Duke energy strategy_application_mba_paper_3-20-2010

Executive Summary
Duke Energy (DUK) is one of the nation’s largest electric power company serving more than 4 million U.S.
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customers with 35,000 GW of generating capacity in the Midwest and Carolinas. By 2008 revenue, they are the
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10 largest investor owned utility. DUK was originally formed in 1917 as Wateree Electric Company, later
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changing its name to Duke Power Company in 1924 . Through CEO Jim Roger’s recent leadership has become
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known for leading changes on the greenhouse gas reduction front, even though, DUK is the U.S.’s 3 largest
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producer of CO2 and 12 largest in the world. DUK operates a broad differentiator, where they operate to
improve their differentiation [through I and C in EQIC] and cost structure [E in EQIC], simultaneously. A thorough
analysis of the electric industry and Duke’s place within the industry is detailed in a later section.
Mission
As stated on the DUK website, the mission is to “make people’s lives better by providing gas and electric
services in a sustainable way. This constantly requires us to look for ways to improve and to reduce our impact on
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the environment. ”
Objectives
Stated and/or implied objectives include (profit) achieving long-term profitability of 4-6% adjusted diluted
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earnings per share , (growth) expand their commercial business through wind development moving from a top 10
to top 5 as U.S. largest wind operators, (citizenship) to continue taking the utility lead in climate change, while
remaining good corporate steward, and finally (survival) to avoid bankruptcy as it looks to expand and modernize
its generation feel with capital expenditures between 2010 and 2012 of $14 billion to $15 billion.

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Stated and/or implied strategies have included DUK completed it horizontal merger with Cinergy in April
2006.

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An additional strategy used was concentric diversification in May 2007 when DUK purchased the Austin,

Texas based Tierra Energy, a wind developer from Boston’s Energy Investor’s Funds.

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This leveraged their

commercial, overall utility industry expertise and operations in the value chain. In January 2007, DUK retrenched
by spinning off Spectra Energy, a mid-stream gas operations to allow it focus on its electric operations.

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Industry and How It Operates
While the physics of electric generation has not changed, the technological advances over the past 100
years have changed the environment.

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Currently, electric cannot be stored so much like a service industry, it

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must be generated and delivered to match customer demand. Each utilities is required to maintain a reserve
margin, similar to a safety stock in manufacturing against maintenance, planned and unplanned equipment
outages and variations in usages which can occur from changing weather, economics, etc.

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From a value chain perspective, see attachment 1 providing an overview of the electric utility industry.
First the electric generation requires a fuel source, which could vary between coal, nuclear, natural gas, wind
energy. The fuel is changed into electricity that is sent over power lines, where electricity is lowered in voltage in
the distribution network where it is delivered to the final consumer.
The electric industry is a huge and mature industry but still fragmented as there are 3,273 traditional
utilities.

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A map of larger electric utilities taken prior to DUK’s merger with Cinergy in April 2006 is found at

attachment 2. Historically, regulated utilities have operated as a natural monopoly. A natural monopoly created
economies of scale, more efficient service and lower prices.

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Because the federal government considered supply

of electricity a necessity, it has long supervised the industry extremely closely from state regulators.

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The Public Holding Act of 1935 [PUCHA] created barriers to entry preventing outsiders from constructing
and operating electric generating facilities.

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The utilities agreed to provide integrated electric services to retail

customers in trade for the exclusive right to operate with a given state.

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The state regulators play a big role in

determining a utilities return, since a rate change normally requires a rate cases.
fine line between balancing investors and customer’s best interest.

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The regulators have to walk a

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While there many types of electric utilities including cooperatives, municipals, state and federal utilities,
investor owned utilities like DUK make up 75% of the industries revenue and volume.

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While there had been a

movement toward competition starting in the early 1990’s, but it reversed course following un-regulated trading
issues with companies like Enron in the early 2000s. As of 2008, 14 states including Ohio, where DUK operates,
allows the customers to select alternative power suppliers.

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Following the repeal of PUCHA in December 2005, it was anticipated that a wave of consolidation would
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take place . However, this consolidation never materialized as two major mergers [Florida Power and LightConstellation and Exelon – Public Service Enterprise Group] in 2006 were terminated in trying to obtain approval
from the state regulators.

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Given its maturity with limited growth within the U.S., companies invest in wholesale energy marketing,
trading and international operations.

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These can add major risks [e.g. liquidity, political risks, and foreign

currency translation] to the companies over their regulated operations, increasing risk of losses and bankruptcy.

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Action Items
This strategy application paper will address what DUK should do to achieve their growth and profit
targets, while being a climate change leader and modernizing / de-risking its current fleet from a CO2 perspective.
And, as indicated in this strategy application, our conclusion is that DUK should continue to pursue a competitive
strategy as a broad differentiator which will allow them to remain competitive in a mature industry and allow them
to adjust should competition open up further nationally. DUK should pursue more forward integration by creating
additional joint ventures in transmission which would help to increase the wholesale energy prices and allow for
development of wind projects, which will create growth opportunities as an operator. DUK should also divest of
their Crescent Resource LLC, joint venture with Morgan Stanley since it is not DUK’s core business and DUK does
not really add value much to the business.
Financial Audit
Liquidity and Capital Structure: DUK’s overall liquidity position is stronger than the industry average
leaving room for pursue strategic opportunities and ability to weather the economic recovery, but also pointing to
a risk aversion from upper management. Even while sales have remained flat between 2007 and 2009, the net
profits have continued increasing given their cost savings initiatives (Sales: 12,731-2009, 13,207-2008, 12,7202007; Net Profit: 1,824-2009, 1,773-2008, 1,794-2007). It is important to note that regulated utilities often have
certain pass-through expenses (e.g. –fuel mechanisms), so rising revenues are not always indicative of improved
net profit. DUK has operated with positive net working capital, while its industry usually runs at a net working
liability (1,678-2009, 892-2008; -211-I).
Total liabilities to equity provide while increasing from 1.34 in 2007 to 1.62 in 2009 still remains well
below the 2.73 industry average. DUK is also below industry averages in total liabilities to assets (0.62-DUK; 0.73I). DUK has less current to total debt than the industry average (0.12-DUK, 0.15-I). All three of these ratios both
indicate management’s risk aversion.

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Performance: Another positive part in the Company's results is that the company has managed to reduce
cost of goods sold through improved fossil and nuclear plant availability (60.93%-200i9, 63.38%-2008), moving just
below the industry average (64.8). This reduction results in a 6.7% improvement in the gross profit margin
(39.07%-2009, 36.62%-2008). Improvements in gross margins create even better improvements in net margins.
The company’s return on fixed assets has declined as assets have increased, possibly the result of a
regulatory lag coming adding assets but waiting for their returns in rate cases (Return on Assets: 3.20%-2009,
3.34%-2008, 3.61%-2007; Total Assets 57,040-2009, 53,077-2008, 49,704-2007); the ratio even while declining
remains higher than the industry average at 3.2%. In the near-term, the DUK plans to offer voluntary severance
packages to some of its employees and consolidate corporate office functions to remain cost effective.

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DUK’s

higher than industry ROE comes from operating in favorable constructive regulatory environments [attachment 3]
and being able to squeeze costs following rate cases, where the company benefits and delaying future rate cases
(ROE: 8.39%-2009, 8.45%-2008, 8.46%-2007; 6.0% -I).
Activity (including control): The Company while not turning over fixed assets or total assets near the
industry average because DUK sales are not high for their given amount of assets (Fixed Assets Turnover 0.342009, 0.91-I; Fixed Asset Turnover 0.22-2009, 0.40-I). They seem to make up for it with their higher NP as % of
sales [22.2%-2009; 3.9%-I). Over time, it may be necessary to using assets to increase turnover and revenue rather
than focusing on cost initiatives like voluntary severance to maintain current returns. Inventory turnover is 5.12x
compared to an industry average of 22.9x. Part of the increase relates to an increase in coal inventory at the end
of 2009, but part may because coal plants use different grades of coal depending on the amount it is scrubbed and
the risk adverse management fearful of stock outs.
Limits (including resource availability from external sources and improved operations): While increasing
debt is based upon equity is possible, it is overly optimistic to assume they would be able to increase debt $23.98
billion, especially given the current credit market just starting to open up. It seems more reasonable that based
on the amount of total assets to be able to increase their debt by $6.437 billion. And, currently the company is
more efficient than the industry in collecting on accounts, so there is no room for improvement here. There is
room for improvement in inventory turnover as it only turns over every 71 days against an industry average of

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every 22 days. It is overly optimistic to assume moving to the industry average, but it would seem logical that it
could show some marginal improvement.
Competitive Advantage
Efficiency: DUK has strong management and operating capabilities. DUK’s heat rates that are
consistently best in industry and when coupled with higher availability have lowered DUK’s operating costs
[attachment 4 and 5]. A heat rate is how efficiently the generator converts the fuel to electricity.

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The strong

operating capabilities are driven by a strong maintenance program, where the DUK’s management views
generating assets as long-term assets.
capacity factor.

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During 2009, it was their 10 consecutive year exceeding a 90% nuclear

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Management has a strong eye on cost containment as displayed by their exceeding their $150 million
target for O&M reductions in 2009.

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This has allowed DUK to keep their operating and maintenance expense flat

for three years, absorbing inflation during the period.

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During 2010, DUK plans voluntary severance packages

and office consolidations to increase efficiencies. Even the cost reductions, management’s safety has trended
better because of its safety culture and as a result, it helps minimize financial impacts caused from employee and
contractor accidents and fatalities.

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The utilities are operated in favorable regulatory states [attachment 3]. The two main service territories
in the Midwest and Carolinas are contiguous allowing for greater economies of scale of maintaining and serving.
Since Ohio has competition creating a quasi national [state] competitive environment, it forces DUK to constantly
improve and not become compliant from a cost perspective since switching costs are low for customers. DUK is
expanding new generation to their fleet, while the cost of capital is low.

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Quality: DUK has high quality transmission and distribution assets that result in higher service availability,
given its commitment to proactively prevent outages before they occur.

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Average service availability has to be
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one of the most important components of power quality. Although the Southeast has the 2 highest incidents of
lighting in the country and occasional severe weather like hurricanes, DUK averages 99.97%, well above other
utility companies because of its effective operations and high quality assets,.

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The other component of quality is

the number of outages experienced. DUK’s average interruption frequency ranks high amongst competitors in
low outage occurrence at 1.04.

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Innovation: First, Management like CEO Jim Rogers is forward thinkers. By being a leader in greenhouse
reduction, it gives DUK a seat at the table for shaping policies. Their ways of thinking about energy efficiency as a
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5 fuel [along with coal, nuclear, natural gas and renewable energy] creates a 1st mover advantage, which could
be critical, should the industry continue shifting toward increased competition.
DUK’s pushing for smart grid will create two way communications with customers creating differentiation
and enhancing customer value. It will improve DUK’s outage detection, so customer would not need to call when
power is lost, increase service restoration following a storm, and allow for deployment of self-healing circuit. A
self-healing circuit would minimize the outage footprint by automatically switch devices on the distribution system
to restore power to as many customers as possible and isolate the trouble portion of the line.

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It would also

help to decrease the cost of meter reading and the costs associate with having to send personnel to the field to
connect and disconnect. Plus, it will enable customers to better optimize their energy usage and lower their
carbon footprint. Management will be able to offset its cost through a $200 million federal stimulus award, so
making it lower cost for its customers.

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Management has a strong understanding of value creation. They realize their energy efficiency and
smart meter grid initiatives will push the kilowatt hours down on existing meters. DUK is already working with
their five state regulators to address ways they can grow their revenues and shift the paradigm.

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For example,

DUK’s Management plans on pushing for addressing the regulatory lag between cost /capital spending and
recovery as their rate base will be increasing by $8 billion through 2014.

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This will help to increase DUK’s cash

flow and earnings. Rate mechanism could also help to reduce the lag and looking at forward test years rather
than historical would help to offset the regulatory lag.
Management has been an early mover on integrated gasification combined cycle [IGCC]. This turns coal
into gas before being combusted, which helps to lower emissions of sulfur dioxide, particulate and mercury.

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This

could be a technological game changer because of the overall availability of coal particularly in the Midwest and it
provides a platform for capturing carbon dioxide.
Customer Responsiveness: Customer responsiveness serves as way of keeping states from shifting to
competition, if customer service remains high. Customer responsiveness is crucially important in states like Ohio
where competition allows customers to change suppliers given the low switching costs. The smart meter grid as

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discussed will give the customer more power over their energy usage, carbon footprint. When a storm strikes, it
will not be necessary to call the utility to let them know. Since DUK knows faster, it will increase storm restoration
times, minimize the impact on customers and leave them feeling more satisfied. Being able to cut off meters over
the phone, will make power on and off not require the use of crew, which can a times be a constraint.
DUK has strengths with its economic development department. It was named by Site Selection magazine
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as one of its top 10 for the 11 straight year after helping to bring 12,000 new jobs and $3 billion in investment
over their five state service territory.

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Site Selection stated that what made their team differentiated was its

“power web resources [www.locationdukeenergy.com]” and their three person team of internal site consultants
that focused on various industries.

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Having internal consultants, allows Duke to control their quality than if it

were outsourced.
Another way of being responsible to its customers is leveraging it I/T competencies, where it provides
outage maps online to all 5 states in its service territory.
customers to sign up for twitter updates on storms.

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From a social media perspective, DUK also allows

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Porter’s 5 Forces
Threat of New Entrants: Low – Even with PUCHA repealed in December 2005, state regulators in 36 states
like North Carolina, South Carolina, Indiana and Kentucky control if competitors can enter. As discussed, the
utilities exchange their provider of last resort for agreeing to be sanctioned by the state regulators The utilities
operating as utilities can less the chance of competition entering by maintain a high level of service regardless of
its lack of competition. In the other 14 states including Ohio, utilities require significant capital to build
economies of scale to spread the high fixed property plant and equipment costs. Any second mover would be
fighting with existing companies with larger market share. New companies would lack the established name,
making it expensive from a marketing perspective to capture market share.
Power of Suppliers: Medium – because as coal fleet requires specific sulfur content depending on the
portion of plants scrubbed. While most gas and coal contracts are done with long-term contracts with little spot
contracts. The nuclear is much higher as technical complexities [switching costs] of changing fuel fabrications is
sourced through a single supplier. Plus, DUK like other utilities does not possess many generating facilities outside
of natural gas /fuel oil plants that can change fuel types like a flexible manufacturer. Plus, the operating and

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maintenance work force representing 25% of the total work force is represented by unions, so there is always the
threat of a strike.

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Power of Buyers: Low as residential customers is a relatively small portion each collectively. Four of the
five states are regulated so little choice/alternative for consumers. The buyers’ true power comes through their
interaction with the regulators at the state commission and power in numbers if united as a single voice. If there
were enough consistent complaints, the regulators might consider creating rules making the utility’s life more
difficult and creating more burecratic costs. For example, if customers have trouble getting through the call
center, the regulators could institute a mandatory service level that may raises its operating costs. The industrial
and commercial customers have medium power because the revenue and volume side is more significant. While
a utility could sell the excess capacity, it may be constrained by the overall economic situation and availability of
transmission to move the power.
Rivalry among Established Companies: Depends on if regulated or non-regulated/competitive
environment – Low in four regulated states [North Carolina, South Carolina, Indiana and Kentucky] where state
regulators can hold out competition. It would be high in Ohio where competition causes fierce rivalry. In Ohio,
DUK could use excess capacity to use as threat to new entrants driving down prices to a point where entry would
not be profitable. DUK could also manage the rivalry through non-price competition like the reliability of their
power. Larger utilities like DUK fill the gaps through product proliferation by targeting all aspects of the market –
residential, commercial, small commercial, municipals, governmental, street lights and industrial. In competitive
markets, existing competitors could cut prices to signal to price competitors that new entry will be met with price
cuts. DUK may even be able to price signal as long it did not appear the electric utilities were colluding.
Threat of Substitute Products: Low as no/few substitutes for power [e.g. wood stoves, producing own
renewable power] so switching costs are very high. At the present, producing your own renewable energy via a
wind turbine or solar panel is still relatively high on the cost curve making it less of a substitution threat until
technology brings the costs down.
The sixth force has been called the complementors. The gas industry would be theirs since most
customers would have both electric and gas and it could result in one bill and point of contact. There are primary

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and secondary value chain components that could be leveraged across electric and gas [e.g. supply chain,
operations, maintenance, billing collections, finance, customer service and tax].
SWOT Analysis
Strengths
• Management team forward thinkers [e.g. smart grid, renewable energy, energy efficiency, cap and trade,
different rate structures] and strong understanding of the value chain.
• Strong operating and maintenance capabilities have led to high availability. Plants have some of the best heat
rates in the industry [attachment 5].
• Regulated operated in favorable regulatory environments [attachment 3].
• Strong economic development and consulting around businesses.
• Strong management focus on cost-containments.
• Even with cost-reductions, customer satisfaction levels remained significantly higher than the national
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average.
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• For the 3 year in a row, viewed as one of the world’s most ethical companies by Ethisphere Institute.
Weaknesses
• Freezing of non-operating personnel could lead to motivation issues and conflicts with unions, whom were nonfrozen.
• Complexity of multiple businesses creates burecratic costs [see attachments 6 and 7].
• Limited domestic growth in industry creates propensity for more risky investments like in international, where
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had to abandon Greek investment in Attiki, Greece in December 2009.
• Cost containment may eventually lead to long-term costs, if stripped too low [e.g. more storm repair costs from
cutting maintenance costs like tree trimming].
• Management may be slow to employ capital given their risk adverse tendencies.
Opportunities
• Balance sheet has room for levering expansion.
• As a pioneer in greenhouse gas reduction, should have opportunity to influence national policies.
• As leader in smart grid and climate change, technology may change business model creating greater
opportunities by unfreezing the traditional model shown under Porter’s 5 forces and create first mover
advantages.
• As strong operator in fossil fuels and nuclear, could provide consulting services to other utilities.
• Low cost nuclear fleet stands to benefit from carbon legislation.
• U.S. still fragmented so bountiful merger and acquisition [M&A] opportunities.
Threats
• Economic recession may hinder state commission’s ability to justify legitimate rate increases or disallow prudent
fleet capital recovery.
• Economic recession continues to weigh on industrial volumes. During 2009, experienced a 15% reduction.
• Fuel costs are the largest and most variable operating expense and often the most uncontrollable as it is
influenced by your generation mix [e.g. coal, gas, nuclear, renewable] and availability of supply.
• Disaggregation of vertically integrated utilities may result in more competitors in the wholesale power
generation segment.
• Nuclear operation comes with great risks like the potential for just one nuclear incident to occur having a
material impact on their operations.
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• Large carbon footprint with 60% of generation coming from coal. Risk of pending carbon legislation.
• Single supplier in nuclear fuel fabrication creates concentration risk and represents nearly 39% of fuel
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generation.
• Commercial international assets pose risk to other countries politics, laws, taxes, economic conditions and
foreign currency translation [e.g. December 2009 abandoned Greek investment].

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National or regional deregulation places downward pressure on power prices which lowers wholesale margins.
Treasury yields are projected to increase so higher interest expense for fleet modernization program.
Sales may decrease without adequate, reliable, affordable access to transmission assets.
Even with bountiful M&A opportunities, regulators possess approval power and for multiple states can request
favored nation status. This may lead to more of the benefit to the consumer making mergers more apt to
destroy shareholder value.
Issues
DUK has several issues that to be addressed to achieve the 4-6% adjusted diluted earnings per share on

sustainable basis. The first issue that needs to address is figuring out how much cost containment can be done
before it starts creating negative consequences. For example, the cost containing initiative of freezing nonoperating personnel’s salaries, cutting discretionary travel, and not re-hiring after offering severance packages
could take a toll on employee motivation. At which point in the economic recovery should DUK shift to looking at
top line revenue and the opportunity costs of missing out on potential opportunities.
The second issue is that Duke Energy even while on the fore-front of reducing greenhouse gases, it is still
the third largest emitter of carbon in the U.S.

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The proposed legislation could potentially make it economically

unfeasible to run its coal plant crippling their generation capacity and force them to buy power to meets it
provider of last resort by purchasing power from others at a much higher costs. Generally, purchased power costs
are cost pass-through, while generating assets earn a return on the investment which increases profitability.
The third issue is in trying to mitigate their carbon risk and modernizing its fleet of generation, they need
to be very prudent with the capital spending. The economic recession pressures are making it difficult for
regulators to justify legitimate rate increase. For example, in January 2010 Florida Power and Light was only
awarded $75 million of $1.3 billion in requested rate increases in Florida.

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Without spending on capital projects, it

would be very difficult for DUK to achieve its profit objectives without turning to riskier investments.
The fourth issue is deregulation could place downward pressure on long-term power prices, which may
result in impairment charges, loss of retail customers like in Ohio, lower wholesale margins and an increased cost
of capital that increases their cost structure.
The fifth issue is domestic growth is limited, so growth many require turning to higher risk alternatives like
wholesale energy marketing, trading and international operations. As we have seen, international assets carry risk
given their having to walk away from their Greek assets in December 2009. These types of investments would
erode their credit risk, raise their cost of debt and weighted average cost of capital.

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The sixth issue is that without transmission capacity, DUK may not be able to move its power effectively
or be able to develop its wind projects that require transmission lines to move it to denser populations. It may
result in lower wholesale pricing, which lower net margins and profitability and limit their ability to develop wind
energy. The construction of lines can be very costly and requires having right of way access through other
companies’ service territories.
The seventh issue is that DUK’s broad ranging business segments create burecratic costs for reporting and
coordination. DUK has complexity from managing utilities in five states, non-regulated assets across the U.S.,
Central America, and South America and managing its joint venture real-estate land development and real estate
development company. Burecratic costs hurt their ability to be a broad differentiator by increasing their cost
structure.
Alternative Strategies
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Forward integration (Full Accept) – Create more transmission joint ventures to ensure adequate lines to
more power effectively. [Note: viewing DUK primarily a power generators]
Backward integration (Reject) – Purchase a barge company to transport coal.
Horizontal integration (Reject)-Purchase an adjacent utility company like E.ON U.S.
Diversification (Reject) – Leverage operating and maintenance capabilities to consult utilities and nonregulated fleet operators in both coal and nuclear.
Retrenchment (Full Accept) – Sell the remaining Crescent Resources, LLC interest, which is a joint venture
land management and real estate development company with Morgan Stanley
Competitive Strategy (Full Accept) – Broad differentiator.

Evaluation and Recommendation
Forward integration (Full Accept) – DUK could practice forward integration by creating more joint
ventures to ensure more transmission lines. Since the Federal Energy Regulatory Commission {FERC] is offering
higher return on equity incentives, it would help DUK to increases its profit objective. It would help DUK to solve
the issue of transmission constraint, which would help to improve its wholesale energy prices on a long-term basis
and make it able to develop wind projects allowing it to grow into a more leading wind operator. As an extra
benefit, it also increases grid reliability for customers.
In August 2008, DUK started a joint venture with American Electric Power called Pioneer Transmission,
which began in August 2008. It could leverage the learning curve from this initial project, and use some existing
higher level management. It would use DUK strengths of managing transmission lines, which it already possesses.

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While it create another reporting entry, the burecratic costs would not be great since DUK could build on its
economies of scale. It would also provide DUK with greater buying power over its transmission pole and wire
suppliers. Since the transmission line would be a regulated asset, it would require gaining the buy-in of the FERC
and obtaining another competitor, whose service territory it ran through. This allows them to get access into
another market and share the costs and risks. The downside is you might risk giving away some of your
competitive advantage to your competitor and you lose some control over the project, which could impact its
quality.

If DUK is worried about the loss of a particular advantage, they could hole it off from the rest of the

project.
From a production prospective, it would initially involve a lot of engineering design and potentially hiring
more staff and outsiders, if we did not have enough capacity and this would shift to the construction phase after
being approved. It is important to remember that building a large transmission project often takes 5 years, so it
would not prudent to overwork your employees by working them on both and risk burnout and turnover. If DUK
was able to use internal staff that normally were allocated to operations and maintenance expense, the time spent
could be capitalized and result in higher profitability. Given the 240 miles Pioneer project from Kokomo, Indiana
to Evansville, Indiana was only $1 billion in total for DUK and American Electric Power, DUK has plenty of leverage
on the balance sheet, which was estimated to be at least $6.4 billion.
Backward integration (Reject) – DUK similar to AEP could practice backward integration by purchasing a
barge company for transporting coal to theirs and other coal plants.

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This does not seem to fit with DUK strategy

of moving away from carbon based assets like fossil fuels since they have a potential huge exposure to carbon.
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More of DUK’s generation has shifted from coal to nuclear. Integrating with barges would only make it even
harder to exit the coal industry since it is a complementary service to coal.
Horizontal integration (Reject)- Purchasing an adjacent utility like E.ON U.S. This would provide a means
for domestic growth and meeting the 4-6% growth in diluted earnings per share as it extracted operating synergies
from an adjacent service territory similar to the Cinergy transaction. Familiarity of the regulatory environment
would help Duke, but its purchase would like require some divestment of assets to clear the market power issues
in Kentucky with Duke already owning assets in Northern Kentucky. This would be rejected because E.ON U.S.

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produces 97% of its generation from coal, so it would only increase it already sizable carbon footprint and this is
not prudent given the potential threat of carbon legislation in the near-term.
Diversification (Reject) – DUK could practice diversification by leveraging their operation and
maintenance capabilities to consult other utilities and non-regulated fleet operators in coal and nuclear operation.
This would help the objective of achieving long-term growth of 4-6% in diluted earnings per share at least in the
near-term and solve the issues of limited domestic growth. Since it is more people and knowledge expertise than
assets, if it did not work out, you could always layoff these employees to minimize their risk.
The reason that it is rejected is sharing this competitive advantage allows your competitors to even the
playing field. It would improve their operations and if the markets were to move to increased competition, it could
be used against DUK. Creating a consulting arm would also add burecratic layers of reporting. Plus, revenue may
be higher in the beginning as companies are willing to move up the learning curve, but after the initial consulting,
utilities may be apt to rely on their in-house employees. This may result in a short-term revenue stream that is not
sustainable and may be detrimental in the long-run.
Retrenchment (Full Accept) – DUK could sell its Crescent Resources LLC joint venture stake with Morgan
Stanley. DUK would be able to redeploy its capital to meet long-term profit earnings objective and invest more in
wind development for growth objective. This would solve the issue of reducing their burecratic costs by lowering
their complexity and reporting structure. Management would require the involvement of human resources and
legal department given the potential people issues of separating the two entities. Management could use the
opportunity to highlight their strong electric focus, where their true value chain strengths are found. From a
marketing perspective, it would not really impact their 4 million electric customers, but certainly a strong
communication plan would need to be developed to communicate the rationale to internal and external parties.
This would not truly have any impact on the production because their true production is creation electricity, not
managing and developing real estate, which is really a separate industry. Because it is divesting, it would not
require funding, but it would be important for management to lay out the future plans for the re-deployment of
capital.

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Competitive Strategy (Full Accept) – DUK should continue its broad differentiation strategy. This helps
DUK to achieve it long-term growth objective of 4-6% earnings per share. This helps solves the issue of
recessionary pressures make it difficult for state regulators to justify rate increases by keeping the operating cost
component lower. By keeping the cost component low, it also gives Duke more of an opportunity to deploy some
of those offsets into capital expenditures by modernizing its generating fleet, which helps to de-risk the DUK partly
against the potential of carbon legislation. Having lower costs also would help to keep potential new entrants out,
if states began moving more toward competition. The second part of being a broad differentiator is also providing
differentiation or value at the same time.
Management should continue to pushing its costs containment, but should ensure that it is not negatively
impacting other quality factors like safety and system availability through monitoring of results. By DUK being a
leader in greenhouse gas reductions, it gives DUK a chance to influence the policy. Management should continue
pushing to be on the leading edge of energy efficiency, smart meter-smart grid, cap and trade and different pricing
structures. These will lead to first mover advantages like smart grid having quicker restoration times, which is a
non-price competition. These first mover advantages would be crucial should competition open up in their 4 out
of 5 states they operate [North Carolina, South Carolina, Indiana and Kentucky].
Marketing should evaluate the states they operate to determine those key differences that Duke provides
that their competitors does not, for example, lack of outage map reporting and mobile phone communication in
Kentucky. It can be used as soft justification for higher return on equity in rate cases that result in higher
profitability and also be used to capitalize on any market that would open up to competition.
Given the low cost of debt, production should be constructing already approved generating plants as
quickly and safely as possible. It provides them with a cost savings over competitors that lag and end up with
higher interest rates as treasury rates rise. Production should also continue looking at cutting edge technologies
like IGCC, which provide them with more fuel flexibility [differentiation], which allows them more flexibility in
meeting their demand at the lowest costs.
DUK should have plenty of financial capital to pursue this strategy considering they have at least $6.4
billion in capital available. It would be even more if they were able to monetize their joint-venture Crescent
Resources LLC.

14 | P a g e

Duke Energy Balance Sheet
Source: Mergent Online

Currency

12/31/2006

Auditor Status
Consolidated

12/31/2009

12/31/2008

12/31/2007

USD

Standardized Annual Balance Sheet

USD

USD

USD

Not Qualified
Yes

Not Qualified

Not Qualified
Yes

Not Qualified
Yes

Millions

Millions

Millions

Scale
Cash & Equivalents
Short Term Investments

Yes
Millions

1,542

986

678

948

-

437

1,514

1,115

2,462
2,256

Cash & Equivs & ST Investments
Receivables (ST)

1,542

51
1,037

1,741

1,653

Inventories

1,515

1,135

1,767
1,012

968

-

2

28

1,448

1,029

836

4,925
46,056

58,330

Assets Held for Sale (ST)
Other Current Assets

1,358

6,940

5,766

5,273
50,304

Accumulated Depreciation

55,362
17,412

16,268

14,946

Net Property Plant & Equip

37,950

34,036

31,110

16,883
41,447

130

134

153

224

2,201

1,909

115

134

2,625

4,080

4,943
3,517

5,362
2,461

Other Assets

2,533

5,400
3,748
2,577

9,080

Deferred LT Assets

2,953

2,552

Total Assets

57,040
2,040

53,077

49,704

68,700

2,026

2,113

2,422

1,390

1,477

1,686

Accrued Expenses

650

Current Debt

902

549
1,189

1,585
528
2,268

Other Current Liabilities

1,146

1,130

1,327

2,136

Total Current Liabilities
LT Debt & Leases

4,088

5,708

16,113

4,345
13,250

6,613
18,118

Deferred LT Liabilities

5,615

5,117

Minority Interests
Other Liabilities

136
9,338

163
9,214

4,751
181
8,367

Total Liabilities

35,290

Common Share Capital

1
20,661

32,089
1

Total Current Assets
Gross Property Plant & Equip

Receivables (LT)
Assets Held for Sale (LT)
Long Term Investments
Intangible Assets

Accounts Payable & Accrued Exps
Accounts Payable

9,498

28,505

4,243

736
2,055

7,003
805
10,059
42,598
1

20,106

1
19,933

1,460

1,607

1,398

5,652

-372

-726

-133

595

Other Equity

0

0

0

0

Total Equity

21,750
57,040

20,988

21,199

53,077

49,704

26,102
68,700

Additional Paid-In Capital
Retained Earnings
Accum Other Comprehensive Income

Total Liabilities & Equity

19,854

15 | P a g e

Duke Energy Income Statement
Source: Mergent Online

Standardized Annual Income Statement
Currency
Auditor Status
Consolidated
Scale
Sales Revenue
Total Revenue
Direct Costs
Gross Profit
Selling General & Admin
Depreciation & Amortization
Other Operating Expense
Total Indirect Operating Costs
Operating Income
Interest Income
Gains on Sale of Assets
Foreign Exchange Gains
Other Non-Operating Income
Total Non-Operating Income
Earnings Before Tax
Taxation
Minority Interests
Equity Earnings
Discontinued Operations
Extraordinary Items
Accounting Changes
Net Income
Preference Dividends & Similar
Net Income to Common
Average Shares Basic (Actual #)
EPS Net Basic
EPS Continuing Basic
Average Shares Diluted (Actual #)
EPS Net Diluted
EPS Continuing Diluted
Shares Outstanding (Actual #)

12/31/2009
USD
Not Qualified
Yes
Millions
12,731
12,731
7,757
4,974
0
1,656
1,105
2,761
2,213
-674
36
23
581
-34
1,761
758
10
70
12
0
0
1,075
0
1,085
1,293,000,000
0.83
0.82
1,294,000,000
0.83
0.82
1,309,000,000

12/31/2008
USD
Not Qualified
Yes
Millions

12/31/2007

12/31/2006
USD

USD
Not Qualified
Yes
Millions

Not Qualified
Yes
Millions

13,207
13,207
8,371
4,836
0
1,670
724
2,394
2,442
-611
69
-20

12,720
12,720

15,184
15,184

7,827
4,893
0
1,746
649
2,395
2,498
-493
-5
14

9,647
5,537
0
2,049
596
2,645
2,892
-1,063
291
8

729
167
1,993
616
-4
-102
16
67
0
1,362

324
-160
2

369
-395
2,191
843
61

0
1,362
1,265,000,000
1.08
1.01
1,268,000,000
1.07
1.01
1,272,000,000

0
2

1
0
0
0
0
0
2

1,260,000,000
1.19
1.21
1,266,000,000
1.18
1.2
1,262,000,000

732
-156
0
0
1,863
0
1,863
1,170,000,000
1.59
1.73
1,188,000,000
1.57
1.7
1,257,000,000

16 | P a g e

Duke Energy
Financial Audit Form
Y1
Y2
Y3
Y4
2009
2008
2007
2006
Millions
Millions
Millions
Millions
18,881,476 $
57,040 $
53,077 $
49,704 $
68,700
7,704,922
12,731
13,207
12,720
15,184
300,492
2,833
3,341
3,217
2,030
13,812,684
4,088
4,345
4,345
6,613
5,068,792
21,750
20,998
21,199
26,102

Industry [Troys]
Assets
Sales
Net Profit
Total Debt
Stockholder Equity
LIQUIDITY

Millions
Millions
Millions
Millions
Millions

$

Ability to Meet Short Term Obligations

More Li qui d

More Li qui d

Les s Li qui d

More Li qui d

Comments
<-- shows that Duke is large and has economies of scale
<-- Revenue fell following 2006 after spin off of Spectra Energy
<-- Net profit fell following 2006 after spin off of Spectra Energy
<-- Total debt fell following 2006 after spin off of Spectra Energy

<-- less risk averse than competitors, leaves room for expansion

Current Ratio

CA/TCL

0.90

1.41

1.21

0.86

1.05

Net Working Capital

CA-TCL

(211,834)

1,678

892

(783)

<-- most competitors run at deficit, but the have net working
327 capital, not net working liability

Removes inventory liquidity

More Li qui d

Quick Ratio
(CA-INV)/TCL
CAPITAL STRUCTURE
Risk & Cost of Capital Conclusions
Total Liabilities/Equity
(TCL+LTD)/SE
Total Liabilities/Assets
(TCL+LTD)/TA
Current Debt/Total Debt
CD/TD [tcl /td]
PERFORMANCE
Look at all ingredients

More Li qui d

More Li qui d

More Li qui d

0.50

1.04

0.94

0.69

0.84 <-- excluding inventory still risk averse compared to competitors

2.73
0.73
0.15

1.62
0.62
0.12

1.53
0.60
0.14

1.34
0.57
0.20

1.63 <-- less risk averse than competitors, leaves room for expansion

<--- recent high performance at fossil and nuclear moved their
36.47% gross profit above the industry average
63.53%
13.37% <-- earning a good profit, even with less sales for given assets
2.96%
<-- consistently a higher return on equity - positive favorable
RR Net Worth %
NP/SE
6.0%
13.03%
15.91%
15.18%
7.78% regulatory environments
Note: 2006 not comparable to other years because of spun off, midstream gas operations into new company Spectra Energy on January 3, 2007

Gross Profit Margin
CGS % Sales
NP % Sales
RR Assets %

GP/SALES
COGS/SALES
NP/SALES
NP/TA

38.60%
61.40%
3.9%
3.1%

39.07%
60.93%
22.25%
4.97%

36.62%
63.38%
25.30%
6.29%

17

38.47%
61.53%
25.29%
6.47%

ACTIVITY
Draw control conclusion

Wors e

Wors e

Wors e

COGS/INV
365/INV TURN

22.9
16 days

A/R Turnover
AR Collection (Days)

SALES/AR
365/AR TURN

6.6
55 days

7.31
50 days

7.99
46 days

7.20
51 days

FA Turnover

SALES/NFA

0.91

0.34

0.39

0.41

TA Turnover
LIMITS
Stock
Debt
Improved Operations

SALES/TA

0.40

0.22

0.25

0.26

Inventory Turnover
Inventory Days O/S
Draw control conclusion

5.12
71 days
Good

Participants: [Numbers Provided from
Industry [Troys]
Mergent]
Current Assets
10%
1,906,507
Accounts Receivable, net
9%
1,700,470
Inventory
1%
206,037
Net Fixed Assets
45%
8,435,375
Total Assets
100.000
18,881,476
Current Liabilities
15%
2,118,341
Long-Term Debt
53%
7,324,107
Total Liabilities (TD)
73%
13,812,684
Stockholder Equity
27%
5,068,792
Total Liabilities + SE
100.000
18,881,476
Sales
100
7,704,922
Cost of Goods Sold
61%
4,730,822
Sales & Admin Exp
N/A
Gross Profit
100.0
2,974,100
300,492
Net Profit [after TAX]
<-- used tax rate
based on 4 year
effective rate rate
of Duke Energy
[see numbers to
Tax
36.67% the left]

7.38
49 days
Good

7.73
47 days
Good

Wors e

<--- worse because fear of stock out for regulated utility; fits with
conservative nature; very high increase in coal inventory at
7.10 current year end
51 days

Good

6.73 <-- could indicate positive credit collection policies
54 days
<--- Duke sales are not high when compared to the amount of
0.37 fixed assets
<--- Duke sales are not high when compared to the amount of
0.22 fixed assets

23,980 <-- Not realistic given the tightening credit markets
6,437 <--- Seems more realistic given the tightened credit markets
1,174 <--- Part of this may be realizable, but certainly not the total amount shown above for inventory improvement

2009
5,766
1,741
1,515
37,950
57,040
4,088
16,113
35,290
21,750
57,040
12,731
7,757
N/A
4,974
1,824

2008
5,237
1,653
1,135
34,036
53,077
4,345
13,250
32,089
20,998
53,087
13,207
8,371
N/A
4,836
1,773

2007
4,925
1,767
1,012
31,110
49,704
5,708
9,498
28,505
21,199
49,704
12,720
7,827
N/A
4,893
1,794

2006
6,940
2,256
1,358
41,447
68,700
6,613
18,118
42,598
26,102
68,700
15,184
9,647
N/A
5,537
2,030

43.04%

30.91%

34.25%

38.48%

18

Limits Calculations
Total Shareholders' Equity
21,750
20,998
21,199
26,102
SE * Industry D/E Ratio:
2.73
59,270
57,220
57,768
71,129
Subtract Total Liabilities
35,290
32,089
28,505
42,598
Amount debt can be increased based on Equity
23,980 $
$
25,131 $
29,263 $
28,531
The $23,980 seems far fetched given the tight credit markets
Total Assets
57,040
53,077
49,704
68,700
TA * Industry D/A Ratio:
0.73
41,727
38,828
36,361
50,257
Subtract Total Liabilities
35,290
32,089
28,505
42,598
Amount debt can be increased based on Assets
6,437 $
$
6,739 $
7,856 $
7,659
The $6,437 seems like a realistic total given the condition of the tight credit markets
A/R Days less Industry A/R days
50 - 55 =
46 - 55 =
51 - 55 =
54 - 55 =
55 days
(5)
(9)
(4)
(1)
Percentage of Company more (less) than industry
-70%
-117%
-60%
-11%
Divided by Company A/R days
-10.19%
-20.39%
-8.47%
-1.42%
A/R
1,741.0
1,653.0
1,767.0
2,256.0
Improved Operations Based on A/R Days
$
(177.4) $
(337.1) $
(149.7) $
(32.0)
Duke Energy collects faster than the industry, but could be more aggressive collection policy, but customers/regulators
may not find it beneficial
71-16 =
49- 16 =
47- 16 =
51-16=
Inv Days less Industry Inv days
16 days
55
33
31
35
Percentage of Company more (less) than industry
77%
67%
66%
69%
Inventory
1515
1135
1012
1358
Improved Operations Based on Inventory Days
$
1,173.6 $
764.4 $
667.5 $
932.0
Part of this upside is realizable, but 77% appears to be too aggressive; must be other inherent reasons they lag the
industry
Debt Money
23,979.719
25,131.485
29,263.219
28,531.113
Based on Debt

Based on Debt

Based on Debt

Working Capital Increase (total of improved Ops)
1,173.6
764.4
667.5
Part of this may be realizable, but certainly not the total amount shown above for inventory improvement
19

Based on Debt

932.0

Attachment 1 – Electric Value Chain

Source: http://www.wikiinvest.com/industry/Electric_Utilities
Attachment 2 – Map of Larger Investor Owned, Municipal, and Governmental Electric Utilities
PSD
MAM
PSD
AVA

PAC

EMRAF

XEL

AVA

PG

NWEC

NWEC

IDA

PAC

PAC

PAC

PCG

PAC

SRP

M EC

NPPD

AEE
AEE
AEE
AEE
OPPD

ILA
WR
ILA

UNS

NI

DTE

EDE

AEP

TVA

FE

TNP
AEP

PNM

ETR
HOU
CNP
CNP

City Public Service Board
of San Antonio
Lower Colorado
River Authority

POM

D
AEP

DUK

D
PGN

PGN

Santee Cooper

Jacksonville Electric Authority

SO
SO
CNL
ETR

FPU
PGN

Orlando Utilities Commission

TE

TNP
AEP

POM
PEG*

ETR

ETR
AEP

NST
NGG
UIL
ED KSE

SO

ETR

CNL

TNP

NU

AYE

SCG

TXU

TXU
EE

AEP
AEP

FE

UTL

PPL

AYE

SO
XEL

EXC*
PPL
CEG

DUK

ETR
AEP

FE

PPL FE

AYE

AEP

OGE

AEP

AYE

AYE

CIN

AEE
ILA

NU NGG
NU
NST
NGG NGG

CHG

AYE

AEP FE
AEP DPL AEP
FE

AES
AEE CIN
VVC
AEE
E.ON
E.ON
E.ON
AEE
AEE

EAS
FE
UGI

N N M GK
G
N N M GK
G

FE AYE

FE
FE

FE

TNP

UNS

Salt River Project

AEP

AEE

AEP

OGE
AEP

PNW
UNS

ILA

CV
CV

G

EAS

CMS

PGN

AEP
XEL TNP

PNW

GPX
EDE

PNM

PNW

Los Angeles SRE
Dept. of Water
and Power

ILA

AEE
ILA GPX

ILA

PNM

EXC*

MEC

Colorado
Springs Util.
XEL

M EC

LNT

MEC

EAS

WEC

LNT
LNT MGEE WEC

LNT

BKH
PAC

SRP
EIX

LNT

PAC
PAC

NGG

LNT

NG

XEL

BKH

IDA
IDA

EAS

WPS

XEL

XEL

NWEC

EAS

EAS

WEC

MDU

PAC

WEC

UPENWPS
WPS

OTTR

MDU

VEC

GM P

ALE

MDU MDU

PAC
IDA

OTTR OTTR

Austin Electric

FPL

Note: Just Prior to Duke Energy’s completed merger with Cinergy in April 2006
Source: E.ON U.S. Corporate Development
20

Attachment 3 – Duke Energy Business Model
State Commission
Profiles
North Carolina
Indiana
Ohio
South Carolina

Regulatory Ranking Out
RRA Rating
of 50 State Rankings
Above Average / 2 T-1 [with 3 other states]
Above Average / 3 T -5 [with 2 other states]
Average / 1
T -8 [with 8 other states]
Average / 1
T -8 [with 8 other states]
T-17 [with 15 other
Kentucky
Average / 2
states]
Source: SNL Commission Profiles [paid subscription required]
Conclusion: Geographically located in favorable regulatory environments
http://www1.snl.com/interactivex/CommissionProfiles.aspx?Printable=1

21

Attachment 6

Note: This does not even show their Commercial Assets and its complexity [see attachment 7 ].
Source: http://www.duke-energy.com/pdfs/01q09_org_chart.pdf
24

Attachment 7

Source: EEI International Utility Conference, March 15, 2010
http://www.duke-energy.com/pdfs/Slides_031510.pdf, Slide 13

25

Endnotes
i

http://www.duke-energy.com/about-us/default.asp
S&P Industry Survey – Electric Utilities - October 2009, Page 7
iii
Duke Energy History http://www.mergentonline.com.oberon.ius.edu/compdetail.asp?company2602&Page=hist...
iv
“Why the Coal Guy is Turning Green?” by Marc Gunther (October 14, 2009) http://www.marcgunther.com/2009/10/14/why-a-coal-guy-is-turning green/
v
http://www.duke-energy.com/about-us/charter.asp
vi
Duke Energy Investor and Analyst Meeting. Financial Overview, February 16, 2010, Slide 6
vii
Duke Energy 2009 10-K, Dated February 26, 2010, Page 36.
viii
Duke Energy 2009 10-K, Dated February 26, 2010, Page 36
ix
Duke Energy History http://www.mergentonline.com.oberon.isu.ed/compdetail.asp?company2602&Page=hist...
x
Duke Energy Value Line – November 27, 2009
xi
xii
S&P Industry Survey – Electric Utilities -October 2009, Page 12
xiii
Electric Power Industry Overview 2007. http://www.eia.doe.gov/cneaf/electricity/page/prim2/toc2.html
xiv
S&P Industry Survey – Electric Utilities – October 2009, Page 17
xv
xvi
S&P Industry Survey – Electric Utilities- October 2009, Page 9
xvii
xviii
http://www.wikinvest.com/Industry/Electric_Utilties and S&P Industry Survey – Electric Utilities – October 2009, Page 17
xix
xx
xxi
Electric Power Industry Overview 2007. http://www.eia.doe.gov/cneaf/electricity/page/prim2/toc2.html
xxii
xxiii
xxiv
xxv
S&P Industries Survey – Electric Utilities – October 2009, Page 23
xxvi
xxvii
http://www.energyvortex.com/energydictionary/haet_rate.html
xxviii
Duke Energy Corporation Investor and Analyst Meeting – Conference Call Transcript – February 16, 2010, Page 14
xxix
xxx
xxxi
xxxii
xxxiii
ii

26

xxxiv

http://www.considerthecarolinas.com/rates/service-quality.asp
http://www.considerthecarolinas.com/rates/service-quality.asp
xxxvi
www.dukepower.com/ecdev
xxxvii
“New Technologies for Smart Grid” by Chris McCarthy http://www.electricenergyonline.com/?page=show_article&mag=62&article=476
xxxviii
xxxix
xl
xli
http://en.wikipedia/org/wiki/Integrated_gasification_combined_cycle
xlii
http://www.duke-energy.com/about-us/awards/asp
xliii
http://www.siteslection.com/features/2008/sep/Top-Utilities/
xliv
http://www.duke-energy.com/news/outage-information.asp
xlv
http://www.duke-energy.com/news/outage-information.asp
xlvi
xlvii
xlviii
http://www.duke-energy.com/about-us/awards.asp
xlix
l
Duke Energy 2009 10-K, Date February 26, 2010, Page 12
li
Duke Energy 2009 10-K, Dated February 26, 2010, Pages 12 and 13
lii lii
“Why the Coal Guy is Turning Green?” by Marc Gunther (October 14, 2009) http://www.marcgunther.com/2009/10/14/why-a-coal-guy-is-turning green/
liii
“FPL Rate Hike Request is Turned Down” by Mary Ellen Klas (January 14, 2010) http://www.miamiherald.com/2010/01/13/1424156/fpl-rate-hike-request-isturned-down.html
liv
“American Electric Power Expands Barge Operations With Acquisition of Memco Barge Line, Inc.” (July 23, 2001)
http://www.aep.com/pf.aspx?title=AEP-News-Releases-AmericanElectricPow...
lv
xxxv

27

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