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NRG Energy (NYSE:NRG) is expected to benefit from rising natural gas prices, which will translate into strong financial performance for the company in the coming quarters. Also, the company expects a high growth rate of 23% per annum for the next five years. NRG also expects synergies from its merger, and its cheap valuation make us bullish on the stock.

NRG Energy operates as a wholesale power generation company and is among the largest power generators of the United States. The company provides services to residential, industrial and commercial customers in almost 16 states. NRG is spending on environment-friendly sources of power generation, including solar, wind and nuclear energy. The company is currently working on more than 2,000MW of solar power projects.

Earlier, the company announced its merger with GenOn Energy. The merger deal worth $1.7 billion is expected to be settled in stocks. The deal is subject to regulatory approval and is expected to close in early 2013. If the two companies merge, it would make NRG one of the largest independent power producers in the U.S., with a generation capacity of more than 45,000MW. Also, the company is expected to improve upon its operational efficiencies as a result of the expected synergies. The company will be able to generate additional cash of $300 million and EBITDA of $200 million annually, starting from fiscal year 2014.

The chart below shows the breakdown of revenue according to NRG's reporting segments.

(click to enlarge)

The company's overall financial performance has shown mixed trends. Net sales for the company have increased from $5.9 billion in 2007 to $8 billion in 2011, representing an annual growth rate of almost 6%. Despite achieving growth in its top line, the company's net margin fluctuated, whereas its EBITDA margin decreased, as shown in the graph below.
(click to enlarge)
Source: Qineqt's calculations

NRG reported net revenue of $2.33 billion for the third quarter of 2012, down 13% YOY and missing the market's consensus by $50 million. Despite the negative top line growth for the quarter, the company was able to improve its bottom line. Earnings per share for 3Q 2012 were $-0.01, up from $-0.24 in 3Q 2011. The Texas segment reported the strongest results among the various segments. It reported a 70% YOY increase in EBITDA. The segment's strong performance was driven by favorable weather conditions and better energy margins.

It is being anticipated that NRG will benefit from rising natural gas prices due to natural gas hedging, from 2013 to 2015. The graph below shows the percentage of natural gas hedged by NRG.

(click to enlarge)
Source: Earnings Release

As natural gas prices rise, it will help the company increase its prices, which will eventually translate into growth in margins and bottom line expansion. It is expected that natural gas prices would continue rising and settle in the range of $4 - $4.5/mmBtu in the coming years. The chart below shows natural gas prices for the last one year.

(click to enlarge)
Source: forexpros.com

The company started paying quarterly dividends in the recent third quarter. Currently, the stock offers a dividend yield of 1.7%. Its annualized dividend rate is $0.36 per share. We believe this yield is sustainable because it is backed by an attractive free cash flow yield of almost 20%. Moreover, NRG has a debt to equity of 130%. The chart below shows the debt to equity for NRG from 2007 to 2011.

(click to enlarge)
Source: Annual Reports and Qineqt's calculations.

Valuations

NRG Energy

The AES Corporation (NYSE:AES)

TransAlta Corp. (NYSE:TAC)

PEG

1

1.2

13

5 years growth rate

23%

8%

2%

Price to Book

0.65x

1.8x

1.7x

Price to Sales

0.6x

0.5x

1.7x

Source: Yahoo finance

NRG is trading at cheap valuations compared to those of its competitors, which is evident in its price to book of 0.65x and price to sales of 0.6x. Also, NRG has the highest five-year growth rate of 23% among its competitors. We believe the company has a strong cash flow position. Combined with the expected future synergies from the merger, the stock has significant upside potential.

Risks

Power prices are subject to regulatory approval, which can have a significant impact on the financial performance of company. Also, the unfavorable weather conditions can also squeeze margins for the company in the future.

Source: Rising Natural Gas Prices A Boon For NRG Energy