Warming to Nuclear Power
07/07/2009 1:00 pm EST
Paul Larson and Travis Miller of Morningstar StockInvestor pick Exelon as a big beneficiary from carbon caps designed to slow climate change.
In an era of concerns about global warming and rising fossil-fuel prices, Exelon (NYSE: EXC) maintains an enviable position as the largest nuclear plant operator in the United States. Its ability to produce low-cost, carbon-free electricity should produce substantial, sustainable, and growing shareholder value for many years, regardless of what path power prices take. This is why we consider it the only utility in our coverage universe with a wide economic moat.
Exelon’s 11 nuclear plants in the Midwest and mid-Atlantic generate 18% of US nuclear power and nearly 4% of all US electricity consumed. With power prices hovering between $50 and $70 per megawatt hour and nuclear plants generating power for just $15 per megawatt hour, nuclear plant owners are realizing wide profit margins. While power prices remain volatile depending on weather, commodity prices, and demand, nuclear costs should remain low.
All nuclear operators have two primary competitive advantages. First, nuclear plants take more than seven years to site and build, cost billions of dollars, and typically face community opposition. This gives existing operators an effective monopoly over nuclear power that could last decades. Second, nuclear’s low variable costs and low carbon emissions relative to alternative fuels such as coal and natural gas eliminate substitution threats. Exelon’s world-class operating efficiency allows it to capture nearly all available profits. To sustain its economic value, Exelon must ensure power markets remain deregulated, particularly in the Midwest and mid-Atlantic. Both markets have experienced rate caps and other unfavorable conditions for power plants recently, but the situation continues to improve.
Exelon’s regulated delivery utilities, ComEd and PECO, contribute more total revenue than generation but only one third of the operating profit. Value-destroying regulation in Illinois and Pennsylvania has hurt the segments’ returns, but the situation in both states is improving.
We are reaffirming our $76 fair value estimate and see no incremental value from the potential NRG acquisition. Dislocations in the credit markets and a softer outlook for power demand in a slowing economy support our projection for flat margin growth at Exelon Generation through 2010.
However, fundamental industry drivers such as supply constraints and carbon restrictions should allow Exelon to achieve long-term operating profit growth near 8% annually. A key assumption in our profit forecast is that Exelon maintains a 93% long-run average nuclear capacity factor. Exelon also likely will benefit substantially from carbon restrictions. We assume that carbon emission caps begin in 2012 and carbon credits trade at $7 per ton in 2012, then $10 per ton in 2013 and beyond. This accounts for about 10% of our fair value estimate.