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NRG Hits the ‘Reset’ Button

By Ari Charney on September 18, 2015

When you’re an investor, it doesn’t always pay to be early.

That’s been our experience with NRG Energy Inc. (NYSE: NRG), whose forward-thinking push into renewable energy has thus far, with the exception of contributions from NRG Yield Inc. (NYSE: NYLD), been more of an earnings drag than a growth driver.

Despite NRG’s dramatic evolution during CEO David Crane’s tenure with the company since it emerged from bankruptcy back in 2003, it’s still primarily a wholesale power generator.

And the competitive-power market typically rises and falls with the price of energy commodities, particularly natural gas. The resulting volatility, along with the fact that we’re now in a depressed environment for power prices, is why we favor fully or mostly fully regulated utilities over merchant generators.

To be sure, merchant generators can deliver strong gains when energy prices are rising.

Indeed, our initial recommendation of NRG at the beginning of November 2013 proved timely. The stock largely tracked natural gas prices higher, climbing 33.3%, to a post-Global Financial Crisis high of $37.66 in June 2014.

But while the crash in crude oil prices has grabbed all the headlines, the price of natural gas has also collapsed, causing similar declines in wholesale power prices and, consequently, NRG’s share price.

However, even with these headwinds, analysts have been confounded by the fact that NRG has fallen harder than its merchant-generation peers, making it the worst performer among the utilities on the S&P 500.

Perhaps part of the reason is due to the fact that NRG is by far the biggest independent power producer in the U.S. When sentiment turns sour, sometimes the biggest kid on the block suffers the biggest bruising.

The other reason may be that the market has difficulty valuing NRG because of its confusing operating structure.

Finally, there’s the perception that NRG has been spending too much on its investments in renewable energy.

Facing mounting pressure from investors, earlier this year NRG hinted at the possibility of splitting the company in order to unlock greater shareholder value by simplifying its operating structure, paring debt and cutting costs.

With today’s announcement, management is following through on this initiative a bit sooner than many investors had anticipated.

The biggest change is that NRG will be putting its customer-facing, renewable-energy businesses, including home and commercial solar and electric-vehicle charging, into a unit it’s calling a “GreenCo.”

Management is in the process of courting a strategic partner for its GreenCo, particularly one that can help fund its future growth as a standalone entity.

To that end, NRG sought to reassure investors that its commitment to financing the GreenCo would be limited to a $125 million intra-company line of credit. Their expectation is that this amount should be enough to get the GreenCo up and running through mid-2016, by which point it can sustain itself from internally generated cash flows.

Thereafter, management hopes to unlock additional value via a full spinoff once the market for initial public offerings (IPOs) for such investment vehicles recovers.

In the interim, management still sees significant opportunities from growth in the renewable-energy space, so it intends to maintain some sort of stake in the GreenCo, even if it’s no longer contributing capital to it.

Meanwhile, NRG plans to cut spending by $150 million this year, while freeing up more than $1 billion in capital through reallocations and divestitures.

Those savings will then be redeployed toward debt reduction and share repurchases, with $250 million in buybacks (equivalent to about 4.2% of the $6 billion company’s shares outstanding) to occur later this year.

Assuming the GreenCo is ultimately spun off at some point in the next year or so, then that would leave us with a legacy company that consists of a merchant generation and retail electric business.

To be sure, NRG will still have exposure to cash flows generated from the long-term contracted renewables it’s dropped down to NRG Yield. But aside from that, it sounds like NRG’s ambitions in the green-energy space have been largely shelved, at least for now.

In general, we’re not interested in being long-term holders of merchant generators. For one, we’re not interested in trying to time wholesale power markets.

Additionally, the volatility inherent to these types of investments means they’re not suitable for most income investors. We prefer stocks that we can stick with through thick and thin.

Although these changes no longer support our original investment thesis, we think there will be a better exit point in the year ahead.

We’re certainly not interested in selling the stock at a bottom. And that’s where NRG appears to be today.

Fortunately, it looks like time should be on our side. NRG still enjoys strongly bullish sentiment on Wall Street, at 11 “buys,” three “holds,” and one “sell.” And its consensus 12-month target price currently stands at $28.18, which suggests potential appreciation of 56.6% above the current share price.

So what are we looking for before we sell?

First, we’d like to see the stock get a bump from the buybacks and debt reduction it just announced. Then we’d like to see to what extent NRG is able to monetize its stake in the GreenCo.

Given the recent regulatory push from the Obama administration’s Clean Power Plan, growth from renewable energy is still gathering momentum–just not with NRG.


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