Tag Archives: utilities

Is The Calpine Dip An Opportunity?

Summary Calpine one of the largest power generators in the U.S. and Canada, with ~27,000 megawatts of generation capacity. It’s our belief that this best-in-class operator is being unduly punished by the decline in oil & gas prices. We find the shares to be incredibly attractive at current levels, with an FCF yield of 17.33% (low-end adj. FCF 2016) and EV/EBIT of 13.51. The low commodity prices in natural gas have generate negative sentiment around Calpine (NYSE: CPN ). The company has ~27,000 megawatts of generation capacity, with 97% being natural gas-fired. Normally, you’d think this would be a good thing for the company and its customers, but the market doesn’t see it that way. Anything natural gas-related is being sold, regardless of the underlying fundamentals. The continued drop in oil & gas prices dictates that electricity will remain low. Calpine is still able to generate excess free cash in a low electricity price environment; however, it gets better margins on high prices. With that said, we don’t expect oil & natural gas prices to remain at these depressed levels forever. So, is the dip in Calpine an opportunity to back up the truck in this best-in-class utility operator? The largest provider of electricity from natural gas and geothermal Calpine was founded in 1984, and is one of the largest power generators in the U.S. The company has ~27,000 megawatts of generation capacity from 83 power plants in 19 states and Canada. It has a formidable presence in the increasingly competitive wholesale power markets in the northeastern U.S., California, and Texas. In addition, it owns natural gas and geothermal power plants across North America. (click to enlarge) Essentially, the company’s power generation portfolio consists of natural gas combustion turbines and renewable geothermal conventional steam turbines. (1) Calpine is one of the largest owners of cogeneration plants and industrial gas turbines. (2) It also has one of the largest geothermal power portfolios in the U.S. with its Geyser assets in northern California. The company generates ~15% of renewable energy in California. (click to enlarge) Calpine has strong competitive advantages from its scale, low-cost status, and geographic presence. The natural gas shale revolution has certainly driven down the price of natural gas with the glut in supply. In turn, this has helped the company to generate low-cost electricity from its gas-fired generators. An abundant supply of natural gas and the displacement of older or obsolete power technologies has positioned Calpine to deliver low-cost electricity well into the future. The company’s geothermal power plants position it well against environmental liabilities. (click to enlarge) Calpine’s status as a low-cost provider in the power generation space gives it a big competitive advantage versus competition. The company is well positioned for stricter federal and state environmental regulation, as it has substantially less greenhouse gas emissions than its peers. Competition is increasing in this commodity business As natural gas prices continue to make new lows on a weekly basis, Calpine benefits dramatically. It relies on natural gas to fire its plants. But what happens if there is a dramatic increase in prices for a sustained period of time? We wish we had the answer. Certainly, it represents a risk if natural gas continues increasing in price over the long term. Our view is oil & gas prices in the U.S are likely to be capped for the foreseeable future due to the glut of supply in the market. Alternative energy and solar companies are another threat. This threat is likely to be subdued in a low commodity environment, which makes many of the alternative energy sources more expensive. However, over the long term, renewable energy sources could dramatically hurt Calpine’s business if they gain traction and compete on a cost basis. Main competitors include Atlantic Power (NYSE: AT ), Talen Energy (NYSE: TLN ), Ormat (NYSE: ORA ), NRG Energy (NYSE: NRG ), and Duke Energy (NYSE: DUK ). Long wave of growth potential As we have mentioned before, Calpine’s gas-fired plants should benefit from the ample supply of natural gas in the U.S. over the long term. More importantly, the power industry is one of the largest industries in the U.S. We are all impacted by the generative capabilities of utilities. The deregulation of the power industry presented uncertainty in the markets for a period of time. Wholesale power producers increased competition dramatically and decreased Calpine’s geographic advantages. However, utilities bring with them incredibly high barriers to entry. The secular trends of abundant, affordable natural gas, increased environmental regulations, focus on grid reliability and pay-for-performance, and the need for capacity to help intermittent renewable should pave the way for outsized growth in the future. Management is shareholder-friendly and competent The company generates excess free cash in the amount of ~$700-800 million per year. This leaves plenty of excess capital for share buybacks and dividends in the future. Management has a strong track record of capital allocation that is accretive to shareholders. Since 2010, management has bought companies at an average of ~6x EBITDA, while it has sold companies ~14x EBITDA. It continues to monetize non-core assets through sales or contracts, and is firmly committed to returning capital to shareholders with the excess free cash that the company is generating. (click to enlarge) Bottom Line It’s our belief that this best-in-class operator is being unduly punished by the decline in oil & gas prices. The entire sector continues to get beaten up, while Calpine continues to generate excess free cash. The secular trends of abundant, affordable natural gas, increased environmental regulations, focus on grid reliability and pay-for-performance, and the need for capacity to help intermittent renewable should pave the way for outsized growth in the future. In addition, the company has $6.9 billion in NOLs that still need to be worked through. The market appears to be pricing Calpine for dead, as it trades at a substantial discount to its replacement cost. We find the shares to be incredibly attractive at current levels, with an FCF yield of 17.33% (low-end adj. FCF 2016) and EV/EBIT of 13.51. Future dividends and buybacks should prove to be additional catalysts for this heavily undervalued company. While we are not huge fans of the power generation business, Calpine should do very well for investors over time. Notable Shareholders: Bill Miller | Altalis Capital | Rivulet Capital | Addison Clark Please share your thoughts in the comments section below as I learn just as much from you as you do from me. It can be a timely endeavor, but I answer all of your comments and questions myself. Your patience and understanding is greatly appreciated. I will get to your comments as soon as possible. 🙂 (Source of the above figures: Company Presentation )

Algonquin Power: U.S. Dollar Dividend, Canadian Dollar Share Price, And Huge Insider Ownership

Algonquin Power is getting lots of love from Canadian stock analysts. It has a unique structure of paying its dividend in US Dollars, removing foreign exchange risk for income investors. Insiders own 19% of the company. Algonquin Power and Utilities ( OTCPK:AQUNF ) (AQN.TO) is a Canadian-based electric, natural gas, and water utility serving 488,000 customers. US investors are offered an interesting combination of above-average dividend growth paid in US Dollars while gaining exposure to the benefits of a falling US Dollar with a company well liked by Canadian research analysts. Management expects 15% growth in assets, approximately 15% growth in adjusted EBITDA and greater than 10% growth in adjusted EPS. In Canada, the majority of assets are in renewable power generation while its US footprint is strong to utility distribution with 31 electric, gas, and water businesses. Algonquin Power’s cross-border structure provides an interesting twist for US investors: Income is paid in US Dollars and share prices trade in Canadian Dollars. While dividend growth investors may turn their heads at a huge dividend cut in 2009, an understanding of the company’s structure should overcome this stigma. Water will be a bigger part of Algonquin Power. AQUNF is working on acquiring the water utility assets of private equity firm Carlisle Infrastructure Group LLC. After the acquisition of California and Montana based Park Water is complete, Liberty Utilities will be the 6th largest US water utility by customer count. However, two municipalities, Missoula, MT and Apple Valley, CA are trying to purchase their respective water districts and have been aggressive in filing court documents seeking to force these businesses back into the public domain. Until these issues are resolved, the acquisition cannot proceed. The company recently expanded its Distribution footprint into New England with the purchase of New Hampshire’s Granite State Electric Company and Energy North Natural Gas. In addition, Algonquin Power announced its participation in the Northeast Energy Direct project, a $5 billion natural gas pipeline project that will connect Marcellus production to the Northeast. Algonquin Power went public during the Unit Trust craze in Canada and converted to a C corp. when the Canadian government clamped down on its abuses. In the conversion process, AQUNF cut its dividend in 2009 by 74%, but has been raising dividends since then. The current 5-year dividend growth rate stands at 15.5%. The dividend was most recently increased last June by 10.3%. Based on a $7.70 price for AQUNF (C$10.31 for AQN.TO) and a $0.384 dividend, the current yield is 4.98%. Algonquin Power is expected to earn C$0.43 this year and C$0.50 next. This is slightly less than its dividend, creating a payout ratio of over 100%, but the firm’s trends are positive. Based on its most recent 5-year, $4 billion capital expansion plan, the company is targeting growth in assets and EBITDA of 15% CAGR, EPS and cash flow growth of 7-10% CAGR, and 10% dividend growth rate. More information on its capital plans can be found in its most recent Investor’s Day Presentation pdf. Below is a graph of past and expected EPS, in Canadian Dollars. Source: S&P Algonquin Power is getting lots of love from Canadian stock analysts. For example, BMO Research (Bank of Montreal) recently issued a review reiterating its Outperform rating: Algonquin Power saw its target price increased to C$12.50 from C$11.50 at BMO Research, following an investor day it hosted on December 1. The broker reiterated its outperform view. BMO said Algonquin remains one of its best ideas in power and utility. It also noted that Algonquin is now comprehensively viewing its business from a horizontal and vertical lens to broaden and capture additional growth opportunities. Clear is that this strategy has been successful and expanded its secured opportunity set and provide further support to the 10% dividend growth guidance through 2020, the broker added. BMO increased its EPS estimate to C$0.52 for 2016 while reducing its 2017 forecast to C$0.59. The 2015 outlook remains at C$0.43. BMO is not the only broker who likes Algonquin Power. From Dakota Financial News : A number of other brokerages also recently commented on AQN. RBC Capital lifted their price target on shares of Algonquin Power & Utilities Corp from C$11.00 to C$12.00 and gave the company an “outperform” rating in a research report on Thursday. TD Securities lifted their price objective on Algonquin Power & Utilities Corp from C$11.00 to C$11.50 and gave the stock a “buy” rating in a research report on Monday, November 9th. Scotiabank lifted their target price on shares of Algonquin Power & Utilities Corp from C$11.00 to C$12.00 and gave the stock a “sector perform” rating in a research note on Monday, November 9th. CIBC boosted their price objective on shares of Algonquin Power & Utilities Corp from C$6.50 to C$7.00 and gave the company a “sector outperform” rating in a research note on Thursday, November 26th. Finally, Macquarie began coverage on shares of Algonquin Power & Utilities Corp in a report on Thursday, November 26th. They set an “outperform” rating on the stock. As most international investors know, the sharp spike in the value of the US Dollar has hurt the valuation of its holdings when converted back into USD. For example, the 26% decline in the value of the Canadian Dollar has caused a decrease in dividends paid in Canadian dollars by Canadian firms. When both were at parity, a $1 in Canadian dividends was worth $1.00 in USD. However, currently the same Canadian dollar would translate into $0.734 in USD. Algonquin Power’s unique dividend policy is to pay its dividend in USD for US investors as to make the income portion of an investor’s total return unaffected by the trials and tribulations of the international foreign exchange market. Algonquin Power is able to do this because 80% of its EBITDA is generated in the US and is paid to the company in US Dollars. This attribute should be both a comfort and an advantage to income investors. On the share price side of total return lies an interesting opportunity. If you believe the USD is overvalued compared to the Canadian Dollar, investing in Canadian-listed stocks could provide an interesting boost in potential capital gains. Below is a chart of the US-listed AQUNF (black line) and the Toronto-listed AQN.TO (gold line): The major difference is the slide in the exchange rate starting in Nov. 2013. Over time, if the current exchange rate moves back to parity, share prices should respond positively. However, in the short term, as the US Fed begins to raise rates while the Canadian Central Bank either loosens or maintains its low rates to combat its current commodity-generated economic weakness, the move towards higher exchange rates will favor the US rather than Canada. Insider ownership is substantially larger than most utilities. From Algonquin Power’s tear sheet pdf, insiders own 19.6% of the outstanding stock. Regardless of industrial sector, this level of insider ownership usually connects the retail investor and management at the hip, and should be viewed as a positive attribute. Over the medium term, Algonquin Power should continue to increase its US assets through expansion of alternative power generation and acquisition of smaller US utilities, almost in a roll-up type process. Management’s growing customer base covers the major types of utilities in electric, natural gas, and water services. This allows the company to review opportunities over multiple sub-sectors of the utility sector. Although a cursory review of its dividend history could prove unsettling, I would consider the current dividend supported by management’s growth plan as being a reliable source of income. Investors looking for comfortable utility dividend income and a play on both above-average industry growth and a rebound of the Canadian Dollar over time should review AQUNF. Previous articles on Algonquin Power can be found from Oct. 2014 and March 2015 . I have been long AQUNF since Sept. 2010. Author’s Note: Please review disclosure in Author’s profile. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Pair Trading Opportunity – AGL Resources And Piedmont Natural Gas

Summary Two deals in the same sector with similar conditions and similar payment methods — the perfect situation for implementing a pair trading strategy. Because of regulation, this will be a very long process. So the pair trading strategy is more profitable than a classic merger arbitrage. In my opinion, if the authorities block one of the transactions the other merger will automatically have a lot problems. This risk should be hedged. I have to admit it: I hate mergers with a lot of regulatory conditions and economic intervention . I’m not a lawyer, so I’m not an expert in terms and conditions and I avoid these transactions. However, we can sometimes see very good opportunities in the M&A markets because of similar deals pursuant to the same antitrust approvals. On Aug. 24, 2015, Southern Company (NYSE: SO ) and AGL Resources (NYSE: GAS ) announced a merger agreement. Sometime later, on Oct. 26, 2015, Duke Energy (NYSE: DUK ) and Piedmont Natural Gas (NYSE: PNY ) approved another merger agreement with similar terms and conditions. Both transactions will be paid in cash, and their size is comparable: $12 billion and $6.7 billion, respectively. In this article, I will only assess the terms and conditions of both mergers. If you want to understand more about the financial performance of the companies, check our these articles: Buyers Duke is the largest electric utility in the United States. It serves 7.3 million customers, located in the Southeast and Midwest. It has an enterprise value of $88.01 billion and $1.38 billion cash on the balance sheet; its ROA is 2.83%. You can check some more numbers here. Source: I nvestor Presentation . It is a mature company, with an interesting dividend yield as well as a high payout ratio: Source: Investor Presentation. You can only see this type of payout ratio in mature industries. Merger arbitrage analysts might say that they like this transaction or not, but the fact is that the sector is in a phase of consolidation and mergers will occur. Southern serves more than 4.5 million customers, and it is the leader in the southeast portion of the United States. It has an enterprise value of $67.48 billion and $1.12 billion in cash; its ROA is 3.74%. You can check some more numbers here. Source: Investor Presentation . I would like to mention that the buyers are very big players. Their size is comparable, and the only difference is that they operate in different areas. The negotiation process with the authorities will be the same. Because of this fact, the merger spread should be similar. Targets and Transitions Benefits Piedmont has one million customers in portions of North Carolina, South Carolina, and Tennessee. It has a better ROA than its acquirer (3.54%), and it is also more than 10 times smaller than Duke. The transaction is an interesting move. Duke’s objective is to enhance its regulated business mix. What’s more, this merger creates a strong platform for future growth. AGL is based in Atlanta. It provides energy services to 5.5 million utility customers (including over one million retail customers served by the SouthStar Energy Services joint venture). Its ROA is 3.84%, which is better than that of the buyer. This transaction is a little better than the other one. It is accretive to ongoing EPS in the first full year, and it will create a strong credit profile. Source: Investor Presentation . Overall, the targets are very similar. It looks like a copied transaction, both in size (“same customer base”) and in value. As mentioned earlier, because of this fact the merger spread should be approximately the same. Terms, Conditions and Timing If you are interested, you can read the merger agreement of Duke’s transaction here and that of Southern here . Both mergers are pursuant to the shareholders’ approval. I did not read about any shareholders complaining about the price paid. So, I’m not worried about these conditions. It is more important, in this case, to assess the regulatory conditions. Southern’s transaction is subject to the following regulatory conditions: – The receipt of antitrust clearance in the United States (Hart-Scott-Rodino Act) – The approval of the FCC – The approval of the California Public Utilities Commission, Georgia Public Service Commission, Illinois Commerce Commission, Maryland Public Service Commission, New Jersey Board of Public Utilities and Virginia State Corporation Commission and other approvals required under applicable state laws. Source: Merger Agreement. Duke’s transaction is subject to the following antitrust conditions: – The receipt of antitrust clearance in the United States (Hart-Scott-Rodino Act) – “The merger is subject to the approval of the NCUC. The Company and Duke Energy expect to file in or around January 2016 a joint application for approval by the NCUC of the merger. Section 62-111(a) of the North Carolina General Statutes provides that no merger or combination affecting a public utility may be made through acquisition or control by stock purchase or otherwise without written approval from the NCUC. Under this statute, such approval shall be given if justified by the public convenience and necessity. The Company is a public utility under North Carolina law and two of Duke Energy’s subsidiaries are also public utilities under North Carolina law. Source: Merger Agreement. I do not think that any merger arbitrageur will tell you the outcome of these mergers. It is a very technical question that you might only be able to answer if you have worked approving mergers for a while. So I would not implement a classic merger arbitrage strategy here. I do not like gambling. The pair trading strategy that I will explain below reduces the exposure to these regulatory risks. Overall, the mergers will take a long time because of these regulatory conditions. Both transactions are said to close in the second quarter of 2016. Pair Trading Strategy and Conclusion Duke will pay $60 per share in cash, so the merger arbitrage spread is 5.24% ($60/$57.01 (close on Dec. 11, 2015) – 1). What’s more, we have to include four quarterly dividends paid by Piedmont (0.33 per share; I included the fourth quarterly dividend of 2015 but not that of 2016). So, the merger contribution is $61.32, and the calculated spread is 7.56% ($61.32/$57.01 – 1). Southern will pay an amount of $66.00 per share in cash, so the merger arbitrage spread is 5.21% ($66/$62.73 (close on Dec. 11, 2015) – 1). However, if we include the four quarterly dividends that AGL distributes (0.51 per shares), the merger contribution becomes $68.04, and the calculated spread is 8.46%($68.04/$62.73 – 1). The most recent evolution of the calculated spread can be seen in the following figure: Source: Maudes Capital. I would like to mention that the spread of both companies is somewhat correlated. It makes sense because of the facts explained above. In the future, the evolution will be similar so that you can perfectly implement a pair trading strategy. Today, I would buy PNY shares, and use the same amount of money to short sell GAS. You can make more than 1% return in a short period of time. The best thing in this idea is that you eliminate the regulatory risk included in both transactions. If one merger does not close, the other merger will have a lot of issues as well, and the spread will be enlarged. This means that you hedge the loss in one merger with the gains in the other transaction. To make a long story short, these transactions have a lot of regulatory conditions, and the classic merger arbitrage strategy is not a good idea. The pair trading strategy provides a better risk/return ratio. What’s more, both mergers are necessary moves in the same sector, and therefore good M&A ideas. I believe that both transactions will close, but I do not like playing with regulatory conditions. So, I prefer to hedge the risk. Note: At the moment there are some other merger arbitrage and pair trading investments like this one — you can read about them here , here , and here .