Behind the NumbersEarnings quality is perhaps the biggest question for many watchers of Duke. Almost without exception after last month's second-quarter earnings report, analysts immediately noted that Duke needed padding from one-time gains to meet its targets. But some were harsher than others. Particularly bearish were two J.P. Morgan analysts, who labeled their post earnings-conference report "Missed Opportunity." They chided Duke for fueling, rather than addressing, nagging issues that could affect the company's share price. They singled out Duke's new mark-to-market assumptions, which resulted in a $46 million gain. "Comments by management on the 2Q conference call and actions taken during the quarter have raised additional concerns and, in fact, confirmed some of our fears about what might be lurking in 'left field,'" wrote analysts Jim von Riesemann and Jamie Waters, who rate the stock a market performer. "We would highly discount any 'earnings' associated with these changes in model assumptions, similar to our view of earnings from asset sales." They weren't alone. Analysts at Merrill Lynch joined the chorus, questioning a second-quarter accounting gain that comes even as many peers are reducing their trading expectations. "While this does not sound unreasonable per se," they wrote, "it is worth noting that the Q2 changes come on top of $36 million of similar gains included in the Q1 results. While we recognize that the process of improving valuation assumptions may have taken some time, it would certainly be preferable not to have further significant gains at this line in coming quarters." Merrill Lynch rates the stock near-term neutral and long-term strong buy; both Merrill and J.P. Morgan have underwritten for Duke. Duke spokesman Terry Francisco said much of the mark-to-market gain came after the company streamlined separate models used at its two domestic trading headquarters. "We have a very extensive Western trading operation headquartered in Salt Lake City and an Eastern trading operation headquartered in Houston," Francisco said. "We changed our modeling technique to report both East and West together."
Quality and EarningsUnlike most companies, Duke has always included one-time gains -- and, to be fair, one-time charges -- in its regular reported earnings. The company considers buying and selling assets, such as power plants, a routine part of its business. "It fits into our portfolio management strategy," Francisco said. "It's analogous to real estate. Everything's for sale at the right price."
Duke bouncing back
But some critics have scoffed at the practice, saying a company can sell only so many assets before it eventually runs out. Therefore, they added, proceeds from asset sales should not be mixed with the steady stream of earnings that flows from ongoing operations. In Duke's second quarter, that mixture proved instrumental to hitting earnings targets. The company racked up a net gain of 4 cents a share through asset sales and a one-time construction fee. Mark-to-market "improvements" added another 3 cents a share, allowing Duke to post second-quarter earnings of 56 cents a share -- topping analyst expectations by a nickel instead of missing by 2 cents. Even the company's operational income, particularly from trading, can be difficult to evaluate. Unlike some of its peers, Duke withholds specific information about the gross margins it earns from power and gas trading. "In today's environment, we look hard at what we disclose and what we don't disclose," Francisco explained. "We choose not to disclose that for competitive reasons."