Consistency is a rare and difficult characteristic for any investor to find when looking for investing opportunities. Consistency doesn’t make you rich overnight, is rarely cheap, boring to follow and the only news you ever hear about the stock is good news. Over the long-term these silent, consistent returns provide you stability and appreciation that you’d be hard pressed to find in other corporate names. At some point you look back on your purchase and realize that when you bought the stock few in the market were discussing it and today after returning over 200% in five years even fewer talk about it now.
Of course it’s easy to look at returns on an absolute basis and we frequently hear from the markets that “past performance is no indication of future returns.” But is this always the case? There are a host of companies that year over year consistently meet expectations, raise their profits and dividends and rarely get much respect in the market where many simply chase what’s “hot”, “exciting” or “the next big thing”. Stocks such as JNJ, CL, PG, KO, UPS, GIS and many others are consistent time after time after time and largely command little respect in the markets other than the investors who have bought and held these stocks for decades. So why do we hear little from these investors who have held these stocks for so long and today remain quiet? These stocks have made them rich enough that they don’t need to boast about them anymore.
I can’t place EXC in the same category as some of the stocks I’ve already mentioned or analyzed before, but the lessons learnt from studying consistency can provide valuable insight into where to look for the long-term so that one day you, as an investor, can remain silent on what made you rich.
I’ve owned shares in Exelon since late 2005 and it was one of the first stocks I ever analyzed and bought by using my earliest set of Value Rules. I could try and boast that I used some sort of highly technical valuation in order to determine a good entry price, but the honest truth is that when I looked at the company through a SA for the very first time, the SWOT & PEST spoke so loudly that EXC was clearly a great long-term investment in my mind.
Experienced investors can ignore this section, but what I would advise new readers/investors, when reading this post, would be to revisit my earlier post on the Situational Analysis and take a scrap piece of paper at your side and simply write out the following…
While reading through the rest of this post, jot down the points I mention under each category and anything that you can think of on your own that might impact this company over either the short or long-term. Go back to the stocks I’ve analysed on other names and try to do the same thing. This is likely one of the easiest qualitative methods that you can use to organize ideas, observations, opinions and quantitative data to help you gain a better perspective of how secure an investment might be from a broad perspective. Try this in a note book each time you look at a new investment and keep a copy that you can update in the future when new events happen. Over a period of time you’ll be able to review and reflect back on where the company has come from and where it might be going so that your investment decisions can be more informed. I maintain an active SA on any stock I’ve previously investigated, own or owned.
Exelon is the 4th largest generation company in the US with operations in Illinois, Maine, Maryland, Massachusetts, New Jersey, Pennsylvania & Texas. They boast the largest nuclear fleet after doubling their capacity over the last ten years and operate 10 stations with 17 reactors the comprise 20% of the total US nuclear power capacity. As a public utility holding company, EXC operates in two distinct segments – energy delivery and energy generation. The delivery segment operates under two divisions: ComEd in northern Illinois and Peco in south-eastern Pennsylvania that serve together over 5.7M customers. The generation segment is a diversified group of energy producing assets that give EXC one of the most diverse energy producing portfolios of any utility their size. They also operate a business services company whose sole purpose is to work within the entire corporation to better utilize efficiencies and costs by coordinating the essential daily operations of the full entity.
When you examine the management team of the company what is immediately clear is their long-term vision of the company and execution over the past few years to diversify their power assets. Their nuclear fleet capacity factor for 2007 was 94% and has consistently held above 92% (industry standard of 91.8%) in the last seven years. This large nuclear base is an excellent hedge for the company over the long-term in the event that governments imposes carbon caps against energy producers. The nuclear divisions maintain a strategic relationship with GE Hitachi Nuclear Energy (GEH) and the company is well positioned to develop new nuclear assets in Texas and Pennsylvania if approved by the government. Their power assets are also diversified well among other generation methods including fossils (coal, oil & natural gas), hydroelectric and renewables (wind, landfill capture and solar).
The role of management, and their influence, is clearly demonstrated in the corporate culture, strategic management of the company and management of assets that focus on the highest of standards. They demonstrate accountability, commitment, conservation, dedication and a focus towards community in any and all of their private & public statements. This can be clearly observed in the strong composition of their management team, BOD and political influence within their industry.
A key value factor for this company has always been management’s ability to manage power assets in an effort to improve efficiencies, control costs and position the company for a changing climate within the industry. It’s no surprise that energy prices have increased significantly over the past few years as the basic commodities (uranium, oil, gas, coal) have increased for producers and those costs have had to be passed on to consumers. This is where Exelon’s power assets provide a competitive advantage within their industry. While nuclear comprises only 66% of overall capacity, its responsible for 92% of energy output in comparison to their other assets. While the price of uranium has increased significantly, the capacity factor of their nuclear assets (well above 92%) enjoys a large margin over the other energy production options such as coal (72%), oil/gas (43%-16%), wind (30%), hydro (28%) or solar (20%). This allows the company to balance costs among its diverse portfolio of assets to best utilize where energy production comes from and where costs can be offset by more favourable energy generation methods. This enables the company to then sell to consumers while maintaining their gross margins and maintain relatively strong demand.
EXC has outperformed both the S&P500 and S&P Utilities index on a 5-year basis and have paid a sustained dividend since 1980. While operating revenue has increased on average by 6.2% over the past five years, the efficiency of management’s focus on the asset mix of power production is seen through the increase in operating income over the same period by 21.2%. Over this five year period ROE has averaged 18.1%, payout 68.8%, P/B of 3.27 and dividend growth rate of 15.5%.
The fundamentals (both quantitative & qualitative) are strong, but the company still remains exposed to risk. My first concern is regarding the $2.6B of goodwill which comprises 5.7% of total assets on the balance sheet as book value growth has been a subpar 4.9% over the past five years. Political risk is also a serious consideration when you examine the regulatory environment that the industry operates within. The ICC (Illinois Commerce Commission) has 3 vacancies on its board at this time (traditionally held a democratic majority), the PUC (Pennsylvania Public Utility Corp) possesses a full board (with democratic majority) and the FERC (Federal Energy Regulatory Commission) has a full board (with a republican majority) who all oversee operations and regulatory permissions in the company’s operating states. While no current issues are at hand with regards to new or existing projects, the risk remains that any of these boards could flex considerable influence in corporate operations if they chose to and they tend to be strongly politically aligned. This always holds the potential for partisan positions to be strongly held to for political leverage that could negatively impact industry operations.
This of course is a concern to any company faced with regulatory pressures. Exelon’s answer to combat any economic or political threat has been to create a strategy & policy committee and stack its Board of Directors with highly influential members such as Thomas Ridge (former secretary of Homeland Security & former Pennsylvania Governor), Paul Josklow (Alfred P. Sloan Foundation), Rosemarie Greco (GOHCR), Don Thompson (President McDonald’s USA), Bruce DeMars (retired Admiral US Navy) & John Palms (Ph.D. USC).
The strong political presence of the board, strategic management of power assets and strong financial performance over the years has continued to impress me as an investor in a stock that for the most part is never discussed, talked about or referenced in the financial media. While the stock price has enjoyed considerable success over the last few years when you examine the volatile nature of markets recently, I see no reason that this company cannot continue to grow at 15-20% while returning improved returns through increasing dividends and expanding their power assets through either acquisitions or organic growth.
There are concerns to be noted that include terrorism, a current US economic slowdown and at times highly partisan regulatory environment; but Exelon is well positioned to meet any short-term challenges with competent management and a strong portfolio of growing power assets that allow them to best utilize efficiencies. If as an investor you are looking for diversification into US equities with adequate risk in the face of uncertain market conditions in financials, housing or the consumer market; Exelon might provide an investor a suitable opportunity to invest into infrastructure and earn modest returns while collecting a 2% dividend that continues to grow from a company well positioned for future growth.