen the separation positively for shareholders. A self-regulated utility strengthens Exelon’s narrow moat and lowers the company’s cost of capital.”

I like EXC because its business is centered around T&D. Constellation Energy (CEG) created EXC, and now CEG is basically a production company and EXC is the T&D company. The Chicago-based $45.5 billion market cap electric utility company trades at an attractive 16.9 12-month price-to-earnings ratio and boasts a 2.9% dividend yield , nearly double that of the S&P 500.

EXC Dividend outlook

EXC Dividend outlook

Looking for Alpha

Evaluation

Exelon is trading at a very attractive valuation when using forward estimates. According to data from YCharts, the price/earnings/growth (PEG) ratio of EXC is cheap at just 0.68.

EXC: A favorable PEG ratio

EXC: A favorable PEG ratio

Y-Charts

Compare this PEG to the utility sector’s valuation multiple of 3.1.

Utilities: an expensive segment of the market

Utilities: an expensive segment of the market

Search Yardeni

Another visual I like to use is the PEG heat map. While the numbers differ a bit due to differences in P/E and growth estimates, the relative valuation tells the same story: EXC’s PEG is cheap relative to the sector. Remarkably, it is among the few stocks in the utilities sector with a PEG ratio below 1.5.

EXC: value in an expensive sector

EXC: value in an expensive sector

Finviz

Earnings growth outlook

Profit growth is seen as strong for EXC through 2024, according to BofA. Also consider that this Utilities sector stock should have lower overall risk than the broader market. Dividends are also expected to rise through 2024, so investors are well paid to hold EXC. The company is currently trading at a slight discount to its peers; there is a chance of a bullish relative revaluation as the market discovers that EXC is well positioned for future T&D investment.

Earnings, Valuation and Dividend Yield Forecasts

Earnings, Valuation and Dividend Yield Forecasts

BofA Global Search

Risks

The main potential downside for a business operating in a regulated environment like the utility industry is regulatory change. We saw a big rally following the Inflation Reduction Act (IRA) among many utility and renewable energy companies. EXC must jump at the chance of owning important transmission lines that could be affected. Regulatory, political and adverse legislation is something bulls need to watch out for. Also consider that high-impact storms can destroy large transmission lines and lead to costly repairs, so an increase in weather-related natural disasters could harm the business. Changing tax and interest rates create another layer of uncertainty.

The management team must also remain on the side of the shareholders. A large stock issue would dilute the current owners. Management must also perform well in an inflationary environment where capital costs are higher – investment decisions become all the more important.

The technical grip

Exelon parted ways with Constellation in February, so the chart isn’t particularly useful from a technical standpoint. Still, EXC outperformed the broader market during this time. The stock is currently consolidating and is near an important area. If it cracks above the mid-$40s, its April high is certainly in play. Additionally, a move above $51 would free up space for much more upside in the years to come. . There is support at the $42.50-$43.50 area.

EXC: relative strength, support in the low $40s

EXC: relative strength, support in the low $40s

StockCharts.com

Events to come

Looking ahead, data from Wall Street Horizon shows a quiet corporate calendar of events through its third-quarter release date of Wednesday, Nov. 2.

Events to come

wall street skyline

The essential

Exelon appears well positioned to benefit from a growing need to overhaul the energy grid, with a focus on strengthening transmission and distribution. Getting electricity from cheap areas to expensive places is becoming more and more valuable. More intense weather disasters only make the need even greater, although it does come with a risk for transmission owners. Exelon has an attractive current valuation given the robust growth outlook. While some investors might be aiming for major home runs, I assert EXC will be steady growth with a strong dividend yield to weather any macro volatility.

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