Ameren Corporation(AEE), an integrated utility headquartered in St. Louis, Missouri, has been downgraded from Outperform to Neutral.
The rating has been downgraded mainly due to the projected downside in the near-term at its merchant generation segment as a result of lower realized power prices, reflecting the economic slowdown, and higher fuel and related transportation costs, reflecting the expiration of lower-cost coal and rail contracts.
We also remain cautious on the stock, owing to Ameren’s marked dependence on coal for generating electricity. The company produced 83% of its electricity in fiscal 2009 from coal-fired facilities. This dependence on coal requires significant capital expenditure, such as installing scrubbers to comply with environmental standards set by federal agencies. Management estimates that it would have to shell out approximately $1.6 billion-$1.9 billion in the period 2010-2017 for complying with federal and state clean air standards.
However, Ameren’s stable and regulated electric power operations in the Midwest market generate a relatively stable and growing earnings stream. Future growth will be guided by improved plant operations, a focus on cost management, allowed ROE of 10% (Missouri and Illinois), a recovering economy boosting industrial sales and installation of emissions reduction equipment (scrubbers) at its generation plants.
Ameren’s Missouri service area’s economy is staging lower unemployment rates (9.3%) compared to the national average (9.6% as of September 2010) per the U.S. Bureau of Labor Statistics. Meanwhile, Illinois is staging the eighth straight month of dropping unemployment, which is 9.9% as of September 2010. Steady improvement in its service areas will perk up consumption of electricity, boosting the top line.
The Ameren stock is currently trading at a premium to its peers like, PPL Corporation (PPL), and NRG Energy Inc. (NRG) in terms of current fiscal earnings estimate. However, headwinds in merchant generation, predominantly coal-based generation assets and pending regulatory cases continue to restrain valuation.
Given these headwinds, we believe that Ameren should trade at par with peers if not at a discount. As such, we see limited upside from current levels and downgrade our recommendation for Ameren to market Neutral.
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