FPL Group : (FPL)

INVESTMENT THESIS This week's Focus Stock of the Week is FPL Group (FPL: $57), which carries Standard&Poor's highest investment recommendation of 5-STARS, or Strong Buy. We believe FPL will benefit as its unregulated NextEra Energy Resources unit continues to achieve strong market growth, largely driven by the legislation of Renewable Portfolio Standards (requirements by states that utilities obtain a certain percentage of their total generating power from renewable sources) in states throughout the country. We also believe its earnings will be boosted by tax credits provided by the passage of the federal stimulus package, which should add about $0.15 to annual EPS over the next several years, by our analysis. With the stimulus legislation having extended the wind production tax credit by three years through 2012, the company has obtained a critical multi-year certainty for its wind development investment plans, in our view. It had already intended to add about 1,100 megawatts (MW) of new wind power in 2009, and is now targeting between 1,000 and 2,000 MW of additional wind power expansion in each year from 2010 through 2012. FPL is also developing over 1,000 MW of solar power projects and, by the end of 2010, expects to have approximately 9,000 MW of renewable energy capacity, which is larger than the entire generation fleets of most utilities in the U.S. Although earnings at the company's regulated Florida Power&Light (FP&L) utility have been restricted by the unprecedented downturn in the state's housing market and economy, we believe the long-term outlook remains strong. We expect to see a gradual recovery starting in 2010, and for the utility to eventually recover its well above-average annual customer growth rate of more than 2%. In order to meet this expected growth, FP&L has projected capital expenditures of about $13.4 billion for the five-year period from 2009 through 2013, with major components of the planned expenditures already approved by the Florida Public Service Commission (FPSC). These investments will add substantially to the utility's rate base, which has historically been the primary driver of its earnings growth. This past March, FP&L filed a petition with the FPSC requesting an increase in its authorized rate base that, if approved as requested, could increase annual year-over-year retail base revenues by about $1 billion in 2010 and by an additional $250 million in 2011. While we do not anticipate the FPSC approving the requested increase in its entirety, the regulatory environment in Florida has been historically constructive, and we expect FP&L to receive a good portion of the requested hike. The shares have recovered from their decline in early 2009, which primarily reflected, in our view, the sharp downturn in the broader market. While the Florida housing market remains weak, we believe the stock will benefit from the growth prospects we foresee for NextEra Energy Resources and the expected rate increase at the utility. We expect FPL to realize above-average total return over the next 12 months. COMPANY STRATEGY The company seeks to benefit from its position as the largest generator in North America of renewable energy from the wind and the sun, and, with one of the largest nuclear operations in the U.S., a greenhouse gas emissions rate that is among the lowest of any large power company. With the potential for up to $16 billion in wind power investments by FPL through 2012, the company plans to continue to expand its wind and solar operations and to realize the investment tax credits that have been made available through the passage of the federal stimulus package. In addition to expanding its renewable generation, the company also intends to be involved in the development of transmission projects aimed at transporting that power from remote locations to the population centers that will use it. In so doing, we believe it will be able to obtain the matching grants the federal stimulus package is offering for the modernization of the transmission grid.

As for the regulated utility business, FPL is in the process of seeking a significant increase in its electric base rates, and is determined to maintain what we view as its financial discipline and strong credit profile so as to obtain capital at reasonable rates during the current economic downturn. BUSINESS PROFILE FPL Group FPL Group, one of the largest providers of electricity-related services in the U.S., is the holding company for Florida Power&Light Co. (FP&L), a regulated and vertically integrated utility, and NextEra Energy Resources (formerly FPL Energy), a wholesale generator of electricity with operations in 25 states. Florida Power&Light Florida Power&Light, which had $11.8 billion in operating revenues in 2008, provides electricity to about 4.5 million customers in an area covering nearly all of Florida's eastern seaboard, as well as the southern part of the state. FP&L's retail operations, which are regulated by the Florida Public Service Commission, account for about 99% of its operating revenues. The utility's electric revenues by customer class in 2008 were: residential 53%; commercial 40%; industrial 3%; and other 4%. In March 2009, FP&L filed a request with the FPSC for an increase in its base rates and charges to go into effect as of January 2010, and an additional base rate increase to be effective as of January 2011. Hearings are expected during the third quarter of 2009 with a final decision by the end of the year. The requested hikes are based on a regulatory return on equity of 12.5% and, if approved, would increase annual retail base revenues by about $1 billion in 2010 and an additional $250 million in 2011. At the end of 2008, FP&L had a total power generating capacity of 22,087 MW, with 53% of its 2008 generation produced from natural gas, 22% from nuclear, 14% from purchased power, 6% from coal, and 5% from oil. FP&L is currently constructing three natural gas-fired combined-cycle units of about 1,220 MW each, and we expect them to be respectively placed into service by the third quarter of 2009, the fourth quarter of 2010, and in mid-2011. The projected costs are about $1.3 billion each for the first two units, and about $900 million for the third unit. FP&L is also in the process of adding about 400 MW of new nuclear capacity at its existing nuclear units, which we expect to be placed into service by the end of 2012, at a projected cost of about $1.6 billion. Given its unusually low level of exposure to industrial customers, we consider the company to normally be much less vulnerable to economic downturns. However, after experiencing average annual customer growth of 2.1% over the previous 10 years, FP&L started to experience a slowdown in retail customer growth in 2007, as well as a decline in non-weather related usage, and in 2008, retail customer growth declined to 0.2%. We do not see a recovery in this growth until there is a broader rebound in the state's economy. NextEra Energy Resources NextEra Energy Resources is the leading renewable energy provider in the U.S., with $4.6 billion in operating revenues and $17.2 billion in total assets located in 25 states and Canada. It had interests in independent power projects with a net generating capacity of 16,928 MW at the end of 2008. Natural gas accounted for 39% of its fuel source in 2008, followed by wind power (38%), nuclear (15%), oil (5%), hydro (2%), and other (1%). In addition to its long-term power contracts, NextEra Energy manages a portfolio of merchant assets that includes 7,016 MW of owned nuclear, natural gas, oil and hydro generation, with 965 MW of peak generating facilities. The merchant assets are plants that do not have long-term power sales agreements, and require active marketing and hedging from the company's Energy Marketing and Trading operations. Driven by state renewable portfolio requirements and federal production tax credits, wind power generation has been the most rapidly expanding of NextEra Energy's fuel sources. Its generating capacity grew 25% in 2008, to about 6,375 MW, of which around 69% was under long-term contracts with utilities and power marketers, largely under fixed-price agreements with expiration dates ranging from 2011 to 2033. The projected output of the remaining 31% was substantially hedged through 2010 and partially hedged through 2013. VALUATION FPL shares, which recently traded at about 13.3X our 2009 operating EPS estimate of $4.30, have outperformed the S&P Index of Electric Utility stocks year to date, and given our view of the company's demonstrated ability to capitalize on its renewable energy projects, we expect the stock to continue to outperform over the next 12 months.

Although the yield from the dividend (recently at 3.3%) is below the recent electric utility peer average (5.3%), the company's current dividend payout ratio is only 49% of 2008 operating earnings (compared to 60% for its electric utility peers), and we project it at just 44% (63%) and 39% (54%) of our operating EPS estimates for 2009 and 2010. We believe this relatively low payout ratio should continue to provide the company with an increased level of financial flexibility, while still offering a competitive yield compared to the overall market. We expect FPL to sustain average annual dividend growth of about 8% over the next few years. The shares were recently trading at about 11.8X our 2010 operating EPS estimate of $4.85. In 2008, the shares traded between 8.8X and 19.2X the company's operating EPS of $3.84 (which excluded $0.23 in net one-time gains). Our 12-month target price of $68 reflects a premium-to-peers P/E of 14.0X our operating EPS estimate for 2010. We believe the premium is justified by the company's position as the national leader in the development of wind and solar power.

CORPORATE GOVERNANCE We have a mostly favorable view of FPL Group's corporate governance. We do have a concern that the positions of chairman of the board and CEO are combined, which, though fairly common among electric utility holding companies, presents a potential conflict of interest. However, we view positively that 11 of the 12 board members are independent outside directors, and that the audit, compensation, finance and investment, and governance and nominating committees are comprised solely of outside directors. We also view favorably that regular meetings of the board are held six times a year and special meetings are held as required. INVESTMENT RISKS The main risks to our recommendation and target price include a much slower-than-expected recovery in the economy, the potential for unfavorable regulatory or legislative acts, lower-than-expected results from the unregulated NextEra Energy business, and a significant investor shift away from independent power companies and/or the electric utility group as a whole. CONCLUSION With FPL the country's leading producer of wind and solar power, we believe its independent power subsidiary, NextEra Energy Resources, will benefit from the legislation of Renewable Portfolio Standards in roughly half the states in the U.S., as well as from the tax credits being provided by the recent federal stimulus package. Although earnings at the regulated FP&L subsidiary have been hurt by the weak economy and housing crisis, we expect it to benefit from a gradual recovery in both of these areas, as well as from an anticipated rate increase effective at the start of 2010. With our 12-month target price of $68 implying upside potential of over 18% from recent levels, plus a dividend yield of about 3.3%, we have a Strong Buy recommendation on the shares./Justin McCann

15-Jun-2009 10:00:05 (14322029)   Copyright 2009 The McGraw-Hill Companies, Inc, Standard & Poor's, a division of The McGraw-Hill Companies, Inc., and their affiliates (collectively, "S&P"). Reproduction of this content in any form is prohibited except with the prior written permission of S&P.