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What's Going on With Exelon?

Stocks in this article: EXC CAT SO CVX

People with older maturing bonds, like my friend at the fitness center who asked me Wednesday how he can replace the income from a municipal bond he's owned that paid him 4% tax-free, are stymied. That's why I decided to write this article, because EXC is one of the few major utilities that isn't overpriced at the present time.

With generous dividend-paying energy companies like Chevron (CVX) hitting new 52-week highs and their yield-to-price falling to 3.09%, I thought it was time to find an undervalued company that was paying close to 6%. Exelon fits that description completely.

There are things about EXC that do concern me. Due to its aggressive mergers and acquisitions, it has compiled an uncomfortable total debt load of $19.45 billion, as of its most recent quarter ending June 30. This gives it a total debt-to-equity ratio of over 87. A high debt-to-equity ratio usually is indicative that a company like EXC has been aggressive in financing its growth with debt. No doubt that's a fact.

The risk with growth by increasing debt is that it can result in unstable earnings. EXC saw its most recent quarterly earnings (year-over-year) drop by nearly 54%, partially as a result of additional debt service costs and interest expense.

This is also why its dividend payout ratio is a high 87%. If it doesn't substantially increase revenue and earnings this payout ratio would be difficult to sustain and could force a dividend reduction. That may already be baked into the current price.

Savvy investors know the cost of massive debt financing may outweigh the return that the company generates on the acquisitions and mergers. In Exelon's case, its utilities plus the addition of Constellation Energy's revenue should more than offset that concern.

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