It took some time, even during a recent heat wave that saw multiple days of high demand and price volatility, but the forward curve is finally starting to rip. The mild spring and bearish CDR report (at least the market thought so), left a lot of ground to make up to get back to highs from earlier this year – but 2020/2021 forwards have almost fully recovered (2022 less so). Month-to-date on-peak forwards are now up ~18% in 2020 and ~8%/3% in 2021/2022. This is what ultimately matters for the stocks, as it allows incremental hedging at more attractive prices. For reference, both NRG and VST are 70% hedged in ERCOT for 2020 – leaving ample open capacity.
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Momentum has no valuation ceiling while risks and uncertainties have no valuation floor. This is the story within utilities and among the market overall. A choppy Q2 due to unfavorable weather and weaker core sales growth seemed to only exacerbate this trend. A few companies appear to be re-rating on lower risk perceptions – ETR, FE, EVRG, SO, EIX, SRE – but otherwise we continue to see more divergence between the pure play safe regulateds vs those with diversified businesses or project/regulatory risk. Given our value focus, we are resigned to keep focusing on the messy ones.
More recently we’ve received questions on the difference between Vistra and NRG. To be clear, we like both given similar investment propositions – integrated low cost operations, backed by robust free cash flow generation and strong balance sheets. Both companies are anchored by premier Texas retail operations, with ~50% of total generation capacity also in ERCOT. That said, the companies also have differences in strategy and make-up, which may draw different investors.
We recently hosted meetings with Vistra Energy CEO Curt Morgan and new CFO David Campbell. The company was fresh off its Q2 earnings update, where the financial outlook was reiterated despite a challenging commodities environment. There was some level of frustration with recent stock price performance, but mgmt. is committed to continue highlighting its integrated power model, supported by low-cost operations and low leverage. We agree with mgmt’s view that public markets can ultimately appreciate a story like this, and see a “go private” decision as more of a last resort. While the cash flow generation over the next few years is robust, VST is very focused on proving out the resiliency of its terminal value, namely the modest financial contribution from its coal plants. We expect a detailed update on the company’s long-term prospects with Q3 – a potential positive catalyst. We remain buyers of high-teens Free Cash Flow yields. Outperform.
Wolfe Research's Senior Utilities analyst, Steve Fleishman, hosted a webcast to discuss takeaways from the Vistra roadshow.
2Q19 EBITDA was in line and FY guidance was reiterated. Generation EBITDA was better than expected, while Retail disappointed and NRG’s customer count declined (likely low-margin customers switching). The deleveraging plan has been completed, and 2019 is on track despite declining power prices as the “Integrated Power Company” (IPC) model plays out. That said, the buyback story will clearly moderate from here after a whopping $1.25B of repurchases YTD (11% of shares out). NRG has a new $250M authorization through YE, but minimal dry powder beyond that. On the positive side, ERCOT power prices are finally seeing signs of life this week, which could be helpful to boost forward curves and hedging of generation margins for future years.
Last week we saw PEG, EXC, and VST all report Q2 earnings – with solid financial results across the board. Looking at recent stock price performance, you wouldn’t think that was the case however. The commodity price environment has remained challenging, though hedging has protected near-term impacts. The companies mostly pointed to a lot of the same pricing drivers – mild weather, weak natural gas and CCGT new build financing in PJM (and related revenue put option activity). Both EXC and PEG seem to be tracking modestly behind typical ratable hedging pace further out – reflecting a skewed positive view on PJM pricing from here. VST mgmt. was adamant that it didn’t agree with where forward curves are currently trading, though it is prepared to maintain its $3B+ annual EBITDA outlook in the current pricing set-up. The company believes there are more coal shutdowns to come in ERCOT and that CCGT new build in PJM is uneconomic right now.
Quietly our Wolfe Yieldco Index has become the top income sector YTD and the only one beating the S&P 500 (see Ex 1). Yieldcos have overcome the huge uncertainty caused by PCG’s bankruptcy filing in January. Why have they done so well? 1) long-term contracts that are not subject to ROE resets like utilities so should benefit directly as interest rates fall; 2) the neighborhood improved meaningfully as parent companies changed from distressed owners to higher-quality parents (SunEdison to Brookfield, Abengoa to Algonquin, NRG to Global Infrastructure Partners); 3) Its Renewables stupid – the top growth space in energy with huge economic and tax subsidy momentum. While we are a bit wary of competition and financial discipline in renewables, we think the backdrop remains bullish. There is no better way to play all of this than NEP given their connection to industry leader NEE, huge growth backlog, cost-of-capital advantages and visibility on 15% dividend growth for at least the next 5 y
Vistra Energy posted Q2 EBITDA that slightly edged consensus, while reaffirming its 2019 guidance range, and “approximately flat” 2020 expectations. Power market conditions have been tough, but mgmt. pointed to the resilient integrated model that produces stable results. Financial execution in Q3 will be important, but this was a solid update. The stock rose by 232bps in a risk-off tape Friday (S&P down 73bps), which is encouraging. We continue to believe that high-teens Free Cash Flow yields supported by 2.5x Net Debt/EBITDA, is an attractive investment proposition – particularly when looking at the carnage across the rest of the energy sector over the past week.
This week kicks off earnings for the power names within our coverage – PEG, EXC, and VST all report (NRG is next week). A lot has changed since Q1 reports – it hasn’t been pretty.
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