Duke Energy Earnings Preview: Operational Discipline, Commercial Sector To Drive Results

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Duke Energy (NYSE:DUK), one of North America’s largest utility holding companies, is expected to publish its Q3 2014 earnings on November 5. We expect earnings to increase on a year-over-year basis, driven by higher load from the regulated electric business in the United States and some operating cost-related improvements. During Q2 2014, the company’s revenues grew by only 1% year-over-year to around $6 billion, while adjusted income rose 80% to about $609 million, due to a favorable tax settlement which allowed the company to favorably defer its taxes. In this note, we take a look at some of the trends that we believe will influence Duke’s earnings for the quarter. [1]

We have a $71 price estimate for Duke Energy, which is about 13% below the current market price. We will be updating our price estimate for the company after the earnings release.

See Our Complete Analysis For Duke Energy Here

Commercial Sector Should Drive Regulated Business: The United States witnessed a warmer than normal summer during the second quarter, and this is likely to have driven up demand for electricity. However, Duke Energy also benefited from higher revised rates for electricity, lower effective tax rates and a higher sell through rate of wholesale volumes. On a weather normalization basis, which removes the effects of weather on load growth, the company’s load grew by 1.5% during the previous quarter, driven by residential and commercial segments.

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In the third quarter, the commercial and industrial sectors could be key growth drivers. During Q1 2014, much of Duke’s weather-normalized load growth came from the commercial sector, where improving employment trends as well as better consumer spending resulted in lower vacancy rates for commercial spaces. For instance, through Q1, the office sector saw vacancy rates decline by about 0.2 percentage points year-over-year, to about 15.6% on the back of healthy leasing activity. [2] Economic data relating to employment has continued to improve ever since and we expect the same trends to continue this quarter. In fact, according to Cushman & Wakefield,  the U.S. office market remained on pace to achieve the lowest vacancy rates in the last five years, at the end of the third quarter. [3]

Cost Cutting Can Improve Margins: Given the relatively sluggish long term outlook for retail load growth, Duke has been streamlining its cost base in order to improve earnings. Operation and maintenance expenses are one of Duke’s most significant costs, standing at around 25% of revenues as of 2013. However, since Duke closed its merger with Progress Energy in mid-2012, it has indicated that it was able to keep these expenses flat, owing partly to better management of its corporate costs. The company now aims to maintain these costs at current levels through 2016 through work eliminations and efficiency improvements, headcount management and reduced use of contract workers. This could possibly allow Duke to expand margins for the quarter.

International Revenues: Duke’s international business, which is largely located in Latin America, owns and operates electric generation capacity, and also sells and markets electricity and natural gas. The business is important for the company, since electricity consumption growth in key Latin American markets is at least four times higher than that of the United States. For this quarter, we will be watching the company’s Brazilian operations, which account for about half of the international segment’s generation capacity. Duke expects earnings from the segment to grow on the back of favorable pricing and volumes in Brazil. The company projects that contract pricing in Brazil will rise at a rate of around 6% (in local currency) between 2013 and 2016. [4]

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Notes:
  1. Duke Energy Q2 2014 Earnings Press Release, Duke Energy, August 2014 []
  2. C&W: Q1 U.S. office market occupancy absorption up 133% from last year, FMLink, April 2014 []
  3. U.S. Office Market on Pace for Highest Absorption in 5 Years, World Property Journal, October 2014 []
  4. Duke Energy Q4 2013 Earnings Slides, Duke Energy, February 2014 []