CPN - Calpine

[Cunninghamew]

This idea is way out of my core competency, but there were several positive observations I had about the co. so I wanted to start a thread. I will first provide a brief background of the co. and then I will share the observations that I thought were interesting.

 

CPN owns and operates the largest fleet of natural gas-fired and geothermal power plants in the United States. The company operates in three regions: West (7,524 MW), Texas (9,024 MW), and East Coast (~7,000). Their fleet of natural gas-fired power plants are among the youngest, cleanest, and most efficient power plants in the United States. For example, their heat rate (the amount of energy used by a power plant to generate one kilowatt-hour of electricity) is 7,386 (btu/kwh) compared to DYN and NRG around 10,000.

 

From what I can gather,or what CPN claims, each of their target markets have unique tailwinds. On the east coast, supply is becoming constrained as coal plants are retired. California is apparently flush with renewables, but lacks dispatchable generation (generation that can be turned on and off). Finally, in Texas demand growth has outstripped supply or is projected to. To be honest most of the industry fundamentals are beyond me so I would encourage you to read their May investor presentation.

 

Now for the interesting observations:

 

Jack Fusco took over as the CEO when the company came out of bankruptcy. He is no longer at the helm, but still leads the company's capital allocation efforts. At face value, it looks like he has done a tremendous job and established a strong culture.

 

Here are the "Calpine Guiding Principles"

 

1. Operational excellence: Be the industry's premier operating company

2. Focus on cash: All investments evaluated an Adj. FCF/Share basis (levered returns to equity)

3. Investing in growth and returning capital to shareholders

4. Portfolio optimization: Redeploy capital to capture highest returns

5. Advocacy: Environmentally responsible power generation and competitive wholesale power markets

 

So what have they done:

 

* Recently divested a bunch of non-core assets in the Southeast for $1.57 bill - sold assets for 15.7x adjusted EBITDA and 22x unlevered FCF - note that CPN trades closer to 10x EV/EBITDA and just under a 10% FCF yield

 

* Since 2011 they have repurchased over 20% of their common stock - still have about $500 mm remaining in authorization - the asset divestiture will allow them to continue cannibalizing stock at a fast clip

 

* They have put a substantial amount of capital to work paying down and/or refinancing debt - recently refinanced $2.8B of Senior Secured Notes at 7.5-8% into Senior Unsecured Notes at 5.37-5.75%. Lead to $60mm in annual interest expense savings and extended that maturity of their debt.

 

* They have grown FCF at a very attractive clip over Fusco's tenure

 

Long-story short, it sounds like he has done a pretty good job. Unfortunately, the industry is so far outside my circle of competence that I am hesitant to buy the stock (probably wont), but I thought the positives were worth sharing. The company's goal is to compound FCF per share at a 15% to 20% CAGR. Currently, the stock trades at an 8.77% FCF Yield to its 2014 mid-point guidance and it has an abnormally large cash hoard from the divestiture to do fun things with.

 

tough for me to analyze, but thought this might interest one of you smarter chaps

 

 

 

 

[topofeaturellc]

as a value investor there's usually not a great argument to buy an IPP for more than book.  It is the worst commodity business in the world.  But when you can get them for less than book and with a balance sheet that survives, they can be very profitable investments.

 

For all the buy backs they've done BVPS has actually declined over the last few years. That's not good.

 

Perhaps through the Ch 11 process the CCGT fleet was undervalued in the new start accounting? The geothermal assets are like a rounding error.  Could also say the capital cost of a modern CCGT is about 1000 bucks per Kw, or a million bucks per Mw, they got 23 Gw of capacity and gross PP&E 17 Bil.  Given some of their fleet is single cycle/cogen/geothermal it doesn't seem like the assets are mismarked? IDK.

 

That would be the first thing I would try to figure out.

 

So the first thing I might try to do is just look at PP&E/MW installed and compare that to the other IPPs - especially other gassy ones. If that showed CPN to be an outlier I might dig in. 

 

You also need to underwrite the power pools they sell into.  Usually CCGTs are worth about book because other than gas differentials they are all about the same efficiency. 

 

Without digging in the lower heat rate is just telling you they have a fleet of Geothermal (0 heat rate) and mid-merit/base CCGT.  Coal is cheaper on a per BTU basis so a coal plant can generate more cheaply at a higher heat rate.  I don't know what DYN and NRG's fleets look like.

 

Just some thoughts.

 

[no_free_lunch]

I know very little about the space but it seems like there are some positive long-term fundamentals for the industry.  Basically 2 things:

 

1) If electric car adoption increases and I see it as near certainty, won't the electric utility industry have some major tailwinds with all the increased demand?  Lack of electric capacity is occasionally cited by the critics of electric cars.

 

2) Warren Buffet likes electric utilities.

 

[topofeaturellc]

WEB owns regulated utilities AFAIK. Very very different animal

 

Load growth is also likely to be offset by growth in things like solar.  There is a place for gas-fired CCGT in that environment but that is mostly through capacity payments and I would expect a capacity payment regime to return CoC-ish.

[LC]

And I believe his foray into renewable energy is to maximize the tax breaks associated with that investment. Which may imply that Brk's confidence in renewables is not 100% based on the underlying fundamentals. His recent investment into Exxon is telling in this regard.

[HJ]

as a value investor there's usually not a great argument to buy an IPP for more than book.  It is the worst commodity business in the world.  But when you can get them for less than book and with a balance sheet that survives, they can be very profitable investments.

 

For all the buy backs they've done BVPS has actually declined over the last few years. That's not good.

 

Perhaps through the Ch 11 process the CCGT fleet was undervalued in the new start accounting? The geothermal assets are like a rounding error.  Could also say the capital cost of a modern CCGT is about 1000 bucks per Kw, or a million bucks per Mw, they got 23 Gw of capacity and gross PP&E 17 Bil.  Given some of their fleet is single cycle/cogen/geothermal it doesn't seem like the assets are mismarked? IDK.

 

That would be the first thing I would try to figure out.

 

So the first thing I might try to do is just look at PP&E/MW installed and compare that to the other IPPs - especially other gassy ones. If that showed CPN to be an outlier I might dig in. 

 

You also need to underwrite the power pools they sell into.  Usually CCGTs are worth about book because other than gas differentials they are all about the same efficiency. 

 

Without digging in the lower heat rate is just telling you they have a fleet of Geothermal (0 heat rate) and mid-merit/base CCGT.  Coal is cheaper on a per BTU basis so a coal plant can generate more cheaply at a higher heat rate.  I don't know what DYN and NRG's fleets look like.

 

Just some thoughts.

 

I have been thinking about this company lately.  It's easy to gloss over the stock, or the IPP industry for that matter.  After all, virtually every company in the industry restructured at some point over the past decade and half, Calpine, Dynergy, NRG, for that matter, TXU.  It's a commodity business, subject to the swings of commodities on both the input side and the output side, capital intensive, not a "good business" in the Buffet/Munger notion of the term. 

 

But on closer examination, it has some redeeming quality that maybe warrant a deeper dive into the business, and this particular name: it provides an essential service to society, it seems like nat gas is going to be an advantaged energy source electricity generation wise for quite a while to come, it's arguably trading below replacement cost (reaffirming the notion that it's not a good business, at least in the past decade +, but are we maybe at an inflection point in the industry, ala rail roads in the late 90's?), it's got a boat load of tax loss carry forwards, so not going to pay much cash tax for quite a while.  Enough capital has been lost, both debt and equity, in this business, that just maybe the capital providers to the industry will be sober for a while.  I forgot the data, but think I read at some point that IPP's accounted for something like 40% of total US electricity generation.  The industry and unregulated power generation business model is not going away.  It's never going to have the ROE of a consumer products company, but then again it's not trading that way either.  These IPP's, in the early part of the privatization process, all took what was believed at that point, the best locations, to service the grid.  Let that be the competitive advantage, if you have to squint your eyes to find it.  You can sort of construct a set of reasonable circumstances that can result a decent ROE. Where else do you find close to 10% FCF yield to the equity?