Fools know the value of a stock split: zero. It's a non-event. Instead of a $20 bill in your wallet, you now have two $10 bills. So if they mean nothing, why do them? There are a few reasons, none of which has anything to do with whether the stock is a good investment. Here are the usual ones:
To make the stock look cheap.
To increase liquidity.
To meet stock-exchange listing requirements.
To express a bullish management sentiment.
Sometimes, though, and usually for reasons not so good, companies effect a reverse stock split, reducing the number of shares outstanding and boosting the value of those that remain. Companies in financial trouble or needing to regain stock exchange compliance (or both!) effect reverse splits.
Utility operator Duke Energy (NYS: DUK) recently did a one-to-three reverse stock split as part of its acquisition of Progress Energy. Its charter only allowed for 2 billion shares to be issued, and prior to the merger it had 1.3 billion shares outstanding. As part of the agreement with Progress, though, it had to issue 750 million more shares, taking it over the number allowed by its charter. The reverse split reduced the total pool of stock without affecting the company's operations.
Going in reverse
Just as we'd never advocated blindly buying into any split, we don't recommend automatically selling a reverse split, either -- you still need to do some research. But let's use the announcement as a jumping off point to start the process of determining whether its shares will be three times as good at triple the price.
Despite the logic behind the reverse split, it doesn't mean Duke is a good investment. Chairman and CEO Jim Rogers staged a palace coup within hours of completing its merger. The board fired the man who was supposed to have become CEO of the combined company, installing instead Rogers, who was supposed to give up his CEO position and become executive chairman. Now Rogers will now have both titles. Two directors from the old Progress board ended up resigning as a result, raising questions about Duke's corporate governance, which also led Standard & Poor's to downgrade the utility because of its lack of transparency and the likelihood of increased regulatory scrutiny.
Long gone are the days where utilities were sleepy investments for widows and children. Now, as Duke has shown, they can be every bit as exciting as penny stocks and just as dangerous.
Canary in a coal mine
Utilities are under the gun by regulators to clean up their act, which is why we're seeing more coal-fired plants shuttered in favor of natural-gas-fired ones. Duke is accelerating the closure of two coal-fired plants; Alliant's (NYS: LNT) Wisconsin utility is closing three without a plan in place on how it will replace the energy produced, and according to the EIA, almost 27 gigawatts of coal-fired electric generation capacity will be retired by 2016.
The Fool's Keith Speights writes American Electric Power (NYS: AEP) generates almost a quarter of its power from natural gas and wants to increase that percentage further, while Exelon (NYS: EXC) plans to have natural gas account for more than two-thirds of its power generation in the coming years. Its obvious coal isn't where you want to be investing these days.
Price is what you pay
The utilities need the lower cost inputs natural gas currently provides. The mild weather over this past winter and spring caused demand for power generation to plummet. Southern Co. (NYS: SO) saw sales drop 3% as a result of reduced demand, though one would have to imagine the scorching summer will have everyone cranking their A/C.
At 20 times earnings and 15 times estimates, Duke is valued like peers Southern and Alliant, but add in its growth prospects and the utility in turmoil carries a high price tag. Having promised regulators for the past few years that Progress Energy's Bill Johnson would be running the company, only to perform a bait-and-switch after the fact, doesn't bode well for it getting the necessary rating support from the state regulators when price hikes come up for review. Investors should also question whether they want to put their money in a company that would act that way.
I'm rating Duke to underperform the market on CAPS because they've kneecapped themselves for some time to come, though Loonhaunt21 thinks the creation of a "mega-utility" will smooth out those rough edges.
Investors remain bullish about Duke with 95% of the 1,932 CAPS members rating the utility to beat the Street, but tell me in the comments section below or on the Duke Energy CAPS page if coup d'etat raises questions in your mind about its commitment to good governance.
Split the difference
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The article Is Duke 3 Times as Good at Triple the Price? originally appeared on Fool.com.
Fool contributor Rich Duprey holds no position in any company mentioned. Click here to see his holdings and a short bio. Motley Fool newsletter services have recommended buying shares of Exelon and Southern. Motley Fool newsletter services have recommended creating a write covered straddle position in Exelon. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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