DUK - Duke Energy: Navigating Growth And Risks In The Clean Energy Transition

2023-04-19 12:14:51 ET

Summary

• Duke Energy operates in attractive jurisdictions with favorable regulatory environments, including Florida, North Carolina, and Indiana.
• The company's ambitious $65 billion capital investment plan for 2023-27 focuses on clean energy initiatives to achieve net-zero carbon emissions by 2050 and net-zero methane emissions by 2030.
• Despite growth prospects, Duke faces challenges such as regulatory risk, rising interest rates, and management credibility issues.

Duke Energy ( DUK ), one of the largest regulated utilities in the United States, offers investors a stable source of earnings and various growth opportunities in the clean energy transition. The company has focused on core regulated operations, strategic investments in clean energy technologies, and leveraging favorable regulatory environments. However, investors must also consider the risks associated with Duke's aggressive investment plan, regulatory risk, and potential impacts of rising interest rates on the company's financial performance. In this article, we will delve deeper into Duke Energy's opportunities and risks, as well as the company's valuation.

Analysis of Business, Opportunities, and Risks

Duke Energy, as one of the largest regulated utilities in the United States, has a significant presence in several attractive jurisdictions, offering a stable source of earnings and various growth opportunities. The company has been concentrating on core regulated operations, strategic investments in clean energy technologies, and leveraging favorable regulatory environments to position itself for success in the clean energy transition. However, investors should be aware of the risks associated with Duke's aggressive investment plan, regulatory risk, and potential impacts of rising interest rates on the company's financial performance.

Duke Energy operates in Florida, North Carolina, and Indiana, which provide a strong foundation for growth. Florida stands out as the most favorable region for Duke Energy due to its higher-than-average load growth, best-in-class regulation, and significant potential for solar growth and storm-hardening investments. The state's regulatory environment allows for higher-than-average returns on equity, forward-looking rates, and automatic base-rate adjustments. This environment bodes well for Duke Energy's long-term growth prospects in the state.

North Carolina, Duke's largest service territory, has also seen a significant improvement in its outlook. Recent legislative changes have allowed for multiyear rate plans, including rate increases for projected capital investments. The legislation supports utilities playing a crucial role in the state's clean energy transition by permitting performance incentive mechanisms and usage-decoupled rates for residential customers. These changes protect utilities from underlying usage trends and create a more constructive regulatory environment in the state.

Indiana remains a constructive environment for Duke Energy, allowing for recovery on investments for renewable energy and future recovery on investments for coal ash remediation, with a forward-looking test year. The subsidiary's 20-year integrated resource plan calls for 7 gigawatts of renewables, 400 megawatts of energy storage, and 2.4 GW of natural gas generation, showcasing the company's commitment to clean energy investments in the state.

Duke Energy's ambitious $65 billion capital investment plan for 2023-27 is focused on clean energy initiatives, as the company aims to achieve net-zero carbon emissions by 2050 and net-zero methane emissions by 2030. Management envisions growth opportunities beyond the five-year forecast, with expectations for $80 billion-$85 billion of capital expenditures supporting future rate base growth. To further streamline its operations, Duke has announced plans to sell its commercial renewable energy business, which represents roughly 5% of total consolidated earnings. This move will transform Duke into a fully regulated utility and align the company's focus on core regulated operations and strategic growth investments.

Despite these strategic moves and growth prospects, Duke Energy faces several challenges. Equity issuances and capital growth delays have strained relationships with key stakeholders, and the aggressive investment plan increases regulatory risk. Additionally, rising interest rates could raise financing costs and make the dividend less attractive for income investors. Moreover, while the company operates in mostly constructive regulatory jurisdictions, certain cases may require litigation, such as North Carolina rate cases involving forward-test years and capital projections.

However, Duke Energy's substantial capital expenditure plan should drive rate base and earnings growth in the coming years. Operating in favorable regulatory jurisdictions, we believe Duke can achieve the upper half of management's 5%-7% earnings growth target. Overall, Duke Energy is well-positioned for growth and success in the clean energy transition, given its focus on core regulated operations and investment in forward-looking energy technologies.

Valuation

Note: All numbers in this section come from FactSet.

Our analysis shows that Duke Energy's earnings have been relatively stable over the past few years, with growth mostly in the low single digits. However, we believe that the company's earnings per share ((EPS)) are set to accelerate in the coming years, mainly due to the increased transition into green energy supported by the IRA. Considering consensus estimates, Duke's EPS is expected to increase by 7% in 2023, reaching $5.64, and further growing by 6.1% in 2024 to reach $5.98.

Despite these positive growth prospects, Duke currently trades at a discount compared to other utilities, primarily due to concerns surrounding management credibility issues. We do acknowledge these concerns, but we also note the company's progress in divesting non-core assets and the stock's attractive valuation relative even to its own historical levels. Currently, Duke is trading at 17 times forward 12-month consensus price-to-earnings ((PE)) ratio, within its typical range of 15 to 20 times earnings over the past five years.

Moreover, when compared to the S&P 500, Duke is trading at a 7% discount. Historically, the company has traded at a range between a 30% discount and a 30% premium relative to the S&P 500. Given this context, we believe that if Duke can achieve the consensus EPS, the stock represents an attractive valuation for investors.

Conclusion

Duke Energy's substantial capital expenditure plan, combined with its operations in favorable regulatory jurisdictions, should drive rate base and earnings growth in the coming years. We believe that Duke can achieve the upper half of management's 5%-7% earnings growth target, positioning the company for success in the clean energy transition. However, investors should not ignore the challenges, including regulatory risk, rising interest rates, and management credibility issues. Overall, Duke Energy presents an attractive valuation, given its focus on core regulated operations and investment in forward-looking energy technologies, but investors must weigh the potential risks and rewards carefully before making a decision.

For further details see: