Events: NRG Energy Idea Initiation 

NRG Energy 

Events

February 18, 2017


SUMMARY INFO

  • NYSE: NRG
  • Recent PPS: $17.10
  • Shares Out: 324.6 million
  • Market Cap: $5,551
  • Recourse Net Debt: $7,236
  • Enterprise: $12,787

DISCUSSION

The day Elliot filed on NRG I happened to be in attendance at a lunch presentation by my good friend, a well-respected Power & Utilities MD. He highlighted what he believed to be a strange discrepancy in Power Generation equities – CPN, DYN, NRG – where they were/are trading at distressed multiples on trough earnings – typically a sign of impending bankruptcy – while the bond market was/is signaling robust and likely improving earnings power. DYN was his top valuation pick; but when questioned about that morning’s NRG filing he noted the compelling near-term set-up:

  1. Recent turmoil in the C-suite created a vacuum in shareholder approval, allowing the activist group to step in opportunistically with little opposition
  2. John Wilder of Bluescape Energy Partners, and former CEO of TXU, has an incredible reputation within the industry
  3. An abundance of NT catalysts: GenOn restructuring + NYLD sale + cost cuts + potential sale of the entire entity
  4. Undervaluation, despite the recent run-up in the stock

The stock receives very little coverage, is highly volatile, and therefore prone to extreme undervaluation…until it’s not. At the current price I believe there is a very low probability of permanent impairment. The non-permanent impairment scenario could be framed as follows: 25% chance of downside volatility of 25-50%; 50% it works its way to $25+ over the course of the next 12-18 months; and 25% it goes north of $20 in very short order.

ANALYSIS

(Source: BAML)

Segments. NRG is comprised of four segments: Core NRG (Retail + Generation), GenOn (bankrupt Generation sub), and NYLD (nat gas and renewable assets yield co).

BAML estimates Core NRG will generate $1.79 billion of EBITDA in 2017, and has recourse net debt of $7.24 billion.

NRG’s stake in NYLD is currently worth approximately $1.4 billion.

And BAML estimates ‘disynergies’ of $97 million once GenOn is officially restructured and separated.

Cost Structure. BAML estimates that Core NRG Generation’s SG&A $/Mwh was approximately $4.64 in 2016 versus an average of $1.20 for CPN and DYN. Their upper end cost cut estimate is $500 million for Core NRG.

With John Wilder on board, I like the $500 million target.

2017 PF FCFE. Core NRG EBITDA of $1,790 + $500 of cost cuts – $97 of disynergies = PF EBITDA of $2,194.

Subtracting $550 of capex and $572 of intex (7% on total debt of $8,177), and applying a 30% tax rate gets you to $750 million of FCF to Equity, or $2.31 per share.

Valuation. Adjusted for the value of NRG’s $4.32 stake in NYLD, NRG currently trades for 5.5x FCFE. Assuming $0 of cost cuts, the stock trades for 10.4x, which is arguably slightly overvalued for a below average business (8.33x FV PE?).

8.33x PF FCFE + $4.32 NYLD = $23.56 FVPS, or 38% upside.

Price Action. Navistar’s post-VW deal price action is instructive, IMO. The stock spiked hard on the announcement, backed off a bit, then proceeded to rise 30%+ in short order. I believe NRG is following a very similar script in the wake of the initial Elliot filing.

But this is simply a piece of the mosaic. If the broad market backs off 1-5% in order to consolidate recent gains, NRG could easily break below pre-Elliot levels. This would be a big buying opportunity, IMO.

DUE DILIGENCE

A deep dive into the situation would entail the following:

  1. Long-term economic structure of the power markets
  2. Asset level comp analysis of NRG cost structure v. CPN and DYN
  3. Detailed background of John Wilder
  4. Industry M&A history
  5. In-depth GenOn restructuring analysis

DISCLOSURES

I own the stock and could sell at any time.

This write-up is for informational purposes only.

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