DUKB - Duke Energy's Q1 Earnings: A Mixed Bag For Investors

2023-05-23 16:00:00 ET

Summary

• Despite a Q1 earnings miss, Duke Energy has maintained its 2023 guidance, suggesting confidence in future profitability.
• The imminent sale of the Commercial Renewables business and outcomes in regulatory cases are poised to drive performance through the year's end.
• Duke's credit metrics are expected to improve, supported by the proceeds from the CR sale and fuel recovery, positioning the company favorably for long-term debt targets.

In the past month, we delved into the challenges and prospects of Duke Energy ( DUK ) as it makes its way through the transition to renewable energy. Following that piece, the company has released its Q1 earnings . A number of significant insights have emerged from this report, prompting us to revisit and expand upon our previous discussion in this follow-up article.

In this article, we explore Duke Energy's Q1 earnings report, which, despite a miss on the estimates, paints a complex but potentially promising picture for the company's future. As the energy sector navigates the challenges and opportunities of a renewable transition, Duke's earnings offer valuable insights into its strategic responses and prospects. We assess key financial developments, including the reaffirmed 2023 EPS guidance, the proposed sale of the Commercial Renewables ((CR)) business, and the management's approach to regulatory issues. Our analysis aims to unravel the implications of these factors for investors, shedding light on Duke's potential as a player in the energy transition era.

Earnings Takeaway

The Q1 report from Duke Energy brought forward a number of notable points that necessitate a closer look. Despite missing Q1 estimates by $0.07, coming in at $1.20, the company upheld its 2023 guidance, forecasting $5.55-$5.75 earnings per share ((EPS)) and a solid 5-7% EPS growth. This suggests DUK's confidence in its future profitability.

A significant move was the additional $175M impairment at its Commercial Renewables ((CR)) business. While this might be seen as concerning, the management has stated that this impairment still falls within their planning assumptions. Furthermore, the anticipated sale of the CR business is reportedly nearing its final stages, which could offset some of this impairment. We maintain our estimation that this sale will result in a $0.05-$0.15 dilution.

The proposed sale of the Commercial Renewables business and favorable outcomes in DUK's Duke Energy Progress ((DEP)) and Duke Energy Carolinas (DEC) cases are seen as the primary drivers of performance through the end of the year. We estimate the sale of the CR business, which includes ~5.1 GW of wind and solar operation, could generate $3-3.5 billion in cash proceeds. These proceeds are likely to help avoid future debt issuance at the holding company level.

DUK expects its credit metrics to improve by 50-75 bps by the end of 2023, driven by the proceeds from the CR sale and fuel recovery. We believe this projection makes sense. Additionally, as DUK progresses through its inaugural Multi-Year Rate Plans (MYRPs) in North Carolina and recovers an additional $1,600mm of deferred fuel in 2024, we see its consolidated credit metrics approaching its long-term FFO/Debt target of around 14%.

North Carolina's Carbon Plan has also featured in DUK's recent undertakings. The company filed for 2023 solar procurement earlier this year, with a decision expected by the end of 2023. Furthermore, an updated Carbon Plan and Integrated Resource Plan (IRP) are set to be filed by September 1st with a decision expected by year-end 2024.

There have also been key developments on the regulatory front. Duke reached a partial Settlement Agreement that includes key provisions related to capital projects, prudence of plant-related investments, depreciation rates, and Performance Incentive Mechanisms (PIMs), among others. However, important issues, including the return on equity (ROE) and capitalization structure, recovery of deferred costs resulting from the COVID-19 pandemic, and treatment of certain regulatory asset/liability amortizations remain unresolved.

The recent issuance of $1.5B aggregate principal amount of 4.125% convertible senior notes due 2026 could lead to an annualized EPS dilution of $0.05-$0.10, by our calculation. While it's not a massive concern, it could amount to ~1% of estimated 2027 EPS if Duke delivers the midpoint of its long-term 5-7% EPS growth forecast.

DUK has been active on multiple fronts, taking decisive actions to improve its financial position and align its operations with evolving regulatory and market conditions. This dynamic approach reaffirms our confidence in the company's strategic direction and potential for future growth.

Financial & Valuation

Note: All historical data in this section comes from the company's 10-K filings, and all consensus numbers come from FactSet.

Our review of DUK's latest earnings paints a rather mixed picture for potential investors. The Q1 earnings announced on 05/09/2023 resulted in a marginal stock decline of 0.9%. On a positive note, DUK beat revenue consensus estimates by a significant 10.9%, achieving growth of 2.0% y/y to $7,276 million. Its operating margin of 24.2% showed improvement from the previous year's 19.8%, and the gross margin remained strong at 69.4%. However, the EPS of $1.20 missed the consensus by 4.5% and declined 8% y/y, which raises questions about profitability.

Analyzing DUK's financial trends, we're pleased with the firm's stable revenue growth, with a CAGR of 4.7% over the past three years. However, the sell-side consensus forecasting only 0.8% revenue growth this fiscal year, far below the historical trend, is cause for concern. Additionally, the EPS CAGR of 1.4% over the past three fiscal years, lagging revenue growth, suggests potential inefficiencies in capital allocation or cost management.

The FCF margin trend is worrisome, with the consensus estimating a margin of just 1.0% this fiscal year, in stark contrast to the 3.8% from four fiscal years ago. With an average FCF margin of -2.9% over the past four fiscal years, DUK's ability to generate sufficient free cash flow remains questionable. This uncertainty is further exacerbated by DUK's substantial capex as a percentage of revenue, averaging 40.9% over the same period, indicating very high capital intensity. However, we would note that utilities as a group are poor free cash flow generators given constant capex-heavy projects.

DUK's ROIC of 3.4% demonstrates a rather poor return, and the company's stock performance over the past year has been dismal, underperforming the S&P 500 by a whopping 21% points, which equates to a -11.6% absolute return. In addition, with the stock trading 7.0% below its 200-day moving average and 19% below its 52-week high of $114.50, investor sentiment towards DUK seems bearish.

Its low short interest of 1.0% suggests a lack of speculative pressure. This may be due to its attractive current dividend yield is 4.3%, a significant 280 bps above the S&P 500. This might be seen as a compensatory factor for the company's underperformance.

In terms of valuation, DUK's FY2 PEG ratio is considerably higher than the S&P 500's, at 3.2 versus 1.6, representing a premium of 102.6%. This reflects the certainty of DUK's growth potential given that it is a regulated monopoly. Moreover, the stock is trading at a forward 12-month P/E of 16.0, which is below its 5-year mean of 17.7 but still within its 2-standard deviation range of 15.2 to 20.2, suggesting a medium valuation. However, compared to its peers - NEE, SO, and D, trading at forward 12-month P/E ratios of 23.1, 18.9, and 13.6, respectively - DUK seems fairly priced.

Given the above analysis, our view on DUK's current standing is moderately pessimistic. While it has demonstrated revenue growth and margin expansion, its EPS decline, underperformance relative to the S&P 500, and issues surrounding free cash flow generation cast a shadow over its investment appeal. Investors need to consider these factors in light of their risk appetite and investment horizon.

Conclusion

In sum, Duke Energy's Q1 report presents a mixture of challenges and opportunities. While the company fell short of Q1 earnings estimates, it remains steadfast in its future EPS guidance, indicating an optimistic outlook for profitability. Moreover, strategic actions such as the impending CR sale and progress on regulatory fronts underline the company's adaptability amidst evolving market conditions.

Yet, it's important for investors to tread with caution. While Duke's strategic moves bode well for its future, unresolved regulatory issues, potential EPS dilution from the convertible notes issuance, and concerns about free cash flow generation may pose risks. As Duke continues its journey through the renewable transition, its ability to effectively navigate these challenges will be key to realizing its growth potential. The company's progress warrants close monitoring in the coming quarters as it offers a compelling study of an energy giant's adaptation to a rapidly changing landscape.

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