PPL Corporation [NYSE: PPL]
Recommendation:
Last Price:
1 yr. Price Target:
Implied Upside:
Total 1 yr. Return:
Sell
$28.57
$30.59
7.1%
12.1%
The Ohio State University
SIM Fund
Analyst:
Geno Frissora
Phone:
614-270-2807
Email: frissora.25@osu.edu
Utilities | Electric Utilities | February 31, 2012
Presentation
PPL Corporation acts as a holding company that generates and
sells electricity and delivers natural gas mostly from the
northeastern to northwestern United States. It is the 9th largest
electrical utility by market cap (February 22, 2012). PPL has
grown dramatically over the years helped by many acquisitions.
The Utility Sector as a whole has experienced a major period of
consolidation over the last century and PPL has been a big part
of this secular trend.
Currently PPL faces a period of heavy regulation and high capital
expenditures in order to get their aging power generation
facilities up to date and more environmentally friendly to
accommodate the ever changing regulatory environment.
Investment Thesis
When I began this report I thought PPL was a buy based on price and some valuation metrics.
However, after further analysis it appears PPL Corp. is a bit of a value trap. The company has
experienced serious share dilution from acquisitions and faces high capital expenditures over the
coming years, in order to update an older power generation fleet. I believe in the long term
prospects of the company but think the lack of free cash flow over the next few years could be
problematic and therefore represents a risk to the stock.
PPL has underperformed other utility companies recently and I believe this will continue. An
ambitious but conservative discounted cash flow analysis shows that PPL stock has an intrinsic
value of $30.59. This would offer an implied upside of 7.1% or 12.1% including the annual
dividend with a one year holding period. I believe this is a limited upside and there are better
opportunities currently being offered by the market so I therefore have a sell on PPL stock.
Price:
$28.57
1 yr Price Target:
$30.59
Beta:
0.32
52 wk Range:
$24.10-$30.37
Diluted Shares:
579,347,000
Avg. Vol (3m):
4,889,390
Market Cap:
$16.52B
P/E (ttm):
10.53
EPS (ttm):
$2.71
Div & Yield:
$1.44 (5.00%)
All data from 03/01/2012 close
PPL Corporation
February 21, 2012
Table of Contents
Company Overview
Business History
Stock Performance
Business Segments
Kentucky Regulated
International Regulated
Pennsylvania Regulated
Supply
Segment Summary
Business Environment
Regulation
Competition
Market Share & Growth
Current Positives
LGE & KU Acquisition
UK Midlands Acquisition
Pennsylvania Removal of Rate Caps
Current Negatives
High Capital Expenditures
LGE & KU Acquisition
UK Midlands Acquisition
Earnings Dilution
Departure of CEO
Projections
Income Statement Revenue Projections
Income Statement Expense Projections
Investment Thesis
Fundamental Environment
Financial Analysis
Multiple Analysis
Technical Analysis
Discounted Cash Flows
Risks & Concerns
Risks to Company
Conclusion
Recommendation
Appendix
Exhibit 1: PPL Discounted Cash Flows
Exhibit 2: Projected Income Statement
Exhibit 3: Projected Growth Rates
Exhibit 4: Dupont and Ratio Analysis
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2|Page
PPL Corporation
February 21, 2012
Company Overview
Business History
PPL was founded in 1920 when eight utilities serving central eastern
Pennsylvania merged to form Pennsylvania Power & Light Company
headquartered in Allentown, Pennsylvania. PPL expanded its system
fairly quickly by acquiring 62 companies between 1928 and 1938. Additionally, the company
purchased stock in 12 other companies between 1928 and 1930, all of which were fully integrated
by 1938. By the 1930’s PPL is the largest single user of Anthracite coal and adds natural gas to its
lines of business. In the early 1970’s PPL announced it would build its first nuclear power plant.
But do to problems with many of the early reactors in the U.S. it took PPL until 1983 before the
plant was opened. The 1990’s brought an era of more consolidation and deregulation. PPL forms
Power Markets Development Company, later named PPL Global, to enter the worldwide
unregulated market, investing in power projects domestically and overseas.
In 1996, PPL Global buys a 25% stake in a regional British electric company named South Western
Electricity. In 1997, PPL continues its vertical integration by beginning to acquire mechanical
contracting and engineering companies. The company now generates, distributes, and services
the utility market. By 1999 PPL Global increases its British presence, now owning 50% of South
Western Electricity known currently as Western Power Distribution (WPD). The company
diversifies across the United States as well, acquiring 13 Montana power generation plants. In
2000, PPL expands its UK operations by acquiring South Wales Electricity. In 2010, PPL acquires
Kentucky’s two major utilities Louisville Gas and Electric Company and Kentucky Utilities
Company providing entrance into the Kentucky regulated market. On April 1, 2011 PPL acquires
Central Networks, known as the UK Midlands, electric distribution business in central England
expanding its European presence and making it a dominant provider in the UK.
Stock Performance
PPL stock has performed really
well through the 2000’s
peaking at $54.07 in January of
2008. But the stock fell hard
during the financial crisis
hitting $29.33 by October. The
stock really hasn’t recovered
since this time and has been
trading in a range, shown in
Figure 1. This could be due to
the high amount of leverage
PPL has been operating with.
Total debt has increased by
Figure 1
PPL 10 Year Chart
_________________________________________________________________________________________________________________
PPL Company History - company website (pplweb.com)
3|Page
PPL Corporation
February 21, 2012
$11.425 billion since year end 2009,
representing an increase of 147% over
the last two years The chart to the right
shows Debt/EBITDA for PPL over the last
5 years with the current level of 4.639,
shown in Figure 2 The chart shows
clearly how the level of debt has
increased dramatically during this
period. Although this money was spent
to better the future growth opportunities
of PPL, I believe it has kept the stock in a
range since 2009.
Figure 2
PPL Debt/EBITDA
Business Segments
PPL operates in four main business segments: Kentucky Regulated, International Regulated,
Pennsylvania Regulated, and the Supply business.
Kentucky Regulated
The Kentucky Regulated segment operates in regulated electricity and natural gas delivery and
regulated electricity generation. These activities are done primarily through the subsidiary
Louisville Gas and Electric and Kentucky Utilities which was acquired on November 1, 2010. The
LGE & KU acquisition makes PPL a dominant provider of electricity in Kentucky’s regulated
market. The exposure to a new regulated market provides a new reliable stream of earnings with
a limited retun on equity due to regulatory price caps. This segment has 97% of its current
generating fleet running from coal The Kentucky Regulated segment is expected to have lower
earnings this year due to higher maintenance and operating costs and increased depreciation.
However, these costs are expected to be offset partially by increased margins
International Regulated
The International Regulated segment is composed of PPL’s UK regulated electricity delivery
business, named Western Power Distribution, which serves Southwest and Central England and
South Wales. PPL completed the acquisition of the WPD Midlands operations of the UK on April 1,
2011, expanding its International Regulated operations dramatically. Earnings from this segment
increased $0.34 per share year over year with only a portion of a year coming from the newly
acquired Midlands operation. This segment now has the largest customer base of all of PPL’s
regulated segments with 7.6 million customers. Growth in this area of the business has been
_________________________________________________________________________________________________________________
PPL Annual Reports - PPL company website (pplweb.com)
Bloomberg Terminal - PPL US Equity
Reuters - http://www.reuters.com/article/2011/09/16/us-utilities-ppl-kentuckyidUSTRE78F5KS20110916
PPL Corp. 2011 Earnings - PPL company website (pplweb.com)
4|Page
PPL Corporation
February 21, 2012
strong and should continue to be strong as the company capitalizes on its strong presence in this
region. Some risks to earnings in this area are increasing income taxes, less favorable currency
exchange rate, increasing operation and maintenance expenses, higher financing costs, and
increases in depreciation
Pennsylvania Regulated
The Pennsylvania Regulated segment is essentially the original PPL business composed of the
regulated electric delivery operations in Pennsylvania. Pennsylvanian regulators recently lifted
the cap on delivery rates in 2010 and this segment has experienced high earnings growth since
then. PPL’s January 2011 rate increases and a decrease in income taxes helped record earnings
growth of 33.5% year over year in the recent annual report The planned, optimistic increase in
rates over the coming years will offset some of the expected increases in depreciation, income
taxes, and operation and maintenance expenses. However, the increase in revenue is not expected
to cover all of these increased costs and earnings for this segment are therefore expected to
decline in 2012
Supply
The last segment of PPL’s operations is the Supply segment. This segment provides domestic
wholesale electricity generation and marketing. PPL essentially generates and sells the electricity
they produce to itself or other companies who deliver the electricity to consumers. This segment
expanded dramatically due to the deregulation instituted in the 1990’s. Its earnings declined by
$1.13 per share from 2010 to 2011 The main reason for this decline was lower energy margins
in the eastern US, higher coal prices, lower coal generation, and turbine outages at the
Susquehanna power plant These increased costs were offset somewhat by higher margins in
trading and marketing This segment shows some concerns going forward. If commodity costs
increase substantially this segment good see a good deal of margin compression which could
negatively affect earnings estimates. However PPL has decreased their exposure to this segment
as shown in Figure 3 and Figure 4 below.
Segment Summary
Figure 3
2010 Earnings by Segment
Supply
72%
Kentucky Regulated
Pennsylvania Regulated
Kentucky
Regulated
2%
Int'l
Regulated
17%
Figure 4
2011 Earnings by Segment
Int'l
Regulated
23%
Supply
50%
Penn.
Regulated
International Regulated
9%
Supply
Kentucky
Regulated
15%
Kentucky Regulated
International Regulated
Penn.
Regulated
12%
_________________________________________________________________________________________________________________
PPL Corp. 2011 Earnings - PPL company website (pplweb.com)
5|Page
PPL Corporation
February 21, 2012
Figure 5
All in all the segments are all pretty
2009 PPL Capacity and Production
strong.
PPL is moving towards the
regulated side with 70% of assets now
belonging to the regulated segments
This move will provide more geographic
diversification of earnings with less
exposure to commodity price fluctuations.
The Supply segment is the one that is
worrisome and could lead to lower
earnings estimates. However the company
is well hedged to avoid exposure to large
commodity
price
swings.
The
infrastructure and inputs for their energy
generation are fairly diversified, shown to
the right in Figure 5 This diversification
will continue to increase as the company updates power plants with more environmentally
friendly energy sources to meet regulatory guidelines and improve efficiency.
Business Environment
Regulation
The utility sector is a heavily regulated one. Some state regulatory agencies control the return on
equity of utility of power delivery companies through price caps. Any returns above this level
must be given to consumers in the form of rate savings. The fact that these rate changes need to
be evaluated by government agencies also makes it difficult for the company to change price to
keep up with volatility in fuel costs. However, in 2010 Pennsylvania rate caps were lifted and PPL
has begun raising rates. In order to cover current expansion and environmental updates PPL is
expecting to raise rates dramatically over the coming years which could be problematic because of
the need for government approval. Rates in UK operations are still tightly regulated, under
proposed review every 5 years, making it very difficult to mitigate volatility in fuel costs.
However, PPL does maintain a reasonably cheap and diverse mixture of power generation
sources.
On the positive side there is a program called the Environmental Cost Recovery (ECR) program
instituted by the federal government which helps utility companies recover some of the costs
associated with capital expenditures of power plant updates. Funds are provided in order to give
companies incentives to retire older coal fired power plants and update with more
environmentally friendly ones with a lighter carbon footprint. As mentioned before, 3 of the older
coal fired plants in the Kentucky Regulated segment are being retired and will be replaced by a
large new natural gas plant. Last year PPL was authorized $2.3 billion in ECR funds which will
help provide assistance for this project over the period 2012-2016 Although the recovery act
will help with the costs it is a requirement that projects using ECR funds have a limited ROE,
10.1% in this instance This is just one example of some of the tax benefits that utility
corporations receive due to the high level of capital expenditures needed to keep up with
environmental regulations in the industry.
_________________________________________________________________________________________________________________
Summary of PPL 10k - http://biz.yahoo.com/e/120228/ppl10-k.html?.tsrc=sprint?date=2090209022
6|Page
PPL Corporation
Competitive Advantages
February 21, 2012
Figure 6
PPL Service and Generation Areas
PPL has been a major producer and
transmitter of electricity in the northeast US
for years. PPL is vertically integrated and
generates its own power therefore low inputs
costs are definitely a competitive advantage.
As stated earlier, electric delivery is a low
margin business with ROE often capped by
regulatory agencies. PPL’s generation business
also offsets the low margin delivery business
by providing diversification of earnings. PPL
also has a temporary competitive advantage of
having a fleet of old, low cost coal generation facilities that provides cheap power. However, this
competitive advantage is only temporary because the company will likely be forced to retire many
of these facilities over the coming years due to stricter government regulations.
PPL has tremendous economies of scale because of its size and infrastructure. The company also
has many competitive advantages that enable them to continue to grow. PPL has grown mostly
through acquisition over the years, as is common with companies in the utilities sector. The
company has good access to the debt and equity markets due to its size and has been able to use
these markets to provide capital for acquisitions. PPL through this continuous phase of
consolidation has learned how to integrate these acquisitions close to seamlessly, as was shown
by the recent acquisitions of LGE & KU and the UK Midlands operations. These acquisitions
expanded its business into the northwest US and the UK helping to provide more geographic
diversification, as shown in Figure 6. Management has a good track record of making profitable
investments and capitalizing on them by incorporating efficiencies between the companies
involved.
Market Share & Future Growth
PPL has few competitors on the transmission or delivery side of the business, as they are the main
player in most of the markets their regulated businesses participate in. Due to the high costs of
infrastructure PPL has somewhat of a natural monopoly over the distribution of retail electricity
in the areas that they operate. There is more competition in the generation and unregulated space
but overall PPL’s main competitors include: Duke Energy, American Electric Power, National Grid
Transco, Edison International, Great Plains Energy, Excelon Energy, and TECO Energy. However,
with PPL moving a higher percentage of earnings towards its regulated businesses this
competition should not be a major factor in the analysis of the company.
The new idea of self generated power such as solar and geothermal does pose a threat in the
future as these technologies become more readily available. On the other hand, the supply or
energy generation business does face serious competition and its success is based solely on PPL’s
ability to market and promote its power in a competitive market. There are many competitors in
this market including industrial supply companies, regulated utilities, and non-utility electricity
generators. PPL’s future growth opportunities are good but there are many risks to this growth.
The fact that future earnings estimates are based on high rate increases over the coming years
could pose a problem if regulation changes and these rate hikes are blocked.
7|Page
PPL Corporation
February 21, 2012
Current Positives
LGE & KU Acquisition
PPL Corporation has several things going for it. To start the recent acquisitions of LGE & KU and
the UK Midlands operations will be highly accretive to earnings. These two deals provide major
exposure to new areas for PPL. They now have a dominant presence in Kentucky serving 1.2
million customers through their operations of LGE & KU The Kentucky regulated segment
brought earnings of $0.40 in its first full year of operations This is a whole new stream of
earnings to PPL and will provide stable cash flow going forward. However, in 2012 the average
earnings estimate is $0.34, representing a decline of 1.5% year over year
UK Midlands Acquisition
PPL’s purchase of the UK Midlands operation brings added exposure to the UK. PPL now serves
7.6 million people in the UK making it the second largest delivery business in the UK With this
added exposure PPL has decreased the risks associated with its supply business dramatically. PPL
expects 75% of 2013 EBITDA to come from its regulated businesses This acquisition will also
serve to decrease cost of operations in the UK due to the synergies from the UK Midlands and
Western Power Distribution operations. The International segment containing both UK
businesses had earnings of $0.59 last year and is expected to have earnings of $1.04 next year with
the first full year of earnings from the UK Midlands operations
Removal of Pennsylvania Rate Caps
As previously stated the rate cap in Pennsylvania was removed in 2010 as a move towards further
deregulation to help establish a more competitive market. This will enable PPL to raise rates to
keep up with increases in capital expenditures. The company expects to raise rates as much as 2030% over the coming years in order to cover high capital expenditures for power plant upgrades.
This would definitely be a good driver of growth as the regulated segment has now become the
majority of earnings. However, this could pose a problem in the fact that an increase this drastic
could cause people to move or try to find other ways of getting power, whether it be through other
power providers or simply solar panels or geothermal which are now becoming more popular in
residential settings.
Current Negatives
High Capital Expenditure
That leads us to the current risks to PPL’s operations. Regulations are becoming increasingly tight
_________________________________________________________________________________________________________________
PPL Corp. 2011 Earnings - PPL company website (pplweb.com)
PPL News Room http://www.pplweb.com/newsroom/newsroom+quick+links/news+releases/PPL+Corporation+to+acquire
+Kentucky+two+major+utilities+042810.htm
PPL News Room – LGE & KU acquisition http://pplweb.mediaroom.com/index.php?s=12270&item=26703
EEI Financial Conference – http://www.faqs.org/sec-filings/111107/PPL-CORP_8-K/form8kexhibit99_2.htm
8|Page
PPL Corporation
February 21, 2012
Millions
which will lead to a high level of capital
Figure 7
expenditures. PPL has a large amount of their
6000
Capex
generation capacity in coal, as stated prior the
4000
Kentucky Regulated segment consists of 97%
coal fired generation facilities These power
2000
plant closings will become increasingly relevant
over the next five to ten years as coal plants are
0
closed for less carbon generating natural gas
plants. PPL estimates capital expenditures for
2012 at $3.84 billion, per the 4th quarter 2011
earnings release This represents 26.5% of revenue in 2012, as shown in the PPL DCF Exhibit 1.
But that’s not all capex is expected to increase again in 2013 to $4.3 billion also representing
26.5% of revenue, shown in Exhibit 1. This dramatic increase in capital expenditures is shown in
Figure 7 to the left. This percentage is expected to fall in the following years but it will likely
remain high, as I have reflected in my DCF, Figure 1. Unexpected events, such as weather damage
to infrastructure, can always arise in the utilities industry and require large amounts of capital to
fix. High capital expenditures will lead to negative free cash flow over the next three to four years
possibly leaving dividend growth stagnant and leading to limited upside in the stock.
LGE & KU Acquisition
The LG&E and KU acquisition was completed November 1, 2010 at a cost of $7.6 billion PPL
offered an oversubscribed late June 2010 stock issuance of $3.5 billion in new shares and paid for
the rest of the acquisition with current lines of credit and cash on hand
The company accrued
$800 million in debt from this acquisition The acquisition, as shown by its oversubscribed
status, was seen as a good transaction and has been very beneficial to earnings but has led to a
good degree of share dilution which is a serious concern. This acquisition will provide PPL with
the majority of the delivery service to the state of Kentucky providing a major new source of
revenue.
UK Midlands Acquisition
Even more recently, PPL purchased the UK Midlands operations of the UK on April 1, 2011,
expanding its International Regulated operations. This purchase was financed by PPL with a share
issuance equivalent to $2.3276 billion worth of common stock and $977.5 million worth of equity
units to cover the underwriting of this issuance
PPL also issued another $960 million in debt to
help pay for this acquisition
This acquisition makes their International Regulated segment one
of their largest segments and will provide steady earnings for years to come but was done at a
high cost to shareholders.
_________________________________________________________________________________________________________________
PPL Annual Reports - PPL company website (pplweb.com)
Reuters - http://www.reuters.com/article/2011/09/16/us-utilities-ppl-kentuckyidUSTRE78F5KS20110916
Yahoo SEC Filings - http://biz.yahoo.com/e/120228/151833910-k.html
Yahoo SEC Filings - 11http://biz.yahoo.com/e/110419/ppl8-k.html
9|Page
PPL Corporation
February 21, 2012
Earnings Dilution
Millions
Figure 8
Although these acquisitions will provide
serious earnings growth this sort of
Shares Outstanding
600
dilution will cause serious impairment to
earnings in the short term as these
400
acquisitions are integrated. The two stock
200
issuances over the last two years represent
a serious degree of earnings dilution. The
0
number of shares increased from 483.39
2008
2009
2010
2011
million year end 2010 to 579.3 million year
end 2011 and increase of 19.6% in shares outstanding As bad as this sounds, shares outstanding
actually increased 53% from year end 2009 to year end 2011, with 377.18 million ending 2009
and 579.3 million ending 2011, shown in Figure 8 I believe that this kind of dilution warrants
serious attention from shareholders. On top of this the UK Midlands acquisition was done at a
recorded $2.4 billion of goodwill This type of intangible cost is carried as an asset on the
balance sheet and is likely to never be recovered, therefore taking away from some of the earnings
power the acquisition will bring.
Departure of CEO
Finally, the CEO James Miller who has headed the company since 2006 has recently decided to
step down as of March 31, 2012. He will retire as CEO and resign from the board of directors.
Miller has done an excellent job of heading the company and many believe has left the company
set up for success over the long haul. However anytime a CEO steps down it presents a time of
uncertainty and there is always room for error. William Spence, current COO will take over the
role of CEO and should have a good handle on it as he was fairly close with the current CEO in
running PPL’s operations. This may not be a risk, however it is a source of uncertainty going
forward and could present obstacles involving the implementation of ideas currently in place.
Projections
Income Statement Revenue Projections
My income statement projections are shown in the pro forma income statement in Exhibit 2 and
Exhibit 3. I was relatively optimistic with my earnings estimates so as to be prudent with the
investment decision of whether to stick with PPL or sell our position. I tried to stick with
reasonably high growth estimates so as to give the stock a chance even with the current downside
risks. PPL is in a state of transition right now so I took into account the move towards the
regulated side of the business. I have growth in utility earnings of 20% for 2012 mostly due to the
fact that the UK Midlands acquisition took place in April and therefore was only accretive to
_________________________________________________________________________________________________________________
PPL Annual Reports - PPL company website (pplweb.com)
Yahoo SEC Filings - http://biz.yahoo.com/e/120228/151833910-k.html
Yahoo SEC Filings - 11http://biz.yahoo.com/e/110419/ppl8-k.html
RTT News - http://www.rttnews.com/1764133/ppl-corp-ceo-james-miller-to-retire-mar-31-2012william-spence-to-succeed.aspx
10 | P a g e
PPL Corporation
February 21, 2012
roughly half a year of earnings last year. I have projected growth in this earnings stream as 10%
in 2013 and 5% in 2014.
The unregulated retail electric and gas sales have grown tremendously over the last few years due
to the uncapping of prices in the retail electric market, mostly from the Pennsylvania decision in
2010 to uncap rates. The growth from this portion of earnings has been falling as customers
become used to the open market and find power providers that fit them. Unregulated growth was
175% in 2010 and 75% in 2011 I continued this decline in growth to 50% in 2012, 35% in 2013,
and 20% in 2014. I felt that this was still an optimistic level of growth for this stream of earnings.
Wholesale energy marketing comes from the Supply segment of the business which is currently in
a state of decline. 2011 saw the realized sales decline by 21.21% and unrealized decline
274.78% I was not this aggressive with the decline as I believe that earnings from this segment
will fall at a decelerating rate over the coming years. I projected growth of -10% in 2012, -5% in
2013, and stabilizing at +5% in 2014 for the realized portion of the Supply segment. For the
unrealized activity, which fell a lot harder in 2011, I projected -10% growth over the next three
years. I believe these estimates are still fairly optimistic as the decline in this segment could be far
worse as shown by last years earnings.
Net energy trading margins I have projected to see 0% growth due to the fact that this portion of
earnings is not stable and has oscillated between positive and negative earnings over the last few
years. Energy-related sales growth also had earning oscillating from positive to negative year to
year, therefore I used a very conservative growth rate of a flat 2% for this portion of earnings. In
total this puts sales growth at 13.66% in 2012, 11.95% in 2013, and 8.24% in 2014, which I think
is a reasonable but optimistic estimate for PPL’s growth. The recent acquisitions will keep growth
reasonably high over the next couple year and I believe I have adequately compensated for this.
Income Statement Expense Projections
PPL has a pretty good handle on their expenses from their tremendous economies of scale.
However I believe fuel costs will continue to put pressure on margins and I have set fuel costs as
18% of sales. This is higher than they have been over the past 5 years, high of 15.28% in 2011, but
the numbers show a steady increase in fuel costs so I wanted to adequately compensate for
secular trend of rising commodity prices Realized and unrealized purchase costs have jumped
around substantially over the years moving from positive to negative changes. So I chose slight
positive growth in these costs towards the middle to upper end of the spectrum so as to
compensate for any uncertainty. As for operation and maintenance expenses, they were pretty
high last year and stated as a possible source of dilution to next year’s earnings. Therefore I stuck
with the high end of the recent range and set the cost at 20%, which is reasonably modest
considering the recent acquisitions and possible maintenance expenses these operations could
incur. I set the tax rate at 20% which is below the high that PPL has seen over the last few years
but is still towards the high end of the recent range. I believe the tax rate will not be at the highs
due to some tax credits likely to be seen from the ECR program involving environmentally friendly
upgrades over the coming years. PPL has a considerable amount of debt outstanding most of
which does not mature until 2018-2020. So I have interest expense stable at 7.13% as they have a
debt issuance maturing in 2013 but I doubt they will issue much more before this time Also, I
_________________________________________________________________________________________________________________
PPL Annual Reports - PPL company website (pplweb.com)
11 | P a g e
PPL Corporation
February 21, 2012
have kept shares outstanding stable thinking that the
high degree of earnings dilution over the last
few years will keep the company from issuing any
new shares anytime soon.
Figure 9 PPL Earnings Estimates
With all of these assumptions in place I have net sales
of $14,476.3 million for 2012 compared to an
expected $11,776 million from analysts on the street.
For 2013 I have $16,205.8 million compared to the
$12,397 expected from Wall Street analysts. Earnings
per share come to $2.93 in 2012 and $3.41 in 2013
compared with the consensus estimates of $2.45 and
$2.25 per the Thomson Reuters Baseline predictions
in Figure 9. Even with predicted earnings above
what the street is expecting I see this company to be fairly valued.
Investment Thesis
Fundamental Environment
The utilities sector was once an investor safe haven with stable returns from monopolistic
companies. This is no more. Utility companies now compete in an open market and are seeing
less stable earnings. Rivalry is a very serious threat to power companies. Since there is no
substitute for power and everyone already has it, there is a lot of price cutting in order to get new
business. This leads to decreased margins for companies in this space and essentially a less
attractive industry to operate in. Because economies of scale are becoming increasingly necessary
to compete in the market, companies are using more leverage for industry consolidation and
expansion in order to outgrow their competitors. Buyers are gaining more power through the
open market structure which will likely become increasingly competitive over the coming years.
Commodity costs have been rising over the years squeezing power providers on the supplier side
as well.
The growth in utilities is not very exciting either. You have new housing starts just now starting to
slowly improve and buyers who are moving towards more efficient products that use less power.
Along with this, now there are actual substitutes for electric as you can buy you own solar panels
or geothermal to provide power without requiring utility companies. On top of this, winter this
year has been unusually warm which could lead to lower earnings throughout the year because
utilities often accrue a lot of their annual revenue during the winter months. This is an industry
with increasing regulatory uncertainty, margins squeezing on both sides, and companies taking on
more debt to try to outgrow one another, therefore the fundamentals aren’t exactly good. For
these reasons the utilities sector is in a period of stagnant growth with limited upside potential.
_______________________________________________________________________________________________________________________________________
Morningstar – PPL Debt - http://quicktake.morningstar.com/stocknet/bonds.aspx?symbol=ppl
12 | P a g e
PPL Corporation
February 21, 2012
Fundamental analysis
PPL is a strong company with easy access to capital markets which has provided them the ability
to lever the balance sheet in order to provide future long term growth. PPL has good growth
opportunities because of this leverage but for now it has created a good deal of risk. The company
has a total debt to equity ratio of 1.724, shown in the ratio analysis in Exhibit 4, this is much
higher than the industry average of 1.06. The interest burden, shown in Exhibit 4, shows that a
little more than 30% of the earnings before interest and tax (EBIT) in 2011 will go towards paying
interest on the debt PPL currently has outstanding. This high degree of leverage could be
problematic over the coming years as the company continues to increase capital expenditures.
PPL’s level of assets (blue), liabilities (red), and equity (green) are shown annually from 2006 to
2011 in Figure 10 to the right. The utilities
Figure 10
business is one that is always uncertain.
Power outages and equipment destruction
from weather and aging infrastructure are
always an issue and could pose serious
problems when the company is already
carry high amounts of debt. On top of this
there are currency risks due to PPL’s
exposure to UK that could lead to
unexpected destruction of earnings.
PPL also has a good degree of Intangibles on
its balance sheet. Because the company
operates in an industry that has few patents
and copyrights, these intangible assets must
mostly be accrued goodwill. As stated prior,
the Midlands acquisition was done at a whopping $2.4 billion of goodwill bringing the total
amount of intangibles on the balance sheet to $5.179 billion and the percentage of assets that are
intangibles from 8.3% in 2010 to 12.1% in 2011, Exhibit 4. But this is not the shocking part The
fact is that PPL had only $1.359 billion in goodwill in 2008 meaning that there was an increase of
281% in goodwill being carried on the balance sheet over the last 3 years Goodwill is essentially
a worthless asset as there is really no way to sell an intangible like this unless it is a patent or
copyright, which are not prevalent with utility companies. This large amount of goodwill clearly
came from the two major acquisitions over the last couple years, which will likely be very
profitable, but this will limit the near term earnings from these operations as this money is
basically an overpayment for the takeovers.
As stated prior, shares outstanding have increased dramatically over the last two years mostly due
to the recent acquisitions in Kentucky and the UK. PPL has little cash and therefore has to access
capital markets in order to get enough capital for major projects. The amount and debt and equity
outstanding has skyrocketed because of the two recent acquisitions. This could mean future
projects, including infrastructure updates, could lead to further leverage or worse dilution of
shares. If this happens the earnings per share will drop and share price will likely follow. This is a
major concern because utility companies often incur sudden functional expenses in order to keep
_________________________________________________________________________________________________________________
PPL Annual Reports - PPL company website - pplweb.com
13 | P a g e
PPL Corporation
February 21, 2012
providing power when something ceases to work, is damaged, or simply does not comply with
current regulations.
Multiples Analysis
The valuation analysis I have done has shown that PPL is pretty fairly valued. Compared to the
industry PPL is near the low end of many of the valuation metrics. Price to book, price to sales,
and price to cash flow are all at the lows relative to the industry. Price to forward earnings is
below the median but not currently at the lows, all shown in Figure 10. Even the Price to
Earnings multiple is currently low. These are the reasons that I first thought PPL was a buy when
I started this report. However, I believe the reasons for these multiples being towards the low end
of the range are the recent share issuances and high level of debt.
Figure 10
Relative to Industry
P/Trailing E
High
Low
Median
Current
1.5
.68
1.1
.79
P/Forward E
1.5
.63
.95
.88
P/B
1.6
1.0
1.3
1.0
P/S
1.7
.9
1.1
.9
P/CF
1.8
.8
1.5
.8
The metrics compared to the S&P show that the stock looks relatively cheap but this again could
be because investors are currently shying away from the company due to all the current
uncertainty. The metrics relative to the S&P are all near the low end of the historical range, shown
in Figure 11. These types of metrics can be very deceiving sometimes though due to underlying
issues like some of the issues mentioned above. If a company has fundamental problems then of
course it would underperform the S&P or the other stocks in the industry. I’m not saying that PPL
has major fundamental issues but some of the fundamental risk I have just outlined could be the
cause for these numbers being towards the lower end of the range.
Figure 11
Relative to S&P 500
P/Trailing E
High
Low
Median
Current
1.3
.53
.95
.78
P/Forward E
1.7
.49
.99
.91
P/B
1.5
.6
1.0
.7
P/S
2.6
.9
1.4
1.0
P/CF
1.4
.6
1.0
.6
14 | P a g e
PPL Corporation
Figure 12
Absolute
Valuation
February 21, 2012
High
A.
Low
B.
Median
C.
Current
D.
#Your
Target
Multiple
E.
F.
*Your
Target
Your
Target
Price
G.
H.
P/Forward E
21.6
7.4
12.3
12.2
12.3
$2.33
$28.66
P/S
3.0
1.1
1.5
1.3
1.4
$21.89
$30.65
P/B
3.9
1.4
2.1
1.5
1.7
$18.97
$32.25
P/EBITDA
9.41
3.32
6.37
3.71
5.0
$7.67
$38.35
P/CF
15.0
5.1
9.0
5.9
6.5
$4.82
$31.33
However, the company appears to be reasonably valued according to the absolute metrics I have
estimated, Figure 12. Price to EBITDA makes the company look cheap, but as I have talked about
this is a company that is currently carrying a high debt load therefore using earnings without
taking out the interest expense of 7% leads to inflated estimates. Price to book also looks fairly
cheap but again we have talked about the high amount of goodwill being carried on the balance
sheet as an asset and how that con distort the difference of assets to liabilities which represents
total equity. Therefore this metric is not a good measure either. The other metrics seem to be
fairly in line with the results of my discounted cash flow model making me fairly confident that
this is a fair value for the company.
Technical Analysis
PPL stock has never really
recovered from the fall in price
during the Financial Crisis of
2008. The stock price fell
roughly 54% from its highs of
$54.07 to the low of $24.94, as
shown by the 5 year chart to the
right. Since this time the stock
has been trading in a fairly tight
range with $30 seeming to be
pretty good resistance. It has
flirted with this level a few
times recently, pushing through
it once, but there is not enough
conviction to keep it above this level.
This year the price fell below the 200 day moving average, a bearish sign, for a short period. But
since then, partly because of a good earnings release, it has broken back above the 200 day. The
15 | P a g e
PPL Corporation
February 21, 2012
stock continued to rally until just below $29 and has since fallen again. Currently the 50 day
moving average has crossed
below the 100 day moving
average, a bearish indicator.
This is shown in the 6 month
PPL chart below. I believe
based on this price action that
there is considerable resistance
at $30 and the stock is unlikely
to break through this level. This
limits the upside in the stock
considerably and therefore
indicates a good time to move
out of this stock and into a
better performing one.
Discounted Cash Flows
The discounted cash flow model, Exhibit 1, I have assembled has taken into account many of the
estimated amounts PPL has forecasted over the coming years. Because I think the stock is fairly
valued I have used some optimistic levels of sales as I previously talked about. With earnings
estimates outpacing the consensus by a fair amount as shown by my $3.41 estimate for 2013
compared to the $2.25 the street is expecting. I have forecast 13.66% growth in 2012, 11.95%
growth in 2013, and 8.24% growth in 2014. The following years I began to ratchet down growth
to more normalized levels. I have 7% revenue growth in 2015 and 2016, 6% growth from 20172019, 5% growth in 2020 and 2021, and 4% growth in 2022. I used a terminal growth rate of 3%
because utilities usually have reasonably low growth rates and this seemed appropriate to me.
For the discount rate I used 9.5% because utilities are generally pretty safe companies and PPL is
moving more towards the regulated side of business
which involves much less risk.
Figure 13 Capital Expenditures
The historical operating margins,
shown in Exhibit 3, were between
12% and 25% so I used estimates
around 21.5 for 2012-2014 and
20% flat for the remaining years, in
order to stay on the optimistic end
of earnings estimates. My estimates
for depreciation are around 7%
2012 and slowly increase as the
capital expenditures decrease over
the years with both evening out in
the terminal year so as to represent
the depreciation of the previous
capital expenditures. Depreciation
increases one percent most year
finishing at 14% in the final year. Capital expenditures move the opposite way starting at the
16 | P a g e
PPL Corporation
February 21, 2012
$3,840 million that PPL has forecasted, Figure 13. This number represents 26.5% of my
forecasted revenues and this percentage falls to 14% in the terminal year. Using these number
PPL’s free cash flow is negative all the way through 2015.
With these assumptions in place the terminal value of PPL using this DCF model is $36,889, a free
cash flow yield of 6.31%, a terminal P/E of 14.2, and a terminal EV/EBITDA of 5.8. The stock is
currently priced at $28.56 and my DCF gives an implied value of $30.59. This represents a 7.1%
upside that with the dividend is equivalent to 12.1%.
Risks & Concerns
Risks to the Company
Highly regulated industry with ever changing standards
Limited profitability on some operations due to rate caps
Utilities sector is in a state of decline due to increased product efficiencies
Buyer have more power due to open market structure
Commodity costs continue to increase
High amount of goodwill on balance sheet (12% of assets)
High capital expenditures
High debt burden
Shares dilution (53% new shares issued since 2009)
Conclusion
Recommendation
My recommendation is to sell PPL stock. I believe the company has good long term prospects but
will face near term headwinds with an old fleet of mostly coal power generation. Capital
expenditure will remain high and earnings will remain weak due to margin compression and
operating costs. I believe PPL does have some upside to it and I think my analysis is justified and I
have solid conviction about my $30.59 price target. This price target implies a 7.1% upside that
along with the dividend gives you a decent 12.1% gain which I believe is reasonable. Because we
are in uncertain times right now this is not a bad value. However, I do believe in mispricing in the
market and therefore think there are better opportunities currently being offered. I think the SIM
portfolio should sell PPL Corp. and purchase another stock with more upside.
17 | P a g e
PPL Corporation
February 21, 2012
Exhibit 1: Discounted Cash Flows
PPL Corp.
Geno Frissora
Date: 01/13/2012
Terminal Discount Rate =
9.5%
Terminal FCF Growth =
3.0%
(all data in millions)
Year
2012E
Revenue
14,476
% Grow th
2013E
16,206
11.9%
Operating Income
3,122
Operating Margin
21.6%
Interest Expense
1,032
Interest % of Sales
Taxes
Tax Rate
Net Income
3,480
21.5%
1,155
Free Cash Flow
20.0%
1,338
4,016
20.0%
1,432
6.0%
4,257
20.0%
1,532
6.0%
4,513
20.0%
1,639
25,114
6.0%
5.0%
4,784
5,023
20.0%
20.0%
1,754
1,877
5,274
20.0%
2,008
4.0%
5,485
20.0%
2,149
569
600
632
667
692
718
734
22.0%
22.0%
22.0%
22.0%
22.0%
22.0%
1,200
1,400
1,689
7.0%
2,008
2,126
5.4%
2,342
2,241
5.4%
2,482
2,363
2,454
5.4%
3.8%
2,870
3,014
7.0%
27,425
22.0%
2,016
7.0%
5.0%
531
-5.8%
7.0%
26,370
22.0%
1,884
7.0%
23,918
2.9%
6.5%
7.0%
22,565
2022E
509
2,000
7.0%
21,287
2021E
2.9%
1,878
7.0%
7.0%
2020E
467
2,547
3.8%
3,428
7.0%
2,602
2.2%
3,839
7.4%
8.0%
9.0%
10.0%
11.0%
11.0%
12.0%
12.0%
13.0%
14.0%
(667)
(93)
(124)
(188)
(201)
(213)
(226)
(239)
(251)
(264)
(274)
-4.6%
-0.6%
-0.7%
-1.0%
-1.0%
-1.0%
-1.0%
-1.0%
-1.0%
-1.0%
-1.0%
3,840
Capex % of sales
1,251
3,754
20,082
2019E
2.9%
6.9%
Subtract Cap Ex
21.6%
7.0%
2018E
414
1,000
% of Sales
3,784
18,769
2017E
7.1%
16.5%
Plus/(minus) Changes WC
8.2%
2016E
7.1%
1,612
% of Sales
17,541
2015E
7.1%
% Grow th
Add Depreciation/Amort
2014E
4,300
4,100
26.5%
(1,895)
(1,314)
(823)
(368)
-30.6%
-37.4%
-55.3%
% Grow th
23.4%
3,754
26.5%
20.0%
3,213
16.0%
610
-265.8%
3,406
3,610
16.0%
16.0%
849
888
39.1%
4.6%
3,349
3,516
14.0%
14.0%
1,646
1,700
85.4%
3.3%
3,692
14.0%
2,020
18.8%
3,839
14.0%
2,328
15.3%
.
NPV of Cash Flows
2,837
16%
NPV of terminal value
14,885
84%
Projected Equity Value
17,722
100%
Free Cash Flow Yield
-11.45%
Current P/E
Projected P/E
Current EV/EBITDA
Projected EV/EBITDA
Shares Outstanding (millions)
Implied equity value/share
Upside/(Downside) to DCF
Total Debt (2010)
Cash and Equivalents (2010)
Cash/share
Dividend/share (annual)
Free Cash Yield
10.3
8.8
8.3
11.0
9.4
8.9
8.2
7.2
6.5
8.5
7.5
6.8
579
Current Price
Terminal Value
6.31%
Terminal P/E
14.2
Terminal EV/EBITDA
5.8
432
578 actual shares outstanding
$28.56
$
36,889
30.59
7.1%
18,571
1,202
2.07
1.4
18 | P a g e
PPL Corporation
February 21, 2012
Exhibit 2: Income Statement Projections
PPL
Year
Operating Revenues
(Millions)
Utility
Unregulated Retail Electric and Gas
Wholesale Energy Marketing
Realized
Unrealized Economic Activity
Net Energy Trading Margins
Energy-Related
Net Sales
Consensus
Fuel
2014
2013
Estimates
10797.1
9815.5
1764.2
1470.2
2012
2011
Estimated
8179.6
6292
1089.0
726
3807
1407
-2
507
12737
2010
2009
2008
2007
2006
3668
415
3902
152
4114
151
4114
102
3855
91
4832
-805
2
409
8521
3184
-229
17
423
7449
2138
1056
-121
519
7857
1617
-145
41
769
6498
1412
120
35
618
6131
906
763
843
3417.7
1025.7
-2.0
538.0
17540.7
12854
3255.0
1139.7
-2.0
527.5
16205.8
12216
3426.3
1266.3
-2.0
517.1
14476.3
11705
3157.33
2917.05
2605.74
1946
1235
920
1057
4385.18
526.22
3508.1
4051.45
486.17
3241.2
3619.09
434.29
2895.3
2130
2773
2625
1624
918
1123
-286
155
553
-198
130
2742
1756
1418
1414
1373
1266
11334
Energy Purchases
Realized
Unrealized Economic Activity
Other Operation and Maintenance
Amortization of Recoverable Transition Costs
Depreciation
Taxes, other than Income
Energy-Related Businesses
Operating Expenses
Operating Income
Other Income
Other than Temporary Impairments
Interest Expense
Income before taxes
Taxes
Income from Continuing Ops after Taxes
Income from Discontinued Ops after Taxes
Minority Interest
Dividends on Perferred Securities
Net Income
EPS Basic
EPS Diluted
Consensus
Ave Shares Basic (thousands)
Ave Shares Diluted (thousands)
0
0
0
0
0
304
293
310
282
1400
280
500
13756.9
1200
280
550
12725.8
1000
280
520
11354.4
960
556
455
444
446
419
326
238
280
288
298
281
484
383
396
481
762
638
9711
6655
6553
6154
4815
4622
3783.8
3480.0
3122.0
3026
1866
896
1703
1683
1509
32
26
21
15
1250.6535 1155.4741
2544.2
2335.5
-12
9
1032.163
2068.8
-12
6
908
2100
-31
47
53
95
62
3
18
36
0
0
593
387
447
474
447
1239
538
1273
1304
1124
508.8
2035.4
-15
20
0
2000.4
467.1
1868.4
32
22
0
1878.4
413.8
1655.0
-23
20
0
1612.0
493.5
1606.5
6
18
0
1594.5
263
976
-17
21
0
938
105
433
-7
19
0
407
396
877
73
20
0
930
270
1034
275
3
18
1288
268
856
26
3
14
865
3.63
3.63
2.25
3.41
3.41
2.45
2.93
2.93
2.34
2.90
2.89
2.63
2.17
2.17
1.08
1.08
2.48
2.47
3.39
3.35
2.27
2.24
550.40
550.95
550.40
550.95
550.40
550.95
550.40
550.95
431.35
431.57
376.08
376.41
373.63
374.90
379.94
384.48
381.06
386.16
19 | P a g e
PPL Corporation
February 21, 2012
Exhibit 3: Growth Estimates
PPL
Year
Operating Revenues
(Millions)
2014
Cash & Equiv
% of Sales
Accounts Receiv-Net
% of Sales
Inventories
% of Sales
Accounts Payable
% of Sales
Chg in WC
Utility Sales Growth
Unregulated Retail Electric and Gas Sales Growth
Wholesale Energy Marketing
Realized Sales Growth
Unrealized Economic Activity Sales Growth
Net Energy Trading Margins Sales Growth
Energy-Related Sales Growth
Net Sales Growth
Gross Margin
Chg YoY
Fuel Cost to Sales
Chg YoY
Realized Energy Purchases to Sales
Chg YoY
Unrealized Economic Activity Energy Purchases to Sales
Chg YoY
Operation and Maintenance to Sales
Chg YoY
Operating Margin
Chg YoY
Tax Rate
Interest Expense
2013
Estimates
2012
2011
Estimated
2010
2009
2008
2007
2006
1754.0722 1620.5808
10.00%
10.00%
1596.0
1520.0
10.00%
10.00%
964.73969 972.34847
5.50%
6.00%
1403.3
1458.5
8.00%
9.00%
-123.7
-92.9
1447.634
10.00%
1447.6
10.00%
940.9621
6.50%
1447.6
10.00%
-666.9
1202
9.44%
779.1
9.00%
595
4.67%
1100
11.00%
82.9
925
10.86%
742
8.71%
643
7.55%
1028
12.06%
-151
801
10.75%
468
6.28%
357
4.79%
619
8.31%
-102
1100
14.00%
533
6.78%
337
4.29%
766
9.75%
184
430
6.62%
661
10.17%
316
4.86%
689
10.60%
14
794
12.95%
591
9.64%
378
6.17%
667
10.88%
-302
-6.00%
173.03%
-5.15%
0.66%
0.00%
48.04%
6.72%
12.09%
10.00%
20.00%
20.00%
35.00%
30.00%
50.00%
71.54%
74.94%
5.00%
-10.00%
0.00%
2.00%
8.24%
34.00%
0.00%
18.00%
0.00%
25.00%
0.00%
3.00%
0.00%
20.00%
0.00%
21.57%
0.10%
20.00%
7.13%
-5.00%
-10.00%
0.00%
2.00%
11.95%
34.00%
0.00%
18.00%
0.00%
25.00%
0.00%
3.00%
0.00%
20.00%
0.00%
21.47%
-0.09%
20.00%
7.13%
-10.00%
-10.00%
0.00%
2.00%
13.66%
34.00%
-3.65%
18.00%
2.72%
25.00%
8.28%
3.00%
-5.82%
20.00%
-1.53%
21.57%
-2.19%
20.00%
7.13%
-21.21%
-274.78%
-200.00%
23.96%
49.48%
37.65%
1.94%
15.28%
0.78%
16.72%
-15.82%
8.82%
12.17%
21.53%
0.92%
23.76%
1.86%
23.50%
7.13%
51.76%
48.92%
32.22%
14.52%
251.53% -121.69% -828.28% -220.83%
-88.24% -114.05% -395.12%
17.14%
-3.31% -18.50% -32.51%
24.43%
14.39%
-5.19%
20.91%
5.99%
35.71%
31.29%
40.84%
53.85%
4.42%
-9.55% -13.00%
2.81%
14.49%
12.35%
13.45%
13.94%
2.14%
-1.10%
-0.49%
1.50%
32.54%
35.24%
20.67%
14.13%
-2.70%
14.57%
6.54%
0.38%
-3.36%
2.08%
7.04%
-3.05%
-5.44%
-4.96%
10.09%
-5.17%
20.61%
19.04%
18.00%
21.13%
1.57%
1.04%
-3.13%
0.48%
21.90%
12.03%
21.67%
25.90%
9.87%
-9.65%
-4.23%
1.29%
21.23%
19.52%
31.11%
20.71%
6.96%
5.20%
5.69%
7.29%
51.04%
51.04%
12.44%
12.44%
13.75%
13.75%
2.12%
2.12%
20.65%
20.65%
24.61%
24.61%
23.84%
7.29%
Exhibit 4: Dupont and Ratio Analysis
2011
2010
Payout Ratio
0.560
0.645
ROA
0.056
0.047
Plowback Ratio Times Interest Earned Net Profit Margin Inventory Turnover Total Debt Ratio Debto Equity
0.440
3.316
0.115
13.610
0.747
1.724
0.355
3.089
0.113
9.485
0.750
1.627
2011
2010
ROE=
0.135
0.117
Tax Burden
0.691
0.774
Interest Burden
0.698
0.676
Profit Margin
0.237
0.215
Asset Turnover
0.299
0.259
2011
2010
MV/BV
2.941
2.243
EV/EBITDA
6.504
9.346
Sust. Growth Rate
0.060
0.041
Current Ratio
1.211
1.187
2011
2010
Leverage
3.958
1728.263
Intangibles/Assets
0.121
0.083
20 | P a g e