As InvestorPlace Editor Jeff Reeves just pointed out, the utility sector “is grossly overvalued as a whole” right now owing to a frothy 22.2 price-earnings ratio in the Dow Utilities Index. In fact, Reeves points out 5 utility stocks to avoid right now.
I can add another one: Exelon (NYSE:EXC).
The Chicago-based energy provider and holding company for energy businesses rattled some investor nerves on Thursday in announcing a 38% fall in earnings for the fourth quarter. More ominously, it cut its dividend by 41%, to 31 cents per share, starting in the second quarter.
What’s going on? Simply put, revenue growth and profit margins are lagging well behind spending. Historically low natural gas prices are cutting into electricity prices and demand. And as the owner of three utilities and manager of 10 power plants and 17 nuclear reactors providing electricity across the U.S., Exelon’s portfolio doesn’t make for a good combination.
CEO Chris Crane provided investors with all they needed to hear, saying “We will not see the upside [in 2013] as soon as we had expected.”
We have here what some Washington, D.C., politicians term a “spending problem.” Exelon’s growth and expansion (it acquired Baltimore-based Constellation Energy Group last spring for $8 billion in stock) has cost billions of dollars over the last five years, and with current (and future) revenue growth lagging and profit margins thinning, money is getting tight.
Add in a dividend that will cost EXC about $444 million in the first quarter based on the old 52.5 cents per share payout across roughly 854 million shares, and you get a big cash shortfall.
Indeed, cutting the dividend by 21.5 cents per share saves EXC about $551 million for the remainder of the year (approximately $183.6 million for each of the last three quarters). Not only will EXC save that money and use it for future growth and continued dividend payments, but the move also allows EXC’s corporate parent and its utilities to maintain their investment-grade rating at Moody’s (NYSE:MCO), which has already lowered its ratings on the wholesale power-generation side of the business.
So, even with this bad news (lower earnings and dividend cut) out there for all to see, investors mostly shrugged on Thursday and into early Friday. EXC dropped just over 1% and has kept its head above water (+4.22%) year-to-date. The enticing 6.9% dividend yield makes an investor feel even better, but that drops to 4% if you use the new payout. Still, not so terrible.
However, a longer-term look finds a much bleaker picture: The stock is down nearly 23% over the last year and over 59% in the last five years. Staying in the stock means you need to see that dividend maintained at virtually any cost, with the hope that perhaps one day it ticks up again.
I don’t see that happening. EXC isn’t going anywhere, of course, but neither is the stock price. If the utility market as a whole is stuck in a rut, nothing makes me believe Exelon is going to break free from the pack and make this dividend cut its last. And even if the dividend stays steady, where’s the stock growth?
As long as EXC continues to have that spending problem, I’d avoid it.
Editor’s Note: This article has been updated to correct the figures regarding Exelon’s first-quarter dividend payment total and how much the reduced dividend will save the company.
Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing he does not hold a position in any of the aforementioned securities.