Electric Utility SCANA: Shorts Are Wrong, No Meltdown

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SCANA (SCG) is a natural gas and electric utility with the highest percentage of shares short of any company in the utility sector. Headquartered in Columbia, SC, SCG provides over 600,000 customers with electricity and 700,000 customers with natural gas. With 32% of outstanding shares short, a lot of investors are betting against the company.

The reasons seem pretty obvious. SCANA operates one nuclear power complex and is about 14% completed with the construction of a new nuclear plant of which is will be 55% owner.

The shorts' thesis is:

The current plant, the VC Summer in Jenkinsville, S.C., will have problems relicensing in the future; The $865 million already spent on the new nuclear plant, of a budgeted $6.5 billion capital expenditure, will be in jeopardy if the project is canceled; The federal Construction and Operating License that is due late this year or early next and is critical to continuing, will be denied; As a throwback to the last nuclear construction boomlet in the 1970s, cost overruns will negatively impact the company; and Rising interest rates will put competitive yield pressure on the stock.

Interesting list of plausible scenarios, but many are mitigated with an appreciation of management and the regulatory environment of their service territory.

The VC Summer was issued a 20-yr operating license extension in 2004 and would not need a federal license for many years to come.

Of the twenty COL applications, the construction of SCANA's new reactors is considered to be on the fast track, and is due for completion and operation in the 2016 to 2018 timeframe. It is estimated that if the project is postponed by two years, the costs associated with the delay could be in the between $150 and $250 million. Worse case, the project is canceled. It is anticipated the costs incurred to date would be substantial, but most likely incorporated into future rate decisions.

Cost over runs could be a potential problem, but to date construction has been under budget set by state regulators in Feb 2009. If this trend continues, it may break the cycle of the 1970s of persistent and substantial cost over runs.

One reason SCANA has been a favorite of utility investors is the regulatory climate in their service territory. As with the Southern Company (SO), SCG has the advantage of good relations with the South Carolina regulatory commissions, and accepted returns on invested capital has been favorable. Not only does this allow for improved long-term shareholder opportunities, but could assist in recouping construction delay or cancelation costs, if any.

The completion of the new nuclear facility should almost double the generating capacity of SCG. While still multiple years out, the impact of this additional low-cost production should augment potential for higher earnings and dividends.

Earnings in 2010 were $2.98 a share, slightly ahead of 2009 at $2.85 and flat with $2.98 in 2008. Going forward, earnings growth is anticipated in the 6% to 7% range. Management has generated a five-year average dividend growth of 4.5%. Current yield is 5.0%, above the industry average of 4.4%. Five year average return on invested capital is 5.2%. There are 128 million shares outstanding and the company has a market cap of $5.1 billion.

A large short percentage on a utility is fairly unusual. While not advocating a quick short squeeze as things usually move pretty slowly in the utility field, there are about 40 million shares that will have to be covered. If the shorts are wrong and with average volume under 750,000 a day, systematic short covering may provide a floor for share prices.

Following is a 3-yr chart compared to S&P Utilities ETF (XLU):

(Click to enlarge)

The company has taken on a large gamble that, if successful, should amply reward long-term shareholders. While the risks are historically elevated for usually conservative SCANA, the potential rewards could be above average for the utility sector.

Share prices are down only about 8% from their year high of $42. Fairly valued at current prices, SCG should be on your radar screen to buy on weakness. Total stock returns should be in the 12% to 15% range, improving as the new nuclear capacity gets closer to coming on stream.

As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.