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Power Up With These Utility Takeover Targets
03/01/2011 12:12 pm EST
Utility mergers are one of the surest profit plays around, and Duke Energy and Integrys present the latest enticing opportunities, writes Roger Conrad, editor of Utility Forecaster.
Over the past century-plus, every one of thousands of mergers between regulated utilities has resulted in a stronger company. Duke Energy’s (NYSE: DUK) combination with Progress Energy (NYSE: PGN) will be no exception.
The deal already has passed the market test. Duke is paying little, if any, real premium for Progress. Its credit rating has been affirmed, and its share price has risen since the deal was announced.
Hurdle No. 2 is winning regulatory approvals in the Carolinas and from the Federal Energy Regulatory Commission (FERC) and the US Department of Justice, processes Duke CEO Jim Rogers is “shooting” to complete by the end of 2011.
Expected savings and enhanced ability to cover billions of dollars of capital costs are huge selling points for the deal. Regulators may reduce the pair’s requested rate boosts, and FERC may condition some wholesale market activity. But approvals should be swift, smooth and largely non-controversial.
The most important challenge is delivering shareholder returns in coming years. Fortunately, that should ultimately prove easiest to meet.
Eighty-five percent of new Duke’s earnings will draw from a growing rate base serving 7.1 million-plus customers with 57 gigawatts of generating capacity.
The unregulated portion is largely from renewable power generation, with profits locked in by long-term contracts. Progress’ current boss Bill Johnson will be the CEO, with Rogers becoming executive chairman and focusing on regulatory issues.
Buy Duke Energy up to $19. [Shares closed near $18 Monday.—Editor]
[A month ago, Conrad recommended Comcast (Nasdaq: CMCSA), praising its potential following the purchase of NBC Universal. Comcast shares rose 13% in February.—Editor.]
Another Takeover Target
A decade ago, Wisconsin Public Service launched a quest for growth. Its biggest move—the February 2007 acquisition of Illinois-based natural gas distributor Peoples Energy—created Integrys Energy Group (NYSE: TEG).
Unfortunately, the process of disposing of Peoples’ weaker, unregulated assets was hampered by the weak economy. As a result, by early 2009 the payout ratio ballooned to 163.4% and the stock landed on my Dividend Watch List.
A year later, however, management had dumped the troubled Texas retail electricity marketing unit, boosted returns at regulated utilities and slashed debt, earning an exit from the Watch List.
Today Integrys is on track to meet projected 2011 earnings of between $3.24 and $3.57 per share.
Looking ahead, supportive regulators ensure capital spending in the gas and electric utility business will increasingly drive earnings. Unregulated operations are both complementary and focused, including a major solar venture with Duke Energy (NYSE: DUK), 35% of the upper Midwest high-voltage transmission grid, and downsized energy services.
Despite the strain of Peoples, Integrys held its dividend of 68 cents per share steady during the 2008 crash. Annual profit growth of 4% to 6% between 2011 and 2015 should ensure a return to dividend growth, probably later this year.
Meanwhile, the company sells for just 1.3 times book value, and its market cap is half that of neighboring Wisconsin Energy (NYSE: WEC), making it a potential takeover target.
Integrys Energy Group is a buy up to $52. [Shares closed just below $49 Monday.—Editor]
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