Description

CenterPoint Energy, Inc. (CNP, $8.25) is an excellent value investment. CNP may be purchased for 7.6x 2003 earnings and has a dividend yield of 7.86%. Our model indicates that the company's current valuation is 4.3 times likely '04 earnings and 3.7 times likely '05 earnings. This valuation is coupled with a regulated monopoly business model: the company earns 80% of its income from transmission and distribution of electricity in metropolitan Houston, Texas; 10% of its income from a gas distribution business; and 10% from a gas pipeline business. CNP also owns several electrical generating plants which it consolidated into its Texas Genco subsidiary; Texas Genco will be divested in 2004 in exchange for $4 - $5.5 billion cash.

Before we elaborate on the company’s problem ($10.7 billion of debt, much of it short-term), here is the punch line:

• CNP generates annual EBIT of $1.4 billion and EBITDA of $1.97 billion; both are likely to grow modestly.

• By law, CNP will receive a one time payment of between $4 billion and $5.5 billion during the 4th quarter of 2004 from the divestiture and securitization of its Texas Genco subsidiary. The market is grossly undervaluing the securitization process of Texas Genco.


The rub
CNP’s share price is depressed because of its ongoing liquidity crisis. The company is highly leveraged with a capital structure of 80% debt, 20% equity. To make matters worse, through poor financial planning, CNP finds itself in a situation where much of its debt is short-term. Compounding these two problems, the capital markets have soured on the energy sector. The following table summarizes the company’s debt:

The company has $10.7 billion of debt consisting of $3.7 billion of short-term debt and $276 million of long term debt maturing in the next 12 months. In fact, the company has a total of $5.1 billion of debt maturing in 2003 plus an additional $1.1 billon of funding requirements. CNP needs money at a time when it is difficult to access the capital markets.


Why CNP is a safe bet
CNP is a safe bet because it will continue to generate a lot of cash. It is hard to imagine a business model more solid than a monopoly position delivering electricity to retail customers in a region as dependent on electricity as metropolitan Houston, Texas. Eventually, the bond market will again be interested in financing companies like CNP; until then, CNP makes $1.4 billion in EBIT, which is enough to feed lots of hungry bankers eager to earn fat fees. Consider Berkshire Hathaway’s $1.3 billion loan to the company announced on November 8; though the terms were onerous (three years non-callable at LIBOR + 9.75% subject to a minimum LIBOR of 3%) CNP’s cash flow can easily support the loan. In addition, CNP will divest its Texas Genco subsidiary during 2004 under a process designed and overseen by Texas regulators. This divestiture will result in a cash payment to CNP of between $4 billion and $5.5 billion during the fourth quarter of 2004, enough cash to reduce the company’s debt by 50%. (Please see exhibit entitled “Elements of Value from TX Genco Divestiture” below. Our earnings model uses the $4 billion figure).


Two other positive factors
There are two other factors which will positively impact the value of CNP’s stock:

1. Modest revenue and EBIT growth in its core businesses (electricity transmission and distribution, gas pipelines and gas distribution) driven primarily by an expected 2% annual customer growth and anticipated rate increases.

2. Higher electricity prices reflected in the results from recent Genco auctions; this helps CNP’s cash flow from its Texas Genco subsidiary until the unit is divested in 2004.

To be conservative, we have not included either of these factors in our earnings model.



Results of recent electricity auctions
In the short-term, CNP is likely to experience improved cash flow from its Texas Genco subsidiary, which lost $52 million of EBIT during the first three quarters of 2002. Results from auctions held in October and November of this year indicate that the price of electricity is going up in CNP's market, driven primarily by higher gas prices. One third of Texas Genco’s power is produced using coal and nuclear fuels, fuels who’s prices are fixed under long term contracts. As a result, the company enjoys expanding margins when gas prices increase. This is more than academic; the following table shows that CNP has already realized an additional $70 million of revenue from auctions completed during the current quarter; much of this revenue will translate into incremental cash flow during 2003. Furthermore, the company has an additional 20% of 2003 capacity which will be auctioned during the first half of 2003.


Disclosure: We have been buying CNP shares since August, 2002 and believe the company is still undervalued.

Bibliography

There are a number of financial filings one must digest in order to understand CNP. The following is a partial list of recent filings used to prepare this analysis.


1. TX Genco Holdings, Inc. 10-12B/a 12/6/02
2. 10 Q CenterPoint Energy Inc., 9/30/02
3. 10 Q CenterPoint Energy Houston Electric LLC, 9/30/02
4. 10 Q CenterPoint Energy Transition Bond Company LLC, 9/30/02
5. 10 Q CenterPoint Energy Resources Corp 9/30/02
6. 10 K Reliant Energy Inc. 12/31/01

Catalyst

Twelve Months