Why Duke’s International Business Is Extremely Important To The Company

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Duke Energy’s (NYSE:DUK) international energy business is viewed as one of the cornerstones of the company’s future growth strategy, given the company’s access to the energy hungry Latin American market. The division, which operates in countries including Brazil, Peru, Argentina and Chile, owns and operates electric generation capacity and also sells and markets electricity and natural gas. Although the business only accounted for just about 5% of the company’s total sales last quarter, it is important from a growth standpoint if you compare it to the company’s commercial power business: the latter constitutes 5% of Duke’s total assets and contributes only 1% of the revenue, while the former constitutes 4% of the total assets and contributes 5% of the revenue. The company’s mainstay is still its regulated utilities business from which it derives 90% of revenues. However, this segment is expected to witness relatively sluggish demand growth going forward, thereby making the international business segment the most important growth driver for the company’s growth. [1] In our analysis below, we take a brief look at some of the factors that will drive the performance of Duke’s international energy division.

See Our Complete Analysis For Duke Energy Here

Low Electricity Consumption

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Electricity consumption in Latin America is still very low. Annual per capita electricity consumption in Brazil stands at around 2,300 kilowatt-hour (kWh) while it is around 3,300 kWh in Chile. [2] In comparison, the per capita consumption in the United States stands at around 11,900 kWh. This gives utilities and power generation companies a lot of room to grow in these markets. For instance, electricity consumption in Brazil is expected to grow at a rate of around 4.5% over the next decade and this would require the overall generation capacity in the country to grow by around 56% during the period. [3] In comparison, total load growth in the United States is expected to trend at just about 1% over the next few years.

High Electricity Prices In The Region

Electricity rates  in many parts of Latin America are higher than those in the United States. For instance, retail rates in Brazil stand at over $0.16 per kWh while retail rates in Chile can approach as much as much as $0.23 per kWh. Although part of these high prices can be attributed to higher transmission losses and generation costs, they are also due to high demand and relatively short supply. While Duke does not have retail operations in these countries, it should nevertheless be able to benefit at the wholesale level.

According to our estimates, Duke’s international business generates close to $70 per megawatt-hour (MWh), while the firm’s U.S. commercial power business, which also caters to the wholesale electricity market realized only about $40 per MWh last year. Given its much higher productivity, this is an extremely important segment for the company.

Asset Base Is Spread Too Thin

However, there is one major risk that the company needs to take care of — its undiversified asset base in South America. Duke has been in Brazil since 1999, when it acquired Paranapanema Electricity Generation Company. The subsidiary, which creates just over 2% of Brazil’s total electricity, is highly risky as it generates all its electricity by relying on just 10 power plants spread along two rivers. As a result, when weather conditions are unfavorable, as in the case of this summer with lower rainfall resulting in lower than expected reservoir levels, the company has had to rely on contracts to reduce the volatility in its numbers. However, financial arrangements do not affect the weather; the company still suffers in case of such an event.

We have a price estimate of $68 for Duke Energy, which is about 5% behind the current market price.

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Notes:
  1. Duke Energy 10-Q []
  2. Index Mundi []
  3. The Wall Street Journal []