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Summary Appointment of Mauricio Gutierrez as the new CEO reflects further commitment of NRG Energy’s board to the strategy rolled out earlier this year. Moreover, shifting away from a cash-burning solar business is a positive sign for investors. Based on its fundamentals, the stock is currently trading at a significant discount. Therefore, I recommend SA readers consider buying the stock at cheaper levels. In the past year, the stock price of NRG Energy (NYSE: NRG ) has experienced a decline of 65.5%. This is in contrast to a decline of 8.5% and a rise of 1.0%, respectively, experienced by the Utilities SPDR ETF (NYSEARCA: XLU ) and S&P 500 (NYSEARCA: SPY ). The significant decline in the stock price cannot only be attributed to valuation concerns; it also reflects some combination of overstated risk related to the depressed natural gas price. Although the company is trying hard to focus on cash returns and dialing back the exposure related to clean energy, low levels of confidence on the part of investors on the company’s strategic direction has been a cause of concern. Appointment of New CEO On Dec. 3, the board of NRG Energy revealed that Mauricio Gutierrez will take over the role of the CEO from David Crane . Crane was the company’s CEO for nearly 12 years and will be vacating his position at the end of this year. I think that the appointment of Gutierrez as the new CEO reflects the intention of the board to show further commitment to the strategy that was rolled out earlier this year. Given Gutierrez’s history, it can be expected that his focus will be more toward the core operations of NRG Energy — i.e., retail and power generation, along with a persistent focus toward cost management and optimization and capital discipline. This will result in the optimized use of cash that can be used to reduce debt and increase returns for equity holders. I would like to highlight the fact that the appointment of one individual in such a big organization would not sway the market’s stance on the company’s strategy. However, investors could be interested in investing in the stock again as a result of continuous commitment to a sound corporate strategy. Cheap Valuation Currently, shares of NRG Energy are trading at a forward enterprise-value-to-earnings before interest taxes, depreciation and amortization (EV/EBITDA) multiple of 8.15x. In the past three years, the stock has traded at an average forward EV/EBITDA multiple of 9.33x. This reflects that the stock is currently trading at a discount of 12.7% to its historical three-year average. The recent selling has made the stock cheap in terms of valuation. The selling has been a result of weakened investor confidence and investors waiting to see the implementation of the new strategy. Shift in Focus The company has strong fundamentals that have been further de-risked by hedging activity. Furthermore, the shift away from a cash-burning distributed solar business is also a positive sign for investors. The company’s initiative for additional cost cutting is also positive. During the Q3 FY 2015, ended Sept. 30, 2015, results, the company announced a reduction of $150 million in general and administrative (G&A) expenses . Management also intends to execute an additional $100 million cut in operating and maintenance (O&M) expenses and will pursue an additional $150 million in incremental value through a new “FORNRG” program. Model Assumption and Derivation of Target Price I have kept hedge assumptions for NRG Energy consistent with its updated disclosures. The company now has more than 100% of its baseload Texas exposure, as well as 96% of its baseload eastern exposure, for next year. The change in hedging is particularly notable, as NRG Energy was hedged there as of late July. I anticipate the company to ease up on share repurchases and to focus future free cash flows (FCF) toward debt reduction. NRG Energy anticipates a $1.6 billion decline in debt by the end of 2016. This would be done prior to any additional proceeds as a result of a drop down to NRG yield or proceeds from the GreenCo sale. The company has not updated its credit metric targets beyond the long-standing 4.25x debt/EBITDA, although the push to move lower is clearly there and likely extends beyond next year. I have incorporated these factors into my financial model. Execution of a New Strategy The company is moving ahead with high interest in asset sales focused on eastern power plants. The plan to sell down a majority stake in GreenCo is apparently finding interest, even with the other home solar stocks languishing as well. The company will be slower in finalizing a long-term deal. As for the home solar business, the company remains firm on the $125 million spending cap for next year. Below is my forecast income statement and target price derivation calculation for NRG Energy: Regarding the derivation of the target price, I have assumed 2017 earnings before interest, taxes, depreciation and amortization (EBITDA) of $2.44 billion based on our forecast income statement. I have applied a forward enterprise value (NYSE: EV )-to-EBITDA multiple of 8.66x to our EBITDA estimate. I have arrived at forward EV/EBITDA multiple of 8.66x by taking the estimated three-year average forward EV/EBITDA multiple of 6.79x for the Independent Power Producers (IPP) industry and applying a premium of 27.6% to that multiple. This is the average premium at which NRG Energy has traded against the IPP Industry during the three-year premium. Thus, I have arrived at my target forward EV/EBITDA multiple of 8.66x. Derivation Of NRG Energy’s Target Price 2017 EBITDA $2,444 EV/EBITDA multiple (times) 8.66 EV (in millions) $21,165.04 Less: 2017 net debt $(14,248.00) Market value (in millions) $6,917.04 Shares outstanding (in millions) 298 TP/share $23 Current stock price $9.20 Upside potential 150.0% Scalper1 News
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