NRG Energy’s Transformation Plan: Removing It from Our List of Least Preferred IPPs

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Eric Selmon Hugh Wynne

Office: +1-646-843-7200 Office: +1-917-999-8556

Email: eselmon@ssrllc.com Email: hwynne@ssrllc.com

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

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July 12, 2017

NRG Energy’s Transformation Plan: Removing It from Our List of Least Preferred IPPs

This morning NRG Energy (NRG) announced the results of its strategic review, releasing a plan for an extensive reshaping of the company, paring back to its Texas generation assets, an additional 10 GW of merchant generation and its retail power business. Combined with extensive cost cutting and optimization of operations, NRG believes that by 2020 it will be able to reduce debt by $13 billion, raise $6 billion of cash and only reduce EBITDA by ~$1 billion from original 2017 guidance. While we are not confident NRG will achieve all of its goals, if they can execute the divestment strategy and achieve only half of the $800 million of targeted EBITDA improvements, the stock would be at fair value at $16-$19 per share. We are therefore removing NRG from our list of least preferred IPPs.

Portfolio Manager’s Summary

  • This morning NRG Energy (NRG) announced the results of its strategic review, releasing a plan for a radical transformation of the company that would pare back its asset portfolio, debt and operating expenses, and bring the company close to what it was in 2009.
  • Building on NRG’s restructuring of GenOn earlier this year, which removed 15 GW of generation and $2.6 billion of debt, the plan announced today would divest NRG’s stake in NRG Yield, its remaining renewables operations, and an additional 6 GW of merchant generation. NRG intends to reduce its debt by $13 billion.
  • The divestitures will also remove nearly $1.8 billion of the of the original $2.8 billion EBITDA guidance for 2017.
  • NRG intends to offset the lost EBITDA by reducing operating costs $590 million and increasing gross margins by $215 million, resulting in a pro forma $1.85 billion EBITDA by 2020 based on 2017 results.
  • Importantly, this excludes any impact from the roll-off of hedges or potential changes in generation output or market pricing.
  • We estimate the value of the hedges on NRG’s Texas generation (the bulk of the remaining generation fleet) in 2017, versus forward pricing in 2020, to be $250 million. The roll-off of these hedges thus reduces our estimate of NRG’s pro forma EBITDA in 2020 to $1.6 billion, assuming the company can achieve all of its other goals.
  • Applying this adjustment to NRG’s free cash flows, and assuming that NRG achieves it planned asset sales, our estimate of NRG’s deployable cash through 2020 is $5.5 billion.
  • At a valuation of 6.0-7.0x 2020 EV/EBITDA, assuming NRG achieves all of its goals with respect to asset sales and cost cuts, and assuming all of the $5.5 billion in deployable cash through 2020 is returned to shareholders, we estimate NRG’s fair value to be $27-30 per share.
    • However, if NRG achieves only 75% of its EBITDA improvement targets and 90% of its target asset divestiture proceeds, fair value drops to $20-23.
    • If NRG achieves only 50% of its EBITDA improvement targets and 90% of its target asset divestiture proceeds, fair value drops to $16-$19.
    • Furthermore, every $1/MWh decline in power prices reduces the value of NRG by $2 per share.
  • NRG will be a smaller, but more focused and more valuable company with a better chance to survive the upheaval in the power markets over the next several years. We remain bearish on the outlook for the wholesale power markets, as growing renewable generation and, over the longer term, storage could significantly reduce margins for generators.
  • We are therefore removing NRG from our list of least preferred IPPs. We are not comfortable adding NRG to our list of favorite IPPs, however, because of the uncertainty in execution of their plans and our concerns about the wholesale power markets going forward.

Exhibit 1: Heat Map: Preferences Among Utilities, IPP and Clean Technology


Source: SSR analysis

©2017, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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