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Coverage Initiation: Calpine
Value Line has initiated coverage of Calpine (CPN) in its flagship product, The Value Line Investment Survey. Actually, it is more accurate to say that Calpine is returning to the Survey, which covered its stock before the company filed for protection under Chapter 11 of the Federal Bankrupcy Code in 2005.
Although the company is sometimes considered part of the electric utility industry, it is not a utility. It is an independent power producer, which means that it owns and operates generating facilities that are not under the oversight of state regulatory commissions. (They are subject to other kinds of regulation, such as environmental.) Calpine owns more than 28,000 megawatts (mw) of generating capacity, with concentrations in Texas, California, the Southeast, and the PJM (Pennsylvania-New Jersey-Maryland) region. About 95% of the company’s capacity is fueled by natural gas. Calpine also provides capacity needed by retail power providers.
As is suggested by the aforementioned Chapter 11 filing, Calpine has had an uneven history since it was founded in 1984. The company performed very well in the late 1990s and early 2000s, a period marked by high wholesale power prices. However, as power prices declined and natural gas prices rose, Calpine’s margins shrank, and the company was hurt by its lack of fuel diversity. In 2001, the stock price peaked at $57, but less than a year late the quotation fell to below $10. The company’s problems culminated with its Chapter 11 filing in late 2005. Calpine reorganized and emerged from bankruptcy on January 31, 2008, and its stock resumed trading on the New York Stock Exchange shortly thereafter.
Although natural gas prices have risen this year, they are still far below the levels seen in 2008. Low gas prices make Calpine’s generating assets more competitive and more likely to be dispatched. Indeed, the company’s capacity factor (a measure of how much of its potential output was produced) rose from 44.3% in 2011 to 53.7% in 2012 (excluding peaking units). This figure fell to 49.0% in the first nine months of 2013, due to the rise in gas prices, but was still better than the 2011 result. Stricter environmental rules are another plus for the company. Numerous power producers have closed, or plan to close, coal-fired units, rather than incurring the costs of environmental upgrades. Furthermore, the renewable-energy requirements that many states have instituted (most notably California) indirectly benefit gas-fired generation. These facilities are needed to back up renewable energy, which is intermittent and cannot be dispatched. Calpine is building some gas-fired generating capacity, and now has more than 1,000 mw that are under construction or are being proposed.
Calpine does not pay a common dividend, and has never done so. Instead, the company uses surplus cash flow to repurchase its stock. As of November of 2013, Calpine had bought back $1.1 billion of stock (since August of 2011), and its board of directors has authorized the repurchase of up to $1 billion more. Asset acquisitions are another way that the company deploys its cash. Calpine has agreed to pay $625 million for a 1,050 mw gas-fired plant in Texas in a deal that it expects to complete in the first quarter of 2014. At the start of 2013, Calpine had more than $7 billion of net operating loss carryforwards that it could use as a source of cash. The company also sells assets from time to time.
This company is highly leveraged. As of September 30, 2013, long-term debt amounted to 74% of total capitalization. The company is also affected by market power prices and the price (and availability) of natural gas. Investors should note that mark-to-market accounting gains or losses, which result from hedging fuel and output, make reported earnings more volatile. Considering these factors, and Calpine’s history, its stock is best suited for risk-tolerant investors.
For a more thorough look at Calpine, and the particular investment merits of its stock, subscribers should examine our full report in The Value Line Investment Survey.
At the time of this article’s writing, the author did not have positions in any of the stocks mentioned.