I attended the Calpine (NYSE:CPN) Analyst Day, as I wanted to understand the story better. As one who believes low natural gas prices are likely to persist, I am always looking for potential beneficiaries. It would appear that CPN fits the bill.
In a former life, this stock made me look like a genius and then a fool. For anyone who followed this go-go company a decade ago, the story has gotten much simpler. Instead of close to 1000 pages, the 10-K is now just 210. Kidding aside, it was pretty clear to me that the company is doing things right these days. I was very impressed with CEO Jack Fusco and his team.
The meeting was well attended. I will try to condense four hours of presentations into a few paragraphs. You can access the slides and follow along. One big picture takeaway that I have is that despite the CEO being there just 2 1/2 years, there is a lot of cohesiveness. COO Thad Hill worked with CEO Fusco previously, as did Chief Legal Officer Thad Miller. Many of the other senior execs have deep experience with the company (but weren't making the foolish capital allocation decisions that buried the company).
Speaking of capital allocation, CEO Fusco began his presentation highlighting it as the most important thing that he can do. This shouldn't surprise us, as he has pretty big equity exposure himself, so he thinks like a shareholder. I learned that he purchased 500K shares when he joined in 2008. Those shares are now almost in the black again. He quickly reminded everyone how much has transpired since the last Analyst Day (3/09), including growth in capacity, a large acquisition and some dispositions. One of the most interesting slides detailed the woeful investment made in energy generation capacity: 35% is greater than 40 years old. He believes that CPN will get higher volume and prices over time as a consequence. Too much of the recent investment has gone into "intermittent technology" (solar/wind). He then highlighted several favorable trends:
- Improving Economy
- Favorable Federal Regulatory Environment, especially EPA
- Good State Regulatory Environment
- Security of Domestic Fuel Source - Shale gas is abundant, coal is expensive and nukes looking less likely.
Fusco promised continued operational excellence, the pursuit of disciplined growth and improved financial flexibility. Monetization efforts will include customer origination, long-term contracts, regulatory participation, equity partnerships and asset divestitures (he used the moment to announce two plants that will be auctioned in coming days).
COO Thad Hill described external drivers as well as internal efforts. Tailwinds include a stricter EPA, a rapidly improving Texas market and California becoming more of a managed market. While 2011 is very hedged, 2012 has limited gas exposure but positive heat rate exposure. 2013 is unhedged on all fronts. He cited shale gas abundance as favorable for CPN, while global demand for coal is leading to near-term switching from gas to coal and the likelihood that gas will be the standard in the future. Internally, the company is focused on optimizing its assets, which includes long-term customer origination (hinted at a 10-year deal about to be announced in the Southeast), continued strategic hedging and a focus on maximizing risk-adjusted returns. He described three projects (2 plants in CA., and a turbine replacement program) that are investments at just 5-6X EBITDA, with several other developments under consideration.
CFO Zamir Rauf described what has truly been a radical transformation. While he didn't discuss it, my conversation with the CEO and with him helped me to better understand what a sloppy bankruptcy this was. The company emerged with serious legacy issues, but they are now behind them. The company has refinanced restrictive legacy debt and improved many of its processes, leaving it in a good position to optimize, to decide between build vs. buy, and to potentially return capital to shareholders (through repurchase). One of my favorite slides was page 22, where he showed the massive 2014 debt maturity the company was facing two years ago and what now is a maturity schedule more evenly spread out over the next 12 years, with no material near-term maturities and flexible covenants. He discussed the need for a minimum of $1 billion in liquidity and how the excess cash can be invested in projects IF THEY ARE ACCRETIVE TO FREE CASH FLOW, paying down debt (target is 4.5X Net Debt/EBITDA, or repurchasing stock. On that topic, it appears that the company is likely to announce a repurchase after it has already taken place - they made this point several times.
If you are interested in the many regulatory issues, I will refer you to the webcast. It would appear that many trends in regulation on the federal and state levels would favor CPN.
John Adams described the operations. While there is room for some improvement, most of the low hanging fruit has been gathered. Caleb Stephenson, who was one of the more impressive speakers, explained several key dynamics regarding various exposures. First, he discussed the "gas put," which is some very positive optionality within the portfolio. He then demonstrated that the firm earns a "super peak premium" that adds 10-15% above simple forward curves due to its flexible fleet. He also detailed how higher CO2 prices lead to higher margin. Finally, he showed how EPA rules could be detrimental to coal and favorable for CPN (either lots of pollution control equipment that raises variable operating costs or more retirements).
Steve Muscato discussed what's going on in all of the markets, with the Eastern region being impacted by a stricter EPA (impacting coal) and high oil prices helping CPN. Texas, according to CPN, is about to see a dramatic short-fall in its reserve margin due to rising demand but limited new supply. The West is very challenging for new power plant construction.
The next segment was a discussion panel with the people responsible for origination, and you can listen to the webcast for details. Finally, the day concluded with the Treasurer detailing the transformation of the capital structure. While the company will still use some project financing, most of the debt is now at the corporate level ($7 billion out $9 billion gross).
While the story is indeed complex, I left with more confidence that the long-run outlook is favorable. These guys have great assets and now have the financial flexibility to exploit them. If gas prices are going to remain low, it would seem that the utilization and subsequently the pricing will improve greatly. Fusco is a big shareholder and we should probably expect him to act like one. He has a series of options that are out of the money, and my feeling is that he will prudently allocate capital and optimize assets to hit those targets over the next few years. The stock seems somewhat expensive at close to 10X EV/EBITDA, but these are challenging times in terms of realized power prices. I think I will follow this one more closely.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.