|Shares Out. (in M):||323||P/E||11.1x||26.7x|
|Market Cap (in $M):||7,756||P/FCF||5.1x||5.2x|
|Net Debt (in $M):||10,466||EBIT||1,001||1,015|
While NRG has been written up in the past (reference egec’s write-up from June 2012), we think the equity is well worth revisiting as a long opportunity (currently trading around ~$24 / share with a >16% FCF yield using our 2015E “un-hedged” estimates). At current levels, NRG trades for less than ~6x 2-year forward / un-hedged EBITDA and ~7x EBITDA less maintenance capex. In contrast to its lofty leverage in the recent past when standalone NRG had >5x net debt / EBITDA (and analysts were worried about solar being a liability and the business suffering from liquidity concerns in a $3 natural gas environment), the company has significantly de-risked the balance sheet through its recent purchase of GenOn and currently is accessing the credit markets at sub-5% rates highlighting the credit markets (NRG will be leveraged at less than 3x net debt / EBITDA based on our 2015E un-hedged estimates).
The crux of our thesis is that: (a) NRG’s core Texas market will witness a growing supply / demand imbalance especially during critical on-peak periods - for the supply imbalance to be fixed, we believe power prices in TX will increase to a level that incentivizes new build economics, (b) given the imbalance in TX, we think that local regulators will ultimately make changes to the market structure to force forward power prices upwards that will increase NRG’s cash flow, (c) while NRG has significant hedges through 2014 on its natural gas exposure, we believe the market under-appreciates the significant upside optionality of natural gas prices (every $1 roughly equates to an additional ~20% increase in EBITDA or the equivalent of ~$10 per share) and is myopically focused on natural gas prices falling back to $2 - $3 levels while losing sight of abnormally hot weather that impacted natural gas prices in 2012, (d) NRG’s ownership in solar project assets has been an overhang on the stock but we think is at an the “earnings power inflection point” (lower spend and beginning of harvest stage) that will enhance overall value, (e) given the significant cash flow generation, NRG will likely utilize excess FCF to buy back shares and pay out a larger dividend as the company has effectively removed restrictions in their debt agreements that historically limited capital return to shareholders and (f) NRG’s recent GenOn acquisition is value enhancing and offers significant upside.
While there are many moving parts to the NRG story, we think there are four areas of ”differentiation” between our views and the “Street”:
While our base case valuation for NRG is ~$35 / share (before factoring in the dividend), we think a valuation of >$50 / share is attainable if natural gas prices move up to ~$5 in the medium term. Regarding downside protection, we think a low $20s / share valuation (versus current ~$24 / share) is punitive as it assumes the TX generation assets suffer from a $750 - $1Bln fall-off in earnings power as the hedges roll-off (i.e. >75% reduction in earnings power) partially offset by synergies, solar earnings and GenOn assets and NRG trades at a punitive sub-7x EBITDA multiple and ~9x EBITDA – capex multiple on this reduced earnings estimate.