corner roughly corresponds to our bear case and the lower right hand our bull case. Even with a flat
EBITDA profile (roughly $2b) we believe Calpine is able to buyback on average of ~16% of the float each
year without changing its leverage ratios.
2019 Calpine FCF/share at Different Levels of Buyback and Stock Price
|
| |
|
|
|
|
| |
|
Annual Buyback % Current Market Cap
|
| |
|
5% |
10% |
15% |
| Calpine Share Price |
$14 |
$3.92 |
$4.66 |
$5.52 |
| $18 |
$3.81 |
$4.33 |
$4.90 |
| $22 |
$3.73 |
$4.14 |
$4.56 |
2019 Calpine FCF/share at Different Levels of EBITDA and Buyback
|
| |
|
|
|
|
| |
|
Average Annual EBITDA (m$)
|
| |
|
1,800 |
2,000 |
2,300 |
| Annual Buyback % Current MC |
5% |
$2.99 |
$3.63 |
$5.10 |
| 10% |
$3.55
|
$4.32 |
$6.06 |
| 15% |
$4.06 |
$4.93 |
$6.92 |
How confident are we about the company’s future earnings power?
We believe Calpine’s EBITDA will grow modestly over the next few years as currently depressed power
prices increase (with that said, we don’t need prices to increase in order for the investment to be
successful).
The catalyst for a more positive power price outlook is supply reduction as a function of generation
retirements. In the Texas market, for example, Calpine and other industry analysts estimate ~25% of
production is cash flow negative at current prices. However, the landscape is changing as a considerable
amount of coal-fired capacity is likely to be shut down, as they are already unprofitable and would
require significant capex in order to meet the state’s Regional Haze mandate in 2018-2020. Retirements
are also being seen in the Northeast, where both nuclear and coal power plants have already begun
shutting down in the face of regulatory and environmental hurdles. Beyond more immediate state
specific regulations, coal capacity also faces longer term impacts from the national Clean Power Plan.
Developments also look to be favorable in California, as solar is pushing out older/marginal gas units and
causing volatility in daily pricing. This is a situation on which Calpine can capitalize given its efficient and
flexible fleet. Beyond these forces, one cold winter or hot summer could easily change the narrative
about how slack power markets are.
What about natural gas prices and their impact on the company’s earnings?
We believe downside to Calpine’s EBITDA versus estimates is limited over the next 3-5 years, even if
natural gas prices were to move lower from here. Coal generators are now trading at the marginal cost
of production, such that when gas prices decline power prices tend to lag that decline. Given the
efficiency of its fleet, in that situation Calpine would be able to take share by increasing volumes at the
expense of coal or inefficient gas plants and at the same time would face lower input costs. This gives
rise to what is known as the “Calpine smile” where at gas prices roughly between $3 and $4, EBITDA
would tend not to change with gas prices. At gas prices < $3, EBITDA would rise as gas declines, and at
prices > $4 rise as gas rises. (Though at these low prices earnings are less sensitive to swings and
higher gas prices would likely be seen positively by the market.) On our numbers, assuming power
prices in-line with today’s lows, EBITDA will be roughly flat with 2015 (give or take 5%). Furthermore,
the nature of the EBITDA will be increasingly tied to capacity payments in the Northeast region,
benefiting from an auction mechanism used in the PJM (and elsewhere) to guarantee capacity. These
PJM payments are already set through H1 2019 and will rise ~70% from 2015 levels. These payments
and contractual arrangements in California will account for > 50% of EBITDA in 2018.