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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.

Energy ETFs: Short Interest In Oil Stocks Surges

Summary Investors are turning increasingly bearish on energy sector stocks. Short interest in energy companies is rising. Energy ETFs may be a good contrarian play to capture any potential upside. In the coming days ahead, short-term swings could make or break the energy sector-related exchange-traded funds, as short interest on oil stocks rise to a seven-year high. The Energy Select Sector SPDR ETF (NYSEArca: XLE ) , which tracks energy companies from the S&P 500 index, has declined 8.6% over the past three months, but is slightly up 0.2% year-to-date. As of the end of January, the average energy sector stock had 9.88% of its floating shares sold short, the highest level of short interest for energy stocks since at least 2008, according to Bespoke Investment Group . The close to double-digit short interest reflects growing concern for the energy sector. To put the percentage of short interest into perspective, the only time the markets saw double-digit levels of short interest for any sector was during the global financial crisis. Short interest reflects the percentage of shares outstanding that investors have sold short, but not yet covered or closed out. It provides a gauge of market sentiment, revealing investors’ bearish outlook on the market. However, given the high amount of shorts, a positive turnaround in oil prices could easily fuel a quick rally. For instance, a contrarian investor would benefit from a sudden short squeeze as pessimistic traders rush out of bearish bets if the market turns bullish. “By the way, according to our contacts on the Street, there is an inordinate amount of ‘Street Buzz’ going around that there is so much short selling in energy stocks being done by hedge funds that some stocks are becoming hard to borrow,” NYSE floor governor Rich Barry told Business Insider . “It is a hugely crowded trade at the moment.” West Texas Intermediate crude oil futures rose 4.9% to $51.2 per barrel on Thursday, while Brent crude oil futures increased 5.0% to $57.4 per barrel. XLE was up 1.2% Thursday. Energy Select Sector SPDR Fund (click to enlarge) Max Chen contributed to this article . 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. The author has no business relationship with any company whose stock is mentioned in this article.

UGAZ Capitulates On ‘The Bloodbath’ – It’s Time To Get Long

Summary UGAZ, as expected, capitulated into “The Bloodbath” that was inventory on another miss. UGAZ held $2.50 strong and I believe is a nice round number that energy desks will build positions around. BUY UGAZ or DCA into a lower cost basis if you’re already long – “The Turn” has happened. With the EIA Natural Gas Inventory report coming in at -115 BCF against expectations of -121 BCF and the subsequent drop in natural gas pricing, which is most popularly played using The United States Natural Gas ETF, LP (NYSEARCA: UNG ), I believe post- Blood Bath the bottom for natural gas is in. I’ll explain further. (click to enlarge) After outlining the longer term natural gas bull thesis (click “Blood Bath” above) I believe “The Turn” for natural gas pricing has happened. Now, what does that mean? I can’t possibly outline my positions in real time to readers outside of guiding that I own VelocityShares 3x Long Natural Gas ETN (NYSEARCA: UGAZ ) at $2.90 and will add to my position tomorrow in the early AM to average down my cost basis. Over the next 9 months I’ll be offloading and adding to my net natural gas exposure, inclusive of selling and buying UGAZ and inclusive of selling and buying hedges via UNG options, in an effort to maximize the longer term bullish trend. I’ve ridden trends using this strategy the last two years with great success both on the long and short side. (click to enlarge) So, I’ll outline my thoughts on immediate term, mid-term, and longer term trends with following recommendations – this will become a regular section of these weekly updates, make sure to # FOLLOW me and subscribe to real time alerts for the UGAZ ticker: Immediate Term (next 7 days): bullish, BUY. This is going to be against consensus as weather is expected to be in the mid-70’s for HOD’s for the middle part of the country with LOD’s coming in at just over 50 degrees. Normally, this would be bearish and it just might be during the next 7 days leading into inventory. IF UGAZ is hit – BUY (see Long Term bullet) as we are at what should be generational lows. I’m going against consensus in estimating that UGAZ is higher than its most recent close of $2.48 but 1) I just can’t imagine cooling demand not upticking in the middle part of the country (namely Texas) as this will be the first time in a long time that folks have felt anything resembling heat, I’m betting folks overreact in that it will “feel” hotter than it is and that cooling demand comes on strong and 2) I can’t imagine big energy desks not beginning to build longer term positions right here, that should provide some volume on any drops to pricing. Mid Term (next 30 days): Mixed to flat as of right now, BUY in the immediate term and wait on further buys. Guys, I had watch the inventory report post greater than 90 BCF reports 8 consecutive weeks in the middle of summer (including builds of 91BCF, 87BCF, 94BCF, 105BCF, 112BCF, 97BCF, 90BCF, 92BCF), the middle of what was supposed to be the bull thesis, before the market gave me some credit and ran natural gas pricing down. I was looking VERY foolish for about two months as the price of natural gas was denying all fundamentals. Eventually, everything has to be priced efficiently and thank goodness I had conviction in my short position. That said, I’m never willing to say that my thesis will play out exactly on time or exactly in lock step with developments. Wait on further buys in the mid-term once you get some position on the board at these lows. Long Term (longer than 30 days): bullish, BUY on dips as far as $2.00. I have no question natural gas is higher than its current close in 30 days. If you plan on buying for the long term and not trading around you should build positions on dips down to $2.00. No questions natural gas is at the lows. We’ll see over the next few weeks how many institutional holders have to be wrong (by selling or shorting natural gas) but just like always eventually they’ll come around. If you’re in this name for a once a month buy/sell the decision to buy is easy. Just do it. I understand I can post one update article per regular long article so if a major weather change develops or something else comes along that would change my immediate term opinion I’ll post an update article. Check back daily to make sure no updates have been posted. Remember, mid-term and longer-term reco’s aren’t effected by week to week developments. Also remember, the current bull thesis is as follows: Falling rig counts hurt overall production – that’s good for the supply side of the equation as production is slowed overall. Less oil E&P to come on lower CAPEX across the board for oil and natural gas E&Ps – that’s also good for the supply side of the equation (Source: Bloomberg.com). I’m betting on the fact that spring will start early and summer will be, well, it’ll be hot – that’s good for the demand side of the equation – for clarity these projections are based on longer term weather models from Weather.com which may be unreliable. I believe at poor hedging or at lower than ideal aggregate hedging that natural gas E&P names won’t “pump baby pump” as hard into what has been excellent hedging in size the last few years – that’s also good for the supply side. Examples of companies I’ve reviewed that have 1) less than ideal pricing hedging or 2) less than ideal aggregate hedging coverage are Chesapeake Energy Corporation (NYSE: CHK ), Antero Resources Corporation (NYSE: AR ), Ultra Petroleum Corp. (NYSE: UPL ), Halcon Resources Corporation (NYSE: HK ), SandRidge Energy, Inc. (NYSE: SD ), Quicksilver Resources Inc. (NYSE: KWK ), etc. This list could have been 50 names deep. Finally, please read the disclosure section of this article as playing leveraged commodity ETN’s is dangerous and requires a constant monitoring of positions. Good luck everybody, I’ll see you next week in The Lounge. Disclosure The risks of investing in a 3X leveraged commodity trading vehicle like UGAZ/DGAZ are much greater than those of other vehicles. These risks include (Source: Velocitysharesetns.com/ugaz): ETNs are only suitable for knowledgeable investors seeking daily exposure (including inverse or leveraged exposure) to the underlying index. ETNs are intended for short-term trading, therefore investors with a horizon longer than one day trading should carefully consider whether the ETNs are appropriate for their investment portfolio. Because the inverse leveraged ETNs and leveraged long ETNs are linked to the daily performance of the applicable underlying Index and include either inverse and/or leveraged exposure, changes in the market price of the underlying futures will have a greater likelihood of causing such ETNs to be worth zero than if such ETNs were not linked to the inverse or leveraged return of the applicable underlying Index. The ETNs do not guarantee any return of principal at maturity and do not pay any interest during their term. At higher levels of volatility, and since the ETNs are not principal protected, there is a significant chance of a complete loss of ETN value even if the performance of the index is flat. The closing indicative value on each valuation date is determined in part by reference to the daily percentage change in the level of the underlying index. As a result, to the extent the closing indicative value of the ETNs is greater than or less than the initial indicative value, subsequent changes in the level of the index may have a bigger or smaller impact on the closing indicative value of the ETNs than if the closing indicative value remained constant at the initial indicative value. For example, assuming an initial indicative value of $100, if the closing indicative value of the ETNs increases above $100, a subsequent 1% daily change in the level of the index will result in more than a $1 decrease in the closing indicative value of the ETNs. Likewise, if the closing indicative value of the ETNs is less than $100, a 1% increase in the level of the index will result in less than a $1 increase in the closing indicative value of the ETNs. If the level of the underlying index decreases or does not increase sufficiently (or if it increases or does not decrease sufficiently in the case of the inverse ETNs), to offset the effect of the Daily Investor Fee over the term of the ETNs, the investor will receive less than the principal amount of his investment upon early redemption, acceleration or maturity of the Notes. This particular ETN also runs the risk of being decayed by contango which is defined by Investopedia as: A situation where the future price of a commodity is above the expected future spot price. Contango refers to a situation where the future spot price is below the current price, and people are willing to pay more for a commodity at some point in the future than the actual expected price of the commodity. This may be due to people’s desire to pay a premium to have the commodity in the future rather than paying the costs of storage and carry costs of buying the commodity today. Finally, there are general risks that should also be considered such as liquidity risk (Source: Investopedia.com): The risk stemming from the lack of marketability of an investment that cannot be bought or sold quickly enough to prevent or minimize a loss. Liquidity risk is typically reflected in unusually wide bid-ask spreads or large price movements (especially to the downside – which are magnified in leveraged ETNs) . The rule of thumb is that the smaller the size of the security or its issuer, the larger the liquidity risk. Disclosure: The author is long UGAZ. (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: The author is long UGAZ at equal sizes at $2.90 and $2.48. The author has a cost basis of $2.69