The Value Line Investment Survey

Duke Energy is one of the largest companies in the electric utility industry. The past several years have been very eventful for the company. Duke has been involved in some significant transactions and recovered from the 2001-2002 collapse in the power markets. The stock is attractive for income-oriented investors.

Transforming Transactions

Duke’s first significant deal occurred in 1997, when Duke Power, which was then an electric company, entered the midstream gas business through its acquisition of PanEnergy. The renamed Duke Energy furthered its investments in the midstream gas business by acquiring Westcoast Energy, a Canadian company, in 2002. The company’s next major deal was the purchase of Cinergy, which had utility operations in Ohio, Indiana, and Kentucky, in 2006. Later that year, Duke decided to spin off its midstream gas operations to create a pure-play company, Spectra Energy (NYSE: SE). The spinoff took place in January 2007. Along the way, Duke executed numerous asset purchases and sales, along with a couple of joint ventures (including one involving its Crescent real estate operation).

A Fall, Then a Rise

Duke, like every company that had a large presence in the power-marketing sector, was hurt considerably by the collapse that occurred during the 2001- 2002 period. Besides its energy marketing and trading activities, the company also had a large position in nonregulated power generation. Virtually all of this generation was gas-fired, so these plants became unprofitable after natural gas prices soared. Share earnings fell 43% in 2002, and the company didn’t even earn its dividend the following year. The stock price plummeted accordingly.

Duke wound up writing down many of these assets and selling them at sizable losses. Management used the proceeds to reduce debt, helping to repair the balance sheet. Although earnings never returned to the record level of 2001 (nearly $2 billion), they made a partial recovery in 2004 and improved in 2005. By 2005, the share price had rebounded enough for Duke to use its stock as currency to buy Cinergy.

A Nice Mix

The spinoff of Spectra Energy essentially made Duke Energy a new entity. Duke’s current mix of assets provides an earnings split that is 75%-85% regulated and 15%-25% nonregulated. The utility business in the Carolinas remains traditionally regulated. Electric businesses acquired from Cinergy are regulated in Indiana and partially regulated in Ohio. Duke retained former Cinergy natural gas distribution operations in Ohio and Kentucky, which offered a much better fit with legacy operations than those now a part of Spectra. On the nonregulated side, Duke still owns some generating assets in the Midwest, a 49% stake in Crescent, and some international operations.

Investment Advice

Since Duke Energy spun off Spectra a little over a year ago, neither equity has performed particularly well, both having succumbed to a weak broader stock market. Duke in its current form has not been trading long enough for us to determine a Timeliness rank. The company is financially strong, and its stock offers a yield of just under 5%, which is roughly one percentage point above the electric utility industry average. The board of directors boosted the quarterly dividend by one cent a share, or 4.8%, last year, and we project similar dividend advances over the next 3 to 5 years. This, in our view, makes the stock appealing for income-oriented investors.

Paul E. Debbas, CFA
Senior Industry Analyst