Generating Growth

Exelon is the largest merchant nuclear generator in the U.S., and it saw massive margin expansion in FY '07 from a transition to market rates in Illinois.

Over the '07-'10 period, EXC has some leverage to rising power and capacity prices, an assumed "reversion to the mean" on the ROE at [its unit] Commonwealth Edison, ComEd, and a modest level of annual share repurchases. This is offset in the short run by some cost escalation.

However, upside in 2011 from the roll-off of below market hedges in Pennsylvania followed by our presumption of the EPS impact from implementation of carbon caps in 2012, drives a materially higher earnings power estimate, potentially $8.00 share in 2012.

Outlook for Public Service Enterprise Group (PEG): We are raising our target price from $92 per share to $104 per share. The increase stems from higher near-term earnings per share estimates, as well as a higher open EBITDA analysis valuation given a better valuation for PEG and an increase in our long-term gas price assumption from $7.00/million BTU from $7.50 and a higher carbon value, given our views on emerging legislation.

We believe a handful of near-term catalysts will be positive for PEG, including (1) the Reliability Pricing Model (RPM) capacity auction, (2) the Basic Generation Service (BGS) auction and (3) the company's analyst day. We expect that all three will highlight a favorable supply/demand backdrop for PEG, the need for more infrastructure investment, the improving balance sheet and a more strategically focused story.

We note that our estimates are highly sensitive to our assumption about the price of power and our long-term natural gas price assumption. We currently assume that open energy positions are sold at a roughly 5 percent discount to forward power curves. A removal of this discount would increase our estimates by about 3 percent to 5 percent.

The stimulating impact of higher capacity pricing has driven PEG to announce its intention to build up to 400 megawatts of new gas-fired peaking capacity at a cost of up to about $350 million.

The company is currently conducting a feasibility study of the project under the auspices of PJM [Interconnection LLC]. We expect PJM to approve the project in early '08, construction to start in late '08 and [the peaking power plants or] "peakers" to be online by '10. We assume that these peakers will be eligible for capacity payments starting in '11.

If all of this capacity was successfully bid into the RPM capacity auction, we estimate it could add about $0.05 to $0.10 to EPS on a fiscal year basis. We note that the roughly $350 million cost is incremental to the company's latest capex forecast and that PEG is considering adding up to some 1,000 megawatts of gas-fired peaking capacity over the longer term.