What’s Driving Growth For Duke Energy’s U.S. Franchised Electric and Gas Division?

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DUK: Duke Energy logo
DUK
Duke Energy

Duke Energy’s (NYSE:DUK) U.S. Franchised Electric and Gas division (USFE&G) has been facing sluggish load growth recently. During Q2 2013, the division saw its total load growth climb by just about 0.4% due to an increasing focus on energy conservation as well as a relatively sluggish economy. Going forward, the company expects a weather normalized load growth to remain relatively modest as well at around 1% per year. [1] Considering the middling growth in the company’s load, future earnings growth will partly hinge on operational improvements as well as increases in its rates.

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Operational Efficiency and Synergies From Progress Merger: Duke Energy completed its merger with Progress Energy last year, making it the largest electric power holding company in the United States, serving a customer base of about 7.1 million. Following the merger, Duke has been able to derive synergies by eliminating duplicate functions, increasing scale in power generation, reducing manpower and combining dispatch centers. The firm will see a total of headcount reduction of close to 1,100 by this year. So far, the firm has seen combined savings of over $120 million and this is likely to improve going forward. [2] The company estimates that non-fuel operating expenses can be reduced by 5% to 7%, while savings relating to fuel and transmission are expected to be at least $650 million over the next five years.

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Wholesale Business Will Be Accretive To Earnings: The wholesale electricity business entails short-term and long-term contracts to provide electricity to municipalities and co-operatives within the areas where Duke operates. [3] Duke expects this business to grow at a rate of around 8% per year over the next two years, which is significantly higher than the estimated 4% revenue growth for the USFE&G division. Duke has signed several new wholesale contracts this year, mostly in the Carolinas. Since most of these sales are contracted over the long term, it should provide some additional stability for the company. The wholesale business is expected to be earning accretive for the company, contributing around $1 billion in net margins for this year alone.

Recent Rate Cases Help Revenues: More than 85% of Duke’s Energy’s revenues come from its regulated utility services and the firm is dependent on state regulators for rate increases to offset costs of adding new capacity or upgrading its fleet. Over the last few months Duke’s Ohio subsidiary received approval to increase its rates by around 2.9% while Duke’s Progress subsidiary in North Carolina saw a 5.5% rate increase.  In September, the firm was awarded a 5.1% rate increase for its Duke Energy subsidiary in North Carolina and a 8.2% rate increase for its South Carolina operations. These increases should help the company bolster revenues and profitability going forward.

We have a $73 price estimate for Duke Energy, which is about 10% above the current market price.

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Notes:
  1. Duke Earnings Presentation []
  2. Seeking Alpha []
  3. Seeking Alpha []