Mirant Looks Great - But Don't Rush to Conclusions

 |  About: NRG Energy, Inc. (NRG)
by: Saj Karsan

*Update below

Mirant (MIR) produces and sells electricity in specific markets within the US. It trades at its lowest price in several years, and currently has a P/E of just 3 and a P/B of just .35. It has almost as much cash as it does debt, despite operating in an industry where higher debt loads are considered safe.

As demand for power has dropped as a result of the recession and environmental conservation efforts, prices in the future are expected to be lower than they have been in the recent past, leading to profit projections considerably lower than current profits. Electricity prices are volatile, however, which can allow investors to take advantage of short-term pessimism. Furthermore, Mirant operates in an industry with high barriers to entry, as high regulations and high upfront capital requirements discourage potential new entrants.
But while Mirant is superficially appealing based on traditional value metrics, it is substantially more complex than most of the companies discussed on this site. Not only is it several times larger than most of the companies we look at, but it also operates in several business lines, requiring the investor to understand a myriad of issues. The company uses over-the-counter and commodities market derivatives to manage its production capacity and its supply requirements, both to hedge its revenues and costs, as well as for proprietary trading.
Furthermore, as a producer of dirty energy (fuel and coal based), the company is subject to numerous regulations from all branches of government, from the federal to the state to the local level. Some of these regulations require plant shutdowns (for plants that are not up-to-date technologically), while others can, and have, required billions of dollars in capital expenditures. The market cap of this company is only $1.5 billion, so the nature and timing of any future regulations can have a significant effect on the stock's valuation.
While Mirant may very well generate excellent returns for stockholders at its current price, it's important that the value investor recognize the importance of investing within his circle of competence with an investment like this. An investor that doesn't fully understand the risks to a company such as Mirant (and there are several including environmental, regulatory and financial), can receive unwelcome surprises that destroy his principal, thus violating the first rule of value investing. Indeed, the company went bankrupt just 7 years ago, catching a different group of shareholders off guard (albeit with a much higher debt burden than it currently carries).
*Note: A few hours ago, the company announced that it would merge with Reliant Energy (RRI) in an all-stock deal, making this stock's value somewhat more difficult to estimate, since an understanding of both companies is now required.
Disclosure: None