Factors Duke Energy Needs To Watch Out For In 2016

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Duke Energy (NYSE:DUK) had a bad year in 2015, with its stock falling by over 20%. The main reasons behind this decline were the falling demand for electricity among residential customers, declining profitability of its international business and uncertainty regarding the company’s future investments. Below, we take a look at each of these factors and what can be expected of the company in 2016.DUK

Diversified Asset Base

Most of Duke Energy’s revenue in the past has come from the wholesale electricity market. However, the company has been trying to move away from the wholesale markets towards the regulated markets business and projects with long term contracts. The company’s acquisition of Piedmont Natural Gas for $4.9 billion in cash was consistent with that trend. [1] As electricity demand growth has stalled, the U.S. economy is afloat with an abundant supply of natural gas. Demand for natural gas is also expected to be strong in the coming period, especially in the eastern regions, where natural gas pipelines are under construction.  In this region and others, natural gas is expected toreplace coal and oil for the production of electricity.

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Additionally, Duke has purchased renewable energy assets. This represents a shift away from the company’s traditional asset base of coal. The company has guided for the addition of  another 300 Mega Watts (MW) of commercial wind and solar assets to its portfolio. In addition, 20o more Mega Watts are expected to be added in 2016 and over the next four years around $2 billion worth of assets to its renewable energy portfolio. Duke also sold off its non-regulated Mid-West energy generation business. Wholesale markets have been in terminal decline so this was a good divestiture and using that money for the purchase of commercial wind and solar assets represents a good use of the money generated from those transactions.

Importantly, Duke  has also filed 15-year plans for Duke Energy Carolinas and Duke Energy Progress with the regulators in North and South Carolina late last year. While Duke’s CEO Lynn Good stated that the company is serious about diversifying its assets and expanding into renewables, storage batteries and distributed generation, industry watchers content that the plan submitted to the regulators focused mainly on replacing the company’s existing coal assets with natural gas. [2] A lack of clarity on this issue has also negatively impacted sentiment on the company.

Slow Growth

One reason for a decline in Duke’s stock price in 2015 was the slow growth in retail electricity demand in the year. Demand for electricity from retail customers only grew by 0.3% in the full year, with demand from residential customers actually declining by 0.2%. These customers form the core of Duke’s customer base and the trends impacting their demand are expected to continue in the near term. This makes Duke’s prospects somewhat lukewarm.

The other factor responsible in Duke’s decline has been the impact of foreign exchange on its earnings. Duke’s international power business is expected to be its biggest growth driver. Compared to Duke’s commercial power business, the assets from the international business are much more productive, owing to higher retail electricity rates in South America. Moreover, per capita electricity consumption in the region is still far lower than that in the U.S., so there is considerable growing opportunity. But around 40% of the company’s international revenue comes from Brazil, an economy that has been in free fall. Brazil is majorly dependent on its exports, a major consumer of which is China. The slowdown in construction in the Chinese economy, coupled with the devaluation of the yuan and a shift towards the services industry have all impacted Brazilian exports heavily. Additionally, with the Federal Reserve raising short term interest rates in the U.S., demand for the U.S. dollar has grown considerably in comparison to the fall in demand for the Brazilian real. As a result, the exchange rates have decline considerably and this impacts Duke’s revenues from the region considerably.

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Notes:
  1. Duke Energy to Buy Piedmont Natural Gas for $4.9 Billion, Wall Street Journal, October 2015 []
  2. Duke Energy’s long-term plans can prove dicey in a rapidly changing industry, Charlotte Business Journal, October 2015 []