Long CPN
As a merchant power generator/IPP, CPN’s profitability is generally driven by gas prices, as gas
prices set power prices in most power markets and forward power prices are a determinant in
capacity pricing. The sensitivity to gas prices is less than that of a coal or nuclear generator, as
CPN is a gas power plant operator. But the sensitivity is still there since CPN is an efficient gas
generator with operating heat rates below market clearing heat rates. So any thesis on CPN has
to be grounded with a view on gas prices.
Even as gas strip pricing has recently collapsed due to an oversupplied market (continued
production growth in the Marcellus and Utica), there are numerous dynamics at play that I
believe make CPN’s cash flow story attractive and sustainable. The dynamics discussed in this
write-up should support continued cash returns to shareholders via stock buybacks, regardless of
further declines in natural gas prices. Furthermore, whenever commodity markets balance, the
balancing is not smooth and production generally over-adjusts. Therefore, I see longer-term
natural gas prices as undervalued, as natural gas markets must balance in the short-term via a
production response.
CPN trades at an average ’15, ’16 free cash flow yield of 12% on current Consensus estimates. I
believe the underlying gas market dynamics at play support these cash flow estimates over the
next two years, and when combined with the magnitude of cash flow return to shareholders,
support a minimum 16-22% total return range on the stock over a 12-month horizon.
Importantly, this return estimate assumes no change to CPN’s cash flow multiple (i.e. it
continues trading at a 12% yield).
The energy market today is very fluid and uncertain, and finding anything with high conviction
is pretty difficult. But because I view CPN as having limited earnings sensitivity to natural gas
prices: a 12% free cash flow yield and a forecasted return to shareholders of 33% of its market
cap over the next 3 years make it one of the few near-term energy bets that it is palatable.
Summary:
- Northeast natural gas production growth will have to slow down in order to balance an
oversupplied gas market in 2015 and 2016. Even a Consensus slowdown in 2016 L-48
gas production growth to 2.5 Bcf/d from 3.8 this year will still leave Oct’16 storage at
very high levels and will again require incremental YoY C-to-G switching….a lot of
demand elasticity required of the power market
- Gas supply/demand models require substantial incremental YoY CtoG switching in ‘15 at
a time when:
1. Gas plant power burn already steals market share when gas is below $4.00
2. Coal is oversupplied and incremental gas demand from power gen needs
to today be done at more competitive PRB coal prices
- Oil and NGL prices have driven down well IRR’s and E&P cash flows, meaning break-