Why Investors Don't Need to Bet on This Risky Utility

At first glance, a utility stock with a 4.3% dividend yield and a significantly discounted valuation might seem like a sure thing. That's exactly the case for Exelon , but we should discuss whether the stock is a true bargain, or if it's cheap for a reason.

While Exelon may look attractive, in relation to its peers, many of its core metrics are going in the wrong direction. This leads me to the view that other utilities, such as American Electric Power and Consolidated Edison should receive preference from utility investors.

Is Exelon the value it appears to be?
It's true that Exelon offers a cheaper valuation than most of its peers, and investors may initially favor Exelon because of that. Specifically, Exelon trades for 11 times the midpoint of its full-year 2013 earnings guidance. By contrast, American Electric Power and Consolidated Edison exchange hands for 14 and 15 times their own 2013 earnings expectations, respectively.

However, it appears Exelon is cheaper for a reason. Exelon is the largest owner and operator of nuclear plants in the United States, and throughout the year Exelon's nuclear operations have been fairly volatile.

It's important to give credit where it's due, and in the most-recent quarter, Exelon did show progress in its nuclear segment. The company realized increased nuclear volume in the quarter, thanks to improved capacity. At the same time, lower realized market prices, and higher nuclear fuel costs, served as an anchor on overall performance. As a result, Exelon managed just 1% growth in adjusted (non-GAAP) operating earnings per share in the third quarter. While that figure does represent improvement, it's hardly cause for celebration.

Looking further back, the trend is less encouraging. Despite the improvements made in the third quarter, I'm still reluctant to give the all-clear signal on Exelon. Exelon posted a net loss in the first quarter, and then followed up with 13% lower profits in its second quarter, year over year. This lack of consistency is why Exelon sports a lower earnings multiple than other utilities.

Furthermore, the earnings multiple isn't the only consideration when evaluating utility stocks. Obviously, utility investors place great emphasis on dividends, which is a major reason why investors own utilities in the first place. And, on that front, Exelon simply can't be trusted to the extent of its peers. Recall that Exelon froze its dividend for four years, from November 2008 through February 2013, and then slashed its payout by 41% earlier this year, due to deteriorating business conditions.

This stands in stark contrast to the dividend track records maintained by American Electric Power and Consolidated Edison. American Electric Power just increased its dividend for the second time this year and has paid a dividend every quarter since 1910. Meanwhile, Consolidated Edison has increased its dividend every year for 39 years in a row. Plus, from a current yield perspective, you really aren't being compensated for Exelon's operating uncertainty. Both American Electric Power and Consolidated Edison yield 4.3%, just as much as Exelon does after its previously mentioned dividend cut.

Foolish bottom line
Exelon is a true turnaround play within the utility space, and because of that, it may have higher upside should the company realize a turnaround. At the same time, I'd guess that utility investors aren't in the space to speculate; instead, my assumption is that utility investors prefer stable results that provide peace of mind.

Most utility investors likely prefer to see consistency and reliability, and for those reasons, I continue to favor better-run utilities such as American Electric Power and Consolidated Edison. While Exelon may see its stock price recover, that's far from a certainty. If stable results and dependable dividend payments are what you're after from utility stocks, there's no need to gamble on an Exelon turnaround.

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The article Why Investors Don't Need to Bet on This Risky Utility originally appeared on Fool.com.

Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Exelon. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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