Increase In Operating Expenses And Similar Decline In Rate Case Outcomes Underpins Decline Prediction For Exelon Corp

Business Strategy and Outlook

After spinning off its merchant generation and retail energy segment, Constellation Energy, through a distribution to Exelon shareholders, the new Exelon is now a pure-play electric and gas transmission and distribution utility providing investors a more stable earnings profile. The separation is considered positive for shareholders. A standalone regulated utility strengthens Exelon’s narrow moat and lowers the company’s cost of capital. Exelon’s regulated utilities support the current outlook for 7% earnings growth through 2026, the midpoint of the company’s 6%-8% earnings growth guidance. The company is estimated to spend $36 billion of capital investment through 2026. This investment plan supports the current earnings forecast and dividend growth in line with earnings growth. Exelon operates a diverse set of regulated utilities, including five utilities in the Northeast and the largest investor-owned utility in Illinois.

Regulatory relationships have at times been strained across its Northeast utilities, resulting in low allowed returns. Alternative recovery mechanisms help reduce regulatory lag and risk across the regions for Exelon’s growth capital. Low earned returns below allowed regulated returns should gradually increase to within management’s 9% to 10% goal. Relationships at the company’s most important subsidiary, ComEd, will likely remain strained given allegations of inappropriate lobbying practices tied to the passage of previous utility legislation. Exelon subsequently entered into a deferred prosecution agreement with federal prosecutors. Recent Illinois legislation will bring significant changes to the state’s regulatory framework. Current performance base-rate making, which ties allowed returns to the average 30-year Treasury rate, have produced some of the lowest returns among U.S. utilities. After 2023, Illinois utilities may opt in for a four-year rate plan beginning in 2024. Under the multi year plan, ComEd would be allowed to “true-up” earned returns to allowed returns and continue usage-decoupled rates. Regulators could issue incentives and penalties based on performance. The legislation will likely lead to higher returns for the subsidiary

Financial Strength

With over 4.0 times interest coverage, Exelon’s financial health is sound for a regulated utility, particularly given its stable, low-risk business model. With the current forecast for $36 billion of capital spending planned through 2026, Exelon will be a frequent debt issuer. The company has manageable long-term debt maturities and anticipated to be able to refinance its debt as it comes due, maintaining its current debt/capital ratio. The company is expected to issue $1.0 billion in equity to fund its capital investment plan, in line with management’s expectations. Total debt/EBITDA is expected to remain in the 4.5-5.0 times range. Exelon will target a 60% dividend payout ratio. Dividend growth is projected to remain in line with the current 7% annual earnings per-share growth forecast through 2026.

Bulls Say’s

Exelon’s divestiture of its merchant generation eliminates its earnings sensitivity to cyclical commodity prices that have dragged down returns recently.
Exelon has good regulated growth investment opportunities that should support earnings and dividend growth.
Nearly all of the company’s growth capital is recovered through constructive regulatory mechanisms that reduce regulatory lag.

Company Profile

Exelon serves approximately 10 million power and gas customers at its six regulated utilities in Illinois, Pennsylvania, Maryland, New Jersey, Delaware, and Washington, D.C.

(Source: MorningStar)

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