There’s an argument to be made that the solar systems of companies like SolarCity Corp (NASDAQ:SCTY)’s and consumer-purchased windmills will be the way of the future. Will we be seeing utility companies playing less of a role in electricity generation?
Electric utilities have seen electric volumes dropping over the past few years as these installments become more common, and buildings become more efficient. However, traditional utility companies are, and will continue to be, vital in providing stable electric currents to everybody.
Duke vs. SolarCity
Companies like SolarCity Corp (NASDAQ:SCTY) have been moving forward with consumer installations of solar panels. These companies are trying to bypass utility companies by providing electric generating capacity right to consumers. SolarCity is engaged in the design, installation and sale or lease of solar-energy systems to residential and commercial customers. SolarCity Corp (NASDAQ:SCTY) then has long-term contracts with customers to purchase electricity generated from the solar panels newly installed atop their roofs.
Even if we saw a huge increase in the number of installations, there are two factors that will keep utility companies in the loop. To completely cut the cord would involve a large investment from consumers or SolarCity Corp (NASDAQ:SCTY) in electricity storage, and there are certain consumers that are unable to make the switch at all: city dwellers.
People in the rural south may be able to sever the cord by the use of an array of solar panels and batteries. The non-battery option to “cut the cord” for rural consumers is to augment a solar system with a natural-gas backup generator.
Both of these scenarios are very capital-intensive solutions just to eliminate an electric bill. Geographically speaking, companies like Duke Energy Corp (NYSE:DUK) and The Southern Company (NYSE:SO) are the most susceptible, and this may keep their rate-increase requests in check.
Duke Energy Corp (NYSE:DUK) is one of the nation’s largest integrated electric companies. Duke Energy Corp (NYSE:DUK) sees its customers demanding more renewable power, and it’s been investing heavily in wind farms.
Duke Energy Corp (NYSE:DUK) has a customer base mostly in the southeast, as well as some international operations in South America. Duke sports a dividend of 4.1% and a payout ratio of 73%. As we move into 2013, we should see synergies relating to the Progress Energy merger materialize, adding to bottom-line results. These synergy savings will help lower the payout ratio in the future.
Northern lights & big cities
Electric utility companies have natural safe havens within large cities. Even if cities and buildings become more efficient, they will still consume more electricity than can be provided by solar panels attached to their roofs — there just is not enough surface area. Companies like MGE Energy, Inc. (NASDAQ:MGEE) located in Madison, WI, or Consolidated Edison, Inc. (NYSE:ED) in Manhattan have natural moats given the dense energy demand of cities, especially ones that have harsh winters.
Electric utilities that are located in northern geographies have another advantage; there just is not as much sunlight available as there is in the south. Between shorter days in the winter and snow covering the solar panels, consumers will still be dependent on the grid.
MGE Energy serves the capital city of Wisconsin. The city is home to many state buildings, as well as the sprawling University of Wisconsin-Madison. MGE Energy has a natural safe haven given the stability of these two large customers, and the amount of residents that the state government and university attract year round.
MGE Energy has a modest dividend of 2.9% with a very reasonable 55% payout ratio. It has an operating margin of 21%, which will continue to increase as MGE Energy embarks on its cost reduction and efficiency projects. The company has made a conscious shift from issuing shares to fund asset expansions to using retained earnings.
Over the past decade, MGE Energy went from $650 million in generating and distribution assets to $1.6 billion in assets, an annual growth rate of 8.5%. With a constant share count, I expect to see these assets accelerate earnings per share as time moves forward.
Consolidated Edison serves the most densely populated area in the US, New York City. ConEd makes most of its money distributing electricity and natural gas to New Yorkers, and like most utilities, has a monopoly on these services.
ConEd’s dividend is marginal at 3.9% and the company has a relatively conservative payout ratio of 62.3 %. Consolidated Edison’s distribution network will make money regardless of electric and gas prices, as it charges customers for the use of its wires and pipes while passing through the cost of electricity. This is a great business model that eliminates much of the risk associated with commodity-price fluctuations. Other utilities that have large electricity wholesale divisions are held hostage to commodity price swings like coal and natural gas.
ConEd’s business model also insulates it from governments administrations that support changing sources of energy by being the middle man. When the current administration pushed for more restrictions on coal power, ConEd continued its business as usual with minimal impact compared to competitors like Southern Company.
Foolish bottom line
Companies like SolarCity Corp (NASDAQ:SCTY) are currently reducing the demand of electricity from the grid. Even though the company has growing revenue, it is still struggling to make a profit. Unless SolarCity Corp (NASDAQ:SCTY) is able to drive down the costs it incurs during installations, or build up another revenue stream these loses will eventually be the demise of this renewable energy company.
Electric utilities may see some consumers severing the cord and removing themselves from the grid. Customers will continue to try and make their homes as efficient as possible, however most customers will continue to be plugged into the grid.
City dwellers will continue to depend on the grid for reliable flows of electricity and gas. As time moves forward, electric companies will still pay an integral part of generation and distribution of electricity. Consolidated Edison and Duke Energy Corp (NYSE:DUK) are pillars of stability, and will provide strength to any investor’s portfolio.
The article The Grid and the Green Energy Threat originally appeared on Fool.com.
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