Adventures in Power Market
Stress Tests
SECTOR REVIEW
11 Scenarios Stressing Gas and Coal Prices
We are updating our earnings estimates and targets for the Power stocks
to incorporate current Credit Suisse commodity price expectations.
Our 2009-2012 EPS estimates for the Integrateds fall on average 6%, 8%,
9%, and 12% with greater deterioration in the out years as hedges roll off (Ex4).
The biggest declines to our estimates come at EIX, AYE, and FE which
reflect open exposures to generation repricing. Our estimates are again below
consensus but with fewer setting new lows – a good sign to us (Ex 8-10).
Our targets are down 3% on average but still offer average upside of 30%.
To better appreciate forward earnings power we updated our earnings
models by re-running our hourly economic dispatch model (supply – demand)
using 11 different commodity price scenarios (gas from $3-9 / mcf and two
coal scenarios). Our updated comp sheet can dynamically adjust for the
scenarios and is available for ease of use.
■
The Integrateds look to be discounting natural gas prices in the $6-7 /
mcf range without the benefit of carbon policy and in the $5.50-6.50 range
with carbon assuming a ‘normal’ multiple is 7.5x EBITDA (Ex 30-31).
■
The Integrateds are currently discounting $7 gas prices using our DCF
models and an 8% unlevered after-tax cost of capital (Exhibit 34).
■
Stocks with the most leverage to natural gas prices are DYN, AYE, and
ETR with average leverage to $1 / mcf moves in the 3-8% range (Ex 28).
■
Consensus appears to be using $7 gas in ’10 and $7-8 in ’11 (Ex 36).
With stock price weakness we were a little surprised at first to see
embedded gas prices at $6-7 / mcf; that said, we see upside to commodity
prices from those levels (as does the curve) pointing to room for growth
still to come. That said, we remain nervous about Q109 earnings for the
Competitive names as they address the potential earnings risk from low
demand and commodity price weakness. That said, after this wave of
expected revisions we think expectations may reasonably trough, creating
an opportunity to buy the Power stocks.
Interestingly, we see unique challenges for most of the names we are
recommending but still favor ETR and PEG. We worry somewhat about
Outperform rated FE and AYE that both have upcoming resource auctions
that could lock in what we view as weak power prices for an extended time.
Table of contents
Executive Summary 3
Updating Our Estimates and Targets 3
Estimates versus the Street 6
Thinking About the Alternatives 8
Earnings Sensitivities 8
Commodity Prices Currently in the Stocks 9
Scenario Analysis 11
The Scenarios 11
Natural Gas Prices 11
Coal Prices 12
The Dilemma 12
Our Fix 12
Our Coal Price Assumptions 13
Demand Growth 15
Numbers From the Scenarios 16
EBITDA Outcomes 16
EPS Outcomes 18
Natural Gas Price Sensitivity 20
What are the Stocks Discounting? 22
EV / EBITDA Multiples 22
The Screens 22
How to Translate 22
P/E Multiples 25
Embedded Discount Rates 26
What is the Street Thinking? 28
Dispatch Curves, Heat Rates, and Power Prices 29
Closing Thoughts on Power Markets 29
Reserve Margins 33
Appendix A – All The Gearing 35
Appendix B: – Sum-of-the-Parts Valuation 43