Illinois Regulatory Environment Could Prove Challenging for Exelon

Strategist

Andrew Bischof

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Exelon is a pure-play electric and gas transmission and distribution utility providing investors a stable earnings profile. 

Exelon's regulated utilities support our outlook for 6.5% earnings growth, in line with the company's 6%-8% earnings growth guidance through 2026. We estimate the company will invest $38 billion through 2027, supporting 8% rate base growth. This investment plan supports our earnings forecast and dividend growth in line with earnings growth.

Exelon operates a diverse set of regulated utilities, including five utilities in the Northeast and the largest investor-owned utility in Illinois. Regulatory relationships have at times been strained across its Northeast utilities, resulting in low allowed returns.

Constructive regulatory outcomes will be critical for management to achieve its long-term earnings growth expectations and support 9%-10% operating returns on equity. We expect supportive outcomes across the company's regulatory proceedings, though we think this could be challenging as some of Exelon's regulatory environments can be difficult.

Recent Illinois legislation will bring significant changes to the state's regulatory framework. Current performance-based rate making, which ties allowed returns to the average 30-year Treasury rate, have produced some of the lowest returns among U.S. utilities. Beginning in 2024, Illinois utilities have opted in for a four-year rate plan. Under the multiyear plan, ComEd would be allowed to "true-up" earned returns to allowed returns and continue usage-decoupled rates.

We believe the first outcome in ComEd's rate case in Illinois under new legislation will set the tone for the regulatory environment in the state. In Illinois, the administrative law judge recommended just 9.28% allowed return on equity with a 50% equity layer, well below the 10.5% allowed ROE requested in the first year of the proposed multiyear rate plan beginning in 2024. Commission staff have recommended an 8.9% ROE. We expect a final decision in line with these recommendations.

Business Strategy & Outlook

Considering Exelon's full suite of regulated businesses, we think the Exelon has a narrow economic moat.

Service territory monopolies and efficient scale advantages are the primary sources of an economic moat for regulated utilities such as Exelon. State and federal regulators typically grant regulated utilities exclusive rights to charge customers rates that allow the utilities to earn a fair return on and return of the capital they invest to build, operate, and maintain their distribution networks. In exchange for regulated utilities’ service territory monopolies, state and federal regulators set returns at levels that aim to minimize customer costs while offering fair returns for capital providers.

This implicit contract between regulators and capital providers should, on balance, allow regulated utilities to outearn their costs of capital, though observable returns might vary in the short run based on demand trends, investment cycles, operating costs, and access to financing.

Intuitively, utilities should have an economic moat based on efficient scale, but in some cases regulation offsets this advantage, preventing excess returns on capital. The risk of adverse regulatory decisions precludes regulated utilities from earning wide economic moat ratings. However, the threat of material value destruction is low, and normalized returns exceed the costs of capital in most cases, leaving us comfortable assigning narrow moat ratings to many regulated utilities.

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Economic Moat

Exelon

Exelon Corp. operates as a utility services holding company, which engages in the energy generation, power marketing, and energy delivery business. It operates through the following segments: Mid Atlantic, Midwest, New York, Electric Reliability Council of Texas (ERCOT) and other Power Regions. The Mid-Atlantic segment represents operations in the eastern half of PJM, which includes New Jersey, Maryland, Virginia, West Virginia, Delaware, the District of Columbia and parts of Pennsylvania and North Carolina. The Midwest segment operates in the western half of PJM, which includes portions of Illinois, Pennsylvania, Indiana, Ohio, Michigan, Kentucky and Tennessee, and the United States footprint of MISO, excluding MISO's Southern Region, which covers all or most of North Dakota, South Dakota, Nebraska, Minnesota, Iowa, Wisconsin, the remaining parts of Illinois, Indiana, Michigan and Ohio not covered by PJM, and parts of Montana, Missouri and Kentucky. The New York (NY) segment provides operations within ISO–NY, which covers the state of New York in its entirety. The ERCOT segment includes operations within the Electric Reliability Council of Texas, covering most of the state of Texas. The Other Power Regions consist of the operations in New England, South, West, and Canada. The company was founded in February 1999 and is headquartered in Chicago, IL.

Earnings data Q1 2024

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