February 18, 2017
- NYSE: NRG
- Recent PPS: $17.10
- Shares Out: 324.6 million
- Market Cap: $5,551
- Recourse Net Debt: $7,236
- Enterprise: $12,787
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:
- Recent turmoil in the C-suite created a vacuum in shareholder approval, allowing the activist group to step in opportunistically with little opposition
- John Wilder of Bluescape Energy Partners, and former CEO of TXU, has an incredible reputation within the industry
- An abundance of NT catalysts: GenOn restructuring + NYLD sale + cost cuts + potential sale of the entire entity
- 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.
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.
A deep dive into the situation would entail the following:
- Long-term economic structure of the power markets
- Asset level comp analysis of NRG cost structure v. CPN and DYN
- Detailed background of John Wilder
- Industry M&A history
- In-depth GenOn restructuring analysis
I own the stock and could sell at any time.
This write-up is for informational purposes only.