At the eleventh hour, the US Court of Appeals issued a stay of the controversial Cross-Tate Air Pollution Rate (CSAPR). The law was to go into effect immediately at the start of 2012, but will now have its fate decided sometime in the second half of the year. In light of the stay, a review on utilities CenterPoint Energy (CNP) and Calpine (CPN) is in order.
Whereas CenterPoint is rated a "hold" on the Street, Calpine is rated a "buy". I find that while Calpine is preferable, the risk inherent in both companies is not worth the potential upside. Macro uncertainty, whimsical regulations, and poor growth prospects will drive unusually high volatility. With Calpine offering no dividend yield, and trading at 73.8x forward earnings, and being 30% more volatile than the market as a utilities firm, investors have reason to look elsewhere.
Dominion (D) and CenterPoint are roughly 55% less volatile than the market and offer a dividend yield of 3.9% and 4.4%, respectively. Despite CenterPoint being the cheapest of the three at a respective 10.3x and 15.4x past and forward earnings, it is still rated a "hold".
During the third quarter, the company had strong performance and benefitted from improved visibility following the resolution of the drawn out true-up proceeding. In addition, Houston Electric posted strong growth.
At the third quarter earnings call, CenterPoint's CEO, David McClanahan, noted the strong results in Houston Electric and implied confidence through capital investments.
The future looks bright for this unit. While we can't count on repeating the weather-driven earnings we experienced this year, we can count on a solid and growing service territory. We have added more than 35,000 customers since this time last year, and believe we'll see a continuation of that pace of growth next year.
Very few areas around the country are experiencing this type of economic activity and growth. Capital expenditures should approximate between $500 million and $600 million annually, as we build infrastructure to serve new loads and automate the grid. The primary earnings headwind this unit faces comes from the rate changes implemented this past September. This will have a negative operating income impact of approximately $35 million next year, when the effect of the change in depreciation rates is also taken into account.
Going forward, the company is likely to focus on acquiring regulated businesses and liquids-rich plays to expand momentum. September rate changes have put pressure on margins and increasing scale would be effective in spreading out fixed costs.
Consensus estimates for CenterPoint's EPS forecast that it will grow by 17.5% to $1.14 in 2011 and then by 6.1% and 7.4% more in the following two years. Assuming a multiple of 16x and a conservative 2012 EPS of $1.19, the company is trading at fair value. Modeling a CAGR of 10.3% for EPS over the next three years and then discounting backwards by a WACC of 9% suggests that the company is worth $16.56.
While I see stronger upside in Calpine, again, the company is not worth the risk. The stay of CSAPR will have the effect of adding pressure to wholesale power's forward prices. In the slightly longer-term, it will add greater uncertainty and thus drive more volatility. Calpine would be a notable beneficiary of CSAPR and thus faces significant risks following the court's approval of the stay. At the same time, spark spreads are widening given the greater decline in natural gas prices compared to power prices. This will have the effect of driving returns in Southwest plants, which are currently underutilized and are speculated as possible strategic sales.
Consensus estimates for Calpine's EPS forecast that it will be flat at $0.22 in 2011, decline by 22.7% in 2012, and then surge by 229.4% in 2013. While utilities are typically strong defensive, Calpine is an exception to the rule.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
