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Market Price (8/9/2016): $35.21/share; ST-Target: $46/share; NIV: $72/share
It seems that EXC is setting up for Generation optionality
We think we finally see EXC’s endgame: Creating optionality for its Generation business (GenCo). Until then, EXC plans to use GenCo as an ATM to fund utility growth that would power CAGR in AEPS of some 7%-9% through 2020, while dividend grows only at a 2.5% CAGR. This enables the six utilities (Utilities) combined dividend payout to go from almost 100% to about 77%. This gap makes it possible for Utilities to self-fund equity for future growth projects beyond 2020, largely negating need for GenCo ATM. This then gives EXC optionality with GenCo, in our opinion. Key to this strategy is to ensure GenCo cash flow, which in turn drives need for very high levels of hedging well in advance. This sacrifices upside potential and sub-optimizes GenCo, but enables EXC to execute on its LT vision. This strategy changes who EXC pursues next, which we thought would be another hybrid. Instead, it may pursue more pure utilities. Still we’d like EXC to buy nuclear, gas and renewable generation, while cheap, so we applaud acquisition of Fitzpatrick nuclear plant in NY. Regardless, we like EXC’s plans for the Utilities and believe it will eventually help drive valuation to the upside, but we reluctantly support its strategy for GenCo, given Utilities need for equity funding. We maintain our $72/share NIV and $46/share ST-Target.