Tag Archives: alternative

Calpine Corp.: A Different Kind Of Utility

Summary Operates diversified, modern natural gas-fired power plants. Company pays no dividend yield, only share repurchases. Management exercises prudent control of debt and input costs. Calpine Corp. (NYSE: CPN ) has a portfolio (including partnership interest) of over 88 power plants generating in excess of 26,000 megawatts of power in North America, primarily in California, Texas, and the Eastern seaboard. As an added benefit, these are modern, clean energy plants using natural gas and geothermal to produce power, resulting in lower carbon emissions – 95% of the company’s power generation was done with natural gas. This marks it as an industry leader going forward as natural gas is expected to be a leading generator of power in the United States in the coming years, as coal continues its decline and natural gas is discovered in shale plays. While the company consumed 793 billion cubic feet of natural gas in 2014 (10% of all natural gas used for power generation), the EIA estimates the US has over 350 trillion cubic feet of proven natural gas reserves at the end of 2013. Prior Bankruptcy, Current Cost Control In 2005, Calpine filed for bankruptcy protection in one of the largest bankruptcies in US history as natural gas prices had soared, a new glut of competing power plants came online, and the company’s debt load of $22B became unmanageable due to poor structure. Calpine’s prior leadership team was poor and mismanaged the company in its debt and hedging practices. The company emerged from bankruptcy to begin trading again in 2008. I think it is important to note that the market today is much different than it was then – Calpine’s current outstanding debt is half of what it was, has been financed at lower interest rates, and the natural gas market has fundamentally changed. (click to enlarge) As noted, the company has done a great job in recent years of paying down and refinancing debt. Total interest expense has fallen from $813M in 2010 to $645M in 2014, a decrease of 20%, as total revenue has grown 22% in that same time frame. Long-Term Outlook, Coal to Gas Switching Depending on the fluctuating spot prices of coal and natural gas, power plants using one or the other frequently set the price of wholesale energy. Most often in the past decade, but as natural gas prices have fallen it has become more commonplace that natural gas sets the price. When this switching occurs, demand and total generation volumes increase for Calpine. If you look back to 2012 when this occurred often, you’ll find elevated levels of operating income. Forward markets for natural gas prices suggest this may happen again in 2015. Fundamentally, in the intermediate/long term, coal to gas switching may become even more prevalent as environmental regulations and political pressures force coal-fired power generation to reduce levels of pollutants like sulfur dioxide and nitrogen monoxide through expensive retrofits. Costs will increase for these market participants and natural gas power plants may overtake coal as the primary form of energy generation in the United States. Wait, No Dividend? Utilities are known for and sought out by income investors for the income that their dividend payouts provide. Retail investors frequently screen stocks by dividend yield and history to choose stocks. CPN does not pay one – but not for lack of profitability or cash flow. Thad Hill, CEO, stated in the Q4 2014 Earnings Release , 2014 wrapped up in a fine year for Calpine, we are proud to report adjusted EBITDA of $1.949 billion, adjusted free cash flow of $830 million and adjusted free cash flow per share of $2.03. So what gives? CPN provides returns to shareholders in the form of share buybacks solely. Thad Hill further states, Finally, we have continued to return money to our shareholders by completing $277 million of buyback since the last quarterly call in November. As our stock price moved down with the recent commodity price sell off, we took advantage of it and stepped up our share repurchase program. Since beginning the program in 2011, we have repurchased approximately 25% of our outstanding shares for $2.4 billion. $1.1B of those share repurchases have been done in the last year. Operating using a model of only share repurchases gives management added flexibility in deploying capital. Who better to know when the shares are undervalued than management? Or when that capital may best be used to fund a timely acquisition that has a greater expected NPV than through shareholder returns? Ownership/Short Interest CPN also has high institutional ownership (95%). This ratio is one of the highest I could find among utilities – only El Paso Electric (NYSE: EE ) and ITC Holdings (NYSE: ITC ) have higher rates, at 98.9% and 95.1%, respectively. Institutional ownership here is key – considering the vast amount of resources, talent, and research that these institutions provide their researchers, their investment decisions generally carry great weight with retail investors. In this case, retail investors have not followed, most likely due to the earlier highlighted issues of the lack of a dividend and prior bankruptcy. Analysts have a similar opinion to institutions. 75% of analysts rate the stock a strong buy/buy, with none rating it as underperform/sell. The average target price is $25.00 – nearly 20% upside from current prices. *Sourced from Yahoo! Finance Short interest in CPN (4% shares held short) is within the top quintile of utilities. Its short interest is similar to utilities that have no free cash flow or those with higher P/E ratios and lower growth prospects. Having no dividend is a double edged sword – no short wants to get stuck covering a dividend over ex-date, so short interest in the sector is usually mild even when the sector trades overvalued. The company’s lack of a dividend yield gives shorts the advantage of not being forced to cover at high prices before ex-date or feeling the sting of that negative dividend payment hit their account. 2015 Guidance (click to enlarge) The company guides $2.10-$2.60 a share in free cash flow/share – 3.5% increase over 2014 on the low end and 28% on the high end. This is forecast to be a record year in cash flow availability for the company, with plenty of available cash for repurchases and acquisitions. As of the February earnings release, the company had already repurchased $125M in shares in 2015 – on pace for another year of over $1B in repurchases – which would retire 12% of the float at the current share price. As the current share price sits below the average share price of repurchases in 2014, so I expect these buybacks to continue as management continues to believe current prices are an excellent investment opportunity. Conclusion A purchase in Calpine is a purchase of a company with a historical stigma and no steady income stream to shareholders. But it is also a purchase in a company that analysts and institutions have committed big to and one that is set to benefit strongly from a coming shift in energy production from coal to natural gas on the heels of the American resurgence of power in oil and natural gas production. I see fair value today at $26.00/share – more than 20% upside from current prices. Disclosure: The author is long CPN. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Betting Against Japan: The Straddle Of The Century

Japan has accumulated an enormous and growing debt load. The Japanese Central Bank’s bond buying may prevent a crisis. The yen is likely to continue weakening. Investors can profit from the JCB’s moves. Japan emerged from the ashes of World War II to becoming one of the largest economic powers in the world by the 1980s. By creating high quality products and making highly publicized corporate purchases, Japan was both respected and feared by competing economic powers. Japan’s economic advancement came to an abrupt end when the Japanese market crashed in the late 1980s and never truly recovered. The once mighty power is now heavily indebted and dealing with a declining population and a declining economy. A crisis is possible, but like with crises of the past, a major Japanese economic event can become a great opportunity, particularly with the right investments. The debt load of the Japanese government stands at just under 1.2 quadrillion yen ($10.1 trillion), greatly exceeding their 484 trillion yen ($4.07 trillion) economy and the 96 trillion yen budget ($812 billion), with projected revenue at only 54.5 trillion yen. This is a precarious financial position, and at a 4.5% interest rate, the projected revenues would only cover debt service. But because the Japanese Central Bank (JCB) is such a large buyer of Japanese government bonds, the interest rate for a 10-year bond stands at under 0.5% as of the time of this writing. Given that this 1.2 quadrillion yen is a debt level unlikely to be paid off, hyperinflation or default would appear to be the only realistic options for addressing the debt. To counter a possible collapse, the JCB started buying larger amounts of bonds than the Japanese government was creating. It’s likely the JCB plans to buy up a large percentage of the outstanding bonds ( it owns about 16% now ) and simply write off the bonds, and hence, that portion of Japanese government debt. If this were to work without destroying the economy, the Japanese government strengthens its financial position by returning to sustainable debt levels. If it fails and Japanese bonds rise to double or even triple digit interest rates, default becomes a possibility. Another possible scenario involves weakening the yen. This has been seen in earnest since 2012 and born of the JCB’s larger levels of aggressive stimulus. The JCB created more yen and pumped the currency into the economy, sending the Nikkei to highs not seen since the 1990s. The price of this stimulus has been a greatly devalued yen falling from 76 to the dollar in early 2012 to the low 120s in early 2015 . Experts such as Kyle Bass predict the yen will fall beyond 140 to the dollar by year-end and further beyond this year. The potential danger of this approach is that more yen chasing the same amount of goods will devalue the yen to the point that investors lose confidence in the currency. In addition to making Japanese consumers poorer, the devalued currency could also lead to higher interest rates that also make the government debt load untenable. Investors can protect themselves from this horrifying yet plausible scenario with a different take on the straddle bet, one based on different vehicles instead of up or down bets on the same investment. In this case, it would be a position betting against Japanese government bonds (the JGBS ETF is the easiest way to accomplish this) coupled with a second bet against the value of the Japanese yen (versus a precious metal or a currency such as the US Dollar). If the JCB can successfully write off a large amount of government debt, investors can still profit from what’s likely to be substantial yen devaluation. If the worst case bond crash occurs, investors can profit or at least protect themselves from what would be a devastating economic event. The once-mighty Japanese economy now finds itself in a situation where the JCB struggles to maintain economic strength. An economic collapse would be the most devastating occurrence to hit Japan since their loss in World War II, and a catastrophic blow to a world economy where Japan exerts wide influence. However, this situation also presents a great opportunity for the prepared investor. Whether the high debt resolves itself through a dramatic collapse or by the JCB engineering a large-scale debt write off, bets on a weaker yen and higher interest rates will likely bring investors outsized returns and possibly protection in a crisis. Disclosure: The author is long JGBS, GYEN. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Dominion Resources Is Boosting Returns To Shareholders, But Is It A Buy?

The utility sector is generally known as a collection of high yield, slow growth companies. Dominion Resources has been a top performer in the sector with an attractive growth rate and dividend yield. Dominion Resources recently announced a boost to the dividend and guided for a higher payout ratio going forward. This article will discuss the current valuation levels for the company and determine if it is worth adding to my dividend growth portfolio. As an avid reader of the dividend growth investing strategy on Seeking Alpha, it’s apparent that many investors using this method have a fond appreciation for utility companies in their portfolios. The consistency of earnings and reliable nature of a long-term, slow and steady growth rate make these companies a great cornerstone for long-term buy and hold investors. One utility that is a great example of this slow and steady growth is Dominion Resources (NYSE: D ). Here is the company description from Dominion’s website: Dominion is one of the nation’s largest producers and transporters of energy, with a portfolio of approximately 24,600 megawatts of generation, 12,400 miles of natural gas transmission, gathering and storage pipeline and 6,455 miles of electric transmission lines. Dominion operates one of the nation’s largest natural gas storage systems with 949 billion cubic feet of storage capacity and serves utility and retail energy customers in 12 states. Dominion has a long history of providing outstanding total returns for investors. The company has a 10-year dividend growth rate of 6.3%, a 10-year earnings growth rate of 4.5%, and during that time has provided investors with 12.4% annual total returns with dividends reinvested. While the past has been great, the future may be even better. On February 9th, the company announced an 8% increase in the quarterly dividend from $0.60 to $0.6475 per share, and stated its intentions to increase the dividend payout ratio from a range of 65-70% of earnings to 70-75% through the end of the decade. Dominion also held its Investor and Analyst Meeting on February 9th, with management providing an overview of operations and expectations for the future. During this meeting presentation, management provided guidance for 6-7% earnings growth and 8% dividend growth through 2020, both of which exceed rates seen over the last decade. With a current yield of around 3.55%, investors buying for the long term can lock in an attractive yield growing at a high rate for a utility company. However, in the short term, the stock appears to be trading at a rich valuation compared to historical levels. (click to enlarge) Compared to a normal PE of 16.2 over the last decade, the current ratio of 21.3 would indicate that shares are trading at a 30% premium to normal values. The current yield shown has not yet updated to the newly announced dividend rate, but the 3.55% yield at that payout is still low compared to historical levels. Much of this premium being paid by the market is due to U.S. Treasuries trading at historically low levels, which is driving income seeking investors into equities as they search for yield. I discussed this in a recent article covering the utility sector , and a similar situation is being seen in the REIT sector as well. This trend has been reversing in recent weeks, as the Treasury rate has rebounded and the utility sector, as shown by the Utilities Select Sector SPDR ETF (NYSEARCA: XLU ), has sold off. 10 Year Treasury Rate data by YCharts Circling back to Dominion, it appears that the share price was driven up by macro factors, as the sector traded higher on the weaker Treasury rate. With that rate appearing to be normalizing, there could be some continued short-term pain for Dominion investors. Dominion is a great company with multiple drivers leading to continued growth. I think it deserves a spot in my portfolio as a core holding, but the valuation appears stretched at current prices. This is a company I hope to own, and it has been added to my watch list for my dividend growth portfolio . I will be looking for an entry point at around $65, which would provide a dividend yield of 4% that would pair quite nicely with an 8% dividend growth rate going forward. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. Additional disclosure: I am a Civil Engineer by trade and am not a professional investment adviser or financial analyst. This article is not an endorsement for the stocks mentioned. Please perform your own due diligence before you decide to trade any securities or other products.