Duke Earnings Preview: Declining Per Capita Electricity Consumption, Currency Effects Could Pressure Margins

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Duke Energy

Duke Energy (NYSE:DUK), one of North America’s largest utility holding companies, is expected to publish its Q2 2015 earnings on August 6th. [1] The company operates three business divisions — regulated utilities, commercial power generation and international power generation. The first of those three contributes around 90% of the company’s revenue but has been experiencing sluggish growth in recent quarters. Duke expects most of its growth to come from the international power business, which contributes around 5% of the revenues despite accounting for only 4% of the company’s total assets.  This is in comparison to the commercial power business, which contributes just 1% revenue but accounts for 5% of the company’s asset base. Additionally, the company has been focused on expanding its renewable energy asset base and selling off its unregulated holdings in recent quarters. We will be watching out for information on the status of various transactions that the company is in the process of pursuing currently.

We have a $68 price estimate for Duke Energy, which is about 10% below the current market price.
Declining Per Capita Electricity Consumption
Duke’s regulated utilities business depends on getting more customers to use more electricity at a standardized rate for growth. However, recent trends have not been favorable for the company. Per capita electricity usage has been declining, due to a number of energy saving initiatives from energy storage companies as well demographic trends such as millenials choosing to live with their families and in multi-family housings. In 2014, Duke saw its regulated utilities customer base increase by just 1%, but average electricity usage per customer declined. [2] As a result, the company’s revenue collection fell by 0.1%. Consequently, the company has been focusing on trying to lower its expenditure on power plants and downsizing power generation capacity to levels appropriate to demand, in order to hedge revenues collections against volatility. In this quarter, the company’s revenue collection from its regulated utilities business will depend on its weather normalized residential sales, a measure of electricity load growth adjusted for fluctuations in weather.
Brazil Weakness
The Brazilian Real has fallen by more than 30% against the US dollar over the past year. [3] The country’s economy is highly dependent on exports of commodities and has suffered from the drop in demand for these commodities from China. [4] The situation has been made worse by the exhaustion of a credit boom, which was responsible for raising consumer demand in the past months. Inflation and unemployment rates are up and the country is also being beset by a major corruption scandal involving major state-owned oil company Petrobras.
This is a problem for Duke as Brazil is one of the biggest opportunity areas for future growth for the company. As outlined above, the international power business is going to be one of the biggest drivers of future growth for the company. In addition to declining demand, revenue collection from the international power business — which apart from Brazil operates in Chile, Argentina, El Salvador, Ecuador, Peru and Guatemala — is also likely to decline due to the strength in the U.S. dollar, even apart from the drop in the value of the Brazilian Real and other currencies.

Power Acquisition Costs Can Weigh On Margins

Before Duke sells electricity to consumers, it has to produce or acquire electricity. The going price of electricity power generation can affect the company’s margins significantly. The company’s electricity is produced from a variety of sources, including water, coal, nuclear and natural gas. It has also been trying to add solar, wind and biomass to this list. In fact, the company has invested more than $4 billion in several green energy projects over the last decade. Its recent investments in solar, wind and biomass are expected to yield almost 6000MW by 2020. Duke also put forward a proposal to purchase swine waste for generation of biogas at two of its sites. If the proposal is accepted, Duke will achieve half of its goal of adding 6000MW of electricity by 2020. [5]

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In the previous quarter, the company’s margins were affected by higher power acquisition costs as the polar vortex pushed prices higher and a power outage at Duke’s mid-west power generation fleet further put pressure on the company’s resources. [6] Similarly its international business had to incur power purchase costs as its hydroelectric dams in Brazil were affected by irregular water levels at its reservoirs due to lower than expected rainfall. Going forward, Duke is pursuing more stable electricity generation sources.

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Notes:
  1. Duke Energy Investor Relations []
  2. DUK 10-K []
  3. Brazilian Real vs US Dollar, XE []
  4. Brazil: Engine trouble, Financial Times, August 2015 []
  5. Why Duke Energy plans to convert a (very) small part of its big natural gas plants to using swine waste, BizJournal, June 2015 []
  6. DUK 10-Q, SEC []