May 2019 Utility Review - NRG Takes A Big Hit

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About: Utilities Select Sector SPDR ETF (XLU), NRG, Includes: BUI, BUYN, CNP, FUGAX, FUTY, FXU, GUT, IDU, JHMU, PSCU, PUI, RYU, SDP, UPW, UTG, VPU, XU
by: Robert Howard, CFA
Summary

Utilities were the top performing sector in May, falling only 0.8%.

The decline came in spite of falling interest rates and higher XLU AUM.

NRG's 17+% fall was the worst of the group.

While short-term pricing issues seemed to go against NRG in May, forward prices and company guidance seem to say that NRG is still in good shape.

Sector Stock Performance

May really wasn’t a very good month for utility investors, but it was a miserable month for investors in other sectors. Owners of the Utilities Select Sector SPDR ETF (XLU) should be happy with only losing 0.8% of their money over that span. The XLU is now ahead of the S&P 500 YTD, and is only trailing the technology, industrial, and consumer discretionary sectors in 2019.

Exhibit 1

Source: FactSet and Garnet Research

Utilities were net losers for the month even though falling interest rates should have been a great tailwind.

Exhibit 2

Source: FactSet and Garnet Research

XLU's assets under management rose to $9.2B at the end of May. This is just below the $9.3B record level that was set in March, and the increase in May helped support the sector as the rest of the stock market was falling.

Exhibit 3

Source: FactSet and Garnet Research

At the end of April the XLU was trading at record levels, and with only a slight decline in May, the XLU is still relatively high on a historical basis.

Exhibit 4

Source: FactSet and Garnet Research

The slight decline in the XLU didn’t do much to its P/E ratio or dividend yield, so the ETF still looks relatively expensive compared to historical levels.

Exhibit 5

Source: FactSet and Garnet Research

Thirteen XLU components were down in May, with five of them down more than 6%.

Exhibit 6

Source: FactSet and Garnet Research

NRG Energy (NRG) was by far the biggest loser for the month, down 17.3% in May, after having fallen 3.1% in April.

NRG can't blame sell-side analysts for the drop. The last sell recommendation was removed during the month, and the stock's target price remained stable as well.

EXHIBIT 7

Source: FactSet and Garnet Research

May seemed to start out on a good note when NRG released Q1 results. Adjusted EBITDA for Q1 was $333M, which beat the Street estimate of $303M by about 10%. NRG also reaffirmed 2019 EBITDA guidance of $1.85-2.05B. At the same time NRG announced it will reopen a 385MW Texas power plant that had been closed since 2016. The reopening implies that the company feels even better about its assets in the Texas market. May also saw NRG perform some refinancing actions, issuing new debt and retiring older debt that will lower costs for the company. NRG also announced an agreement to buy Stream Energy’s retail electricity and gas business for $300M. For a short time NRG’s stock increased after this announcement, but then the downward trend continued.

So with fairly positive news from the company during the month, it seems like the decline would be related to investors’ big picture concerns. Electricity prices are heavily influenced by natural gas prices, and natural gas prices at Henry Hub, the nation’s big gas pricing point, stayed at low levels throughout the month. But what has likely bothered NRG investors even more were the stubbornly low prices at the Waha Hub, located in Texas. I have talked about this issue the last two months (see here and here), and in May gas prices once again went negative at Waha.

Exhibit 8

Source: SNL and Garnet Research

These low Texas gas prices likely had an impact on local power prices, which were lower compared to April and versus last year.

Exhibit 9

Source: SNL and Garnet Research

However, as mentioned earlier, NRG reaffirmed its 2019 guidance, so the company doesn’t seem to think that these lower prices will have much of an impact on 2019 results. Also, when you look at forward power prices for 2020, 2021, and 2022 delivery in Texas (NRG’s biggest market) and in Chicago (NRG’s second biggest market) the price has trended down only slightly, giving reason to believe the long-term positive outlook for the company is still intact.

Exhibit 10

Source: SNL and Garnet Research

With the company’s outlook still healthy, a potential explanation for the stock’s decline is that a lot of shareholders have been cashing out of the stock after its big gains. The following table shows that many of the biggest NRG shareholders substantially reduced their position during the 1st quarter.

Exhibit 11

Source: FactSet and Garnet Research

If this selling momentum has continued it could be driving the stock's decline, and until new investors come to the name it might not reach its previous highs for a while.

Another factor that could be at play is that investors are going into more of a “risk-off” mode. In May the inversion of the yield curve continued to steepen, which is usually a big negative sign for the economy. Independent power producers like NRG are typically more at risk to a downturn than a traditional utility, so some of NRG’s big decline could be from investors worrying about the economy.

Exhibit 12

Source: FactSet and Garnet Research

However, NRG is working toward getting investment-grade credit metrics, and it also has more retail customers than ever before. These two factors should reduce the impact of a recession on the company’s operations compared to the past. So selling NRG as part of a “risk-off” trade is probably not as appropriate as previously.

Exhibit 13

Source: NRG 2019 Q1 Earnings Presentation

For investors who plan to hold on for the long term, today’s lower stock price could actually be a positive. NRG is in the middle of a substantial buyback program with at least $500M of purchases remaining. NRG already bought back $500M of shares this year at an average price of $42.21 (About 11.8M shares). If the next $500M could be purchased at $38/share it would be able to bring in 13.2M shares.

It seems like things are still going well for NRG, and this recent decline could be a good time to increase positions in the name.

CenterPoint (CNP) was the second-worst XLU component in May, dropping 8.3% during the month. CNP released results early in the month, and earnings missed Street estimates by six cents per share. Back in February, CNP started to get pushback from investors about the benefits from its recently completed Vectren merger (See here). Q1 had two months of combined operations for the two companies, and analysts again seemed to overestimate how the combined company would perform. As a result, the sell-side’s target price for the stock declined during the month.

Exhibit 14

Source: FactSet and Garnet Research

Water utility American Water Works (AWK) was the top-performing XLU component in May, up almost 4.5%. AWK released Q1 results on May 2, and actually missed the Street estimate ($0.61/share vs. $0.63 estimate.) But even with the small miss the sell-side increased its target price for the stock, helping push it to new heights.

Exhibit 15

Source: FactSet and Garnet Research

The second best-performing XLU component in May was Eversource (ES), rising over 3%. ES released its results on May 2, and handily beat Street estimates. ($0.97/share vs. $0.91 estimate) The stock also got a boost as sell-side analysts increased their price target for the stock.

Exhibit 16

Source: FactSet and Garnet Research

The stock’s performance is even more impressive because the company sold 15.6M new shares at the end of the month, and the share price still held up against this selling pressure.

Wholesale Power Markets

Exhibit 17

Source: SNL and Garnet Research

Spot power prices performed very poorly in May, with prices lower than in April and in May 2018. Weather was milder this year vs. last year, but it was warmer than in April when power prices were higher.

Exhibit 18

Electricity consumption in different regions was substantially lower than last year, which seems to be consistent with the milder weather. Compared to April, consumption was up substantially in most regions, which seems consistent with the warmer weather.

Exhibit 19

Source: SNL and Garnet Research

Since power demand mostly increased between April and May but prices decreased, it seems likely that lower fuel costs are the culprit.

Natural Gas Markets

As mentioned when discussing NRG above, natural gas prices have been very weak. One reason for the weakness is that gas in storage is quickly approaching 5-year average levels after spending more than a year well below the average.

Exhibit 20

The storage situation has definitely impacted the gas futures curve, with near-term maturities substantially dropping in price over the last month. However, once you go out about a year the curve really hasn’t moved much.

Exhibit 21

Source: SNL and Garnet Research

Disclosure: I am/we are long NRG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.