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We are bullish on NRG Energy, Inc. (NYSE:NRG) because of its expected synergies, high growth rate of 28% per annum for the next five years, and cheap valuations based on a P/B ratio of 0.66x and a PEG of 0.82. It has recently announced that it will acquire GenOn Energy, Inc. (GEN), and that synergies from the acquisition will help it improve operational efficiency and reduce debt.

NRG Energy is an independent power producer that operates as a wholesale power generation company. It is one of the largest power generation companies in the United States. The company's retail electricity providers; Green Mountain Energy Co., Reliant and Energy Plus, along with its thermal energy division, provide services to industrial, residential, commercial and business consumers in 16 U.S. states.

NRG Energy has been actively taking initiatives to reduce greenhouse gases. Under cleaner energy programs, it has been investing in wind, solar and nuclear power generation infrastructure. It is also the largest developer of solar power generation in the country.

NRG's operating revenues for 2Q2012 were $2.17 billion, down 4.9% YoY. Reported EPS for the quarter were $1.08, comfortably beating estimates of 0.16 cents. NRG reported strong adjusted EBITDA of $539 million, as compared to $517 million in 2Q2011. The increase in its EBITDA was mainly due to strong results produced by its retail segment. The retail segment reported EBITDA of $219 million in 2Q2012, up 10% YoY.

The company's operating income margin improved to 18.3% in 2Q2012 from 11.8% in 2Q2011, whereas total operating costs were down 12% YoY. This was mainly due to lower costs for operations and development. NRG reaffirmed its adjusted EBITDA guidance of $1.8-$2.1 billion for fiscal year 2012, with expected wholesale and retail contributions of $1.2-$1.3 billion and $625-$700 million, respectively. It also maintained its 2013 and 2014 EBITDA guidance of $1.7-$1.9 billion.

The company has been focusing more on its retail electricity business, with an improvement of 10% in its EBITDA for the most recent quarter. This was driven by higher customer usage, addition of new customers, and the acquisition of Energy Plus. In the first half of 2012, the company added more than 60,000 new customers.

NRG plans to increase its capacity in Texas. The company announced that it will add a 75MW generation plant in Texas. The plant is coal operated, and is expected to be operational by next summer.

The company has been investing in solar power, and in the coming two to three years, solar power generation might constitute a significant proportion of the company's operations. NRG has more than 2,000 megawatts of projects under development. The contribution of solar energy to total EBITDA is expected to quadruple by 2014; which currently is only 4% of total EBITDA. However, the contribution of wholesale to overall EBITDA is expected to fall from 61%-to-43% by 2014.

In July this year, NRG announced that it would buy GenOn Energy for $1.7 billion in stocks. GenOn is a competitive electricity producer in the U.S., with a generation capacity of ~23,000MW. The deal is expected to close in the first quarter of 2013; however, it is still subject to regulatory approval. The expected synergies from the transaction will be realized by 2014.

The expected benefits from the merger of the two companies are $300 million in annual free cash flows and $200 million in annual EBITDA. The benefits will result from increased operational efficiency and the formation of cost synergies. The approval of shareholders is expected in a special meeting during the fourth quarter of 2012.

The deal's successful completion will make NRG the largest independent power generating company in the U.S., with over 47,000MW of generation capacity. GenOn has a strong liquidity position, with almost $2 billion in cash, and an operating cash flow yield of ~14%. The post-acquisition company is expected to pay off $1 billion of debt by 2014. The deal will help NRG focus and expand its retail business at lower costs. Around 67% of a combined generation capacity will result from the gas and oil fired plants.

Dividends

NRG declared its first ever quarterly dividend of 0.09 cents in August. Currently, it has an annualized dividend of 0.36 cents, and a dividend yield of 1.6%. The CEO of NRG indicated that the company will ensure that it maintains dividends, and that it might even repurchase shares after the acquisition.

NRG

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PEG

0.8

11.7

1.1

16.7

5 years growth rate

28%

2%

8%

3.6%

Price to Book

0.66 x

1.8x

1.35 x

2.2 x

Source: Yahoo Finance.

NRG is trading at a discount when compared to its competitors. It has a high growth rate of 28% per annum for the next five years. Its PEG of 0.8 reflects that it offers cheaper growth as compared to its competitors. NRG's P/B ratio of 0.66x reflects that its stock is trading at cheap valuations.

Source: NRG Energy: Acquiring Its Way To Strong Returns