Duke Energy’s Upside/Downside Scenarios For $25 Fair Value

Duke Energy (NYSE:DUK) derives most of its value through its U.S. Franchised Electric & Gas business that accounts for nearly 84% of our $25 price estimate for the company’s stock. It reported sound growth in domestic customer addition in its recently announced Q1 results. Additionally, it also benefited from increasing electricity tariff especially in Carolinas. A noteworthy emerging trend in the US power generation market is shift towards natural gas power generation and that has potential for margin improvements.

The company provides electricity and natural gas distribution services in the US. Among its other businesses, its commercial and international businesses own and operate diverse power generation assets in North America and Latin America, including a portfolio of renewable energy assets.

See out full analysis of the Duke Energy

Here, we highlight 3 of the most important drivers for Duke Energy’s stock and the upside/downside potential.

1. Revenue per MWh: Duke Energy generated $76 in revenues per MWh sold in the US in 2011.
2. Number of Customers: Duke Energy served just above 4 million domestic customers in 2011 and in the past between 2005 and 2007, Duke’s customer base increased drastically from 2.2 million to nearly 4 million.
3. US Franchised Electric & Gas EBITDA Margin: The margins have hovered between 38% and 44% between 2008 and 2011. This is attributable to wildly fluctuating commodity prices.

18% Upside Scenario | $29 Trefis Price Estimate

1. Higher Revenue per MWh (+5%):

Since 2000, average US electricity rates have increased at 2.5% annually. The Carolinas have seen a price increase during the Q1 2012 and other states will also see higher tariffs in near future on account of rising demand and expected rise in commodity prices. We see an upside of 5% to our current price estimate as revenues per MWh to increase to nearly $100 by 2019.

2. Growth in Customer addition (+8%):

The EIA, in its Annual Energy Outlook 2011, has estimated that between 2008 and 2035, the total electricity demand will increase by around 30% but the production capacity by around 20%. We expect residential electricity demand to pick up on improving economy. We see a 8% upside to our price estimate as total customers reach nearly 5 million by the end of Trefis forecast period in 2019.

3. Margins to Improve (+2%):

Power generation companies are trashing many of their coal fired plants and switching to natural gas because natural gas is environmentally friendly as well as cheaper. The shale gas boom in the US has caused natural gas prices to plummet and it does not look like recovering soon. Accessibility to abundant and cheaper natural gas is expected to improve the company’s margin. Moreover, increases in electricity prices and economies of scale due to the large scale of their operations as it expands its business would improve margins. There could be an upside of 3% to the Trefis price estimate if the company is successful in realizing improved margins and its margin reach 46.7% by the end of Trefis forecast period in 2019.

13% Downside Scenario | $23 Trefis Price Estimate

1. Number of customer remains flat (-5%):

There are other players like The Southern Company (NYSE:SO), NextEra Energy (NYSE:NEE) and PPL Corporation (NYSE:PPL) and the competition will get intense as the business becomes more lucrative because of better margins at offer. Duke Energy has a threat of losing some of its potential market in the form of customers. We believe if customer additions slow down for and Duke give in to its competitors, it will have nearly 4 million customers by the end of 2019. There is a downside of 9% to this scenario.

2. Margins fall lower than current expectations (-5%):

The price of fossil fuels such as natural gas, coal and crude oil, which are the key inputs for electricity generation, is volatile. If the prices are unfavorable for Duke, it is likely to increase the cost of energy production in the future and might not be able to pass it to customers due to regulatory issues. If the margins fall by nearly 2% to our current estimates, there will be nearly 5% downside to our price estimate.

Understand How a Company’s Products Impact its Stock Price at Trefis