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Electric Utilities: Constructive outcome in Illinois power auction; Subject: Industry Overview
o Auction manager declares pricing and winning bidders Late last Friday, the auction manager overseeing the first Illinois power supply auction released the pricing and names of winning bidders for the fixed price portion of the auction. Pricing fell in the $63/MWh-$64/MWh range for ComEd's residential and small commercial customers, and $64/MWh-$66/Wh for Ameren's Illinois utilities. This translates to average rate increases of 22% for ComEd customers and 40%-55% for Ameren customers. Winning bidders in the auction included non-regulated subsidiaries of Ameren, American Electric Power, Centrica, Constellation Energy, DTE, Dynegy, Edison International, Exelon, FPL, Pepco Holdings, PPL, Sempra, and WPS, as well as financial players J. Aron, J. P. Morgan, and Morgan Stanley. The actual amount each bidder has won will not be disclosed at this stage. Auction pricing in line with our expectations The auction results solidly support our expectations. For Exelon, we were projecting a full requirements auction price in the $60/MWh-$65MWh range and a $45/MWh around-the-clock (ATC) price, which is *****ded in our 2007E of $4.75.
ATC is most relevant for EXC given its baseload nuclear assets and limitations on the amount that any single bidder could sell into the auctions. ATC prices were in the $48/MWh range going into the auction, which is generally supportive of our 2007 outlook, and should be sufficient to offset the disappointing outcome of ComEd's delivery rate case. For Ameren, our 2007E includes a $65/MWh auction price. AEE's non-regulated generation is configured to serve full requirements load, so the auction price is more relevant in this case. Edison International was a seller in the auction, and had also been actively hedging out its Midwest generation units in the preceding period leading up to the auction. Political overhang remains; phase-in plans being offered There is still some political risk that the legislature could seek to reopen the auction issue during its veto session in November. Exelon and Ameren have each proposed plans to phase in higher rates over time. Ameren is also expecting an ALJ decision on its Illinois T&D rate cases on October 4. In light of the political overhang, we would expect the companies to remain somewhat silent on the auction outcome for the time being. That said, Exelon has scheduled a conference call for Thursday, September 21 at 10:30 AM EST to discuss auction results, as well as the termination of EXC's merger with PSEG. Hourly price auction under investigation Last week, the Illinois Commerce Commission (ICC) announced it would investigate the hourly-price auction for large industrial customers. This will leave some lingering uncertainty, although we note that the hourly price auction is a relatively small component of the overall process.
Price Objective Basis & Risk
Edison InternationalOur price objective of $46 is based on a sum-of-the-parts valuation incorporating the utility at 14.5x 2007E (in line with comparable regulated peers); Edison Capital at 10x 2007E plus $450M of surplus cash; and parent/other drag valued at 8.0x 2007E. For the MEHC merchant business our valuation is based on a blended enterprise value of $1,040/kW reflecting its mainly coal-fired generation assets. Implied EV/EBITDA for MEHC at our target is 7.6x (2007E), which is a discount to major traded IPP comparables. Risks to our price objective are significant natural gas price and commodity downside in the merchant business; failure to execute on the utility's rate base growth strategy and valuation downside in the broader utility group.Exelon Corp.Our price objective of $64 for EXC looks forward to 2007 earnings potential in the $4.75 range and applies a P/E multiple of 13.5x (modest discount to average forward utility multiple). We believe this range of earnings potential is relatively conservative given current forward commodity prices and assuming a transition to the proposed auction-based utility procurement in Illinois. Likewise, we believe a discount remains appropriate given the commodity earnings component and remaining political risks around the Illinois auction process. Risks to our target are nuclear operations; outcomes of new rate plans in Illinois and Pennsylvania; and longer-term earnings sensitivity to commodity pricing.
Brian (F.K.A. Crazy)
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