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Dynegy: A Growth Story About To Begin

Dynegy has mainly expanded inorganically through acquisitions. Substantial free cash flow generation and margin improvement are preparing the way for upside. Be on the lookout for any dips on which to buy Dynegy’s shares. Small cap companies offer investors the benefit of potentially increased returns with the downside of increasing volatility and/or risk in the investor’s overall portfolio. This risk can be mitigated through the inclusion of large cap and mid cap stocks as well as diversification through the purchasing of stocks of many small cap companies. Another way to increase the stability of these small cap investments is to make these investments in industries that are more stable, such as utilities and/or industrial industries. These industries retain their stability through inelastic consumer and/or firm demands as well as diversification across multiple other industries. With the infusion of small cap status into a firm in these industries, investors can benefit from the growth of the small cap in addition to the stability that comes with being in steady industry. Small cap utilities companies are one such combination of capital appreciation and capital preservation. Dynegy Inc. (NYSE: DYN ) is one such company that possesses these two characteristics, and based on investor sentiment, the shares are essentially up for grabs. The company owns a series of power generating facilities across the Midwest, Northeast, and West coast regions on the United States, so the company is mostly specialized in terms of customer concentration. The company diversifies its energy facilities across multiple utilities submarkets, including coal and gas; this adds the benefit of indirect additional diversification to investors in that investors who purchase the company’s shares get that indirect diversification. Some of the company’s major business segments include its Homefield Energy segment and its Dynegy Energy Services business. From looking at the company’ stock chart, investors can see that the company’s shares have gone on a bit of a roller coaster over the past few years. Capital invested at the beginning of calendar year 2013 would have generated essentially a zero percent return on investment throughout 2015. The shares have gone from a low of about $17 all the way to a high of about $36, and the shares have fallen all the way down again, so the shares are a bit volatile. In technical terms, the 50-day moving average has danced around the 200-day moving average, with the former going above and below the latter multiple times throughout the course of the past three years. Most recently, the 50-day moving average has once again dipped below the 200-day moving average, which could indicate near-term downside, as the spread between the two indicators seems to be widening. (click to enlarge) Source: Stockcharts.com From a fundamental perspective, the company is in a solid financial position: liquidity ratios indicate that the company’s financial health is in good order. The current ratio, quick ratio, financial leverage ratio all have hit all-time highs. However, it also appears that the debt to equity ratio has also hit an all-time high as well, with the ratio at about 2.5. The reason for this is because of the way the company grows. The company has expanded mainly through inorganic growth, and it has accomplished this by using a substantial amount of debt to fund its acquisitions. Some of its more recent acquisitions include the acquisition of Duke Midwest for $2.8B , which is extremely large for a company with a market cap of just under $3B. Although this particular method of growth has worked for the company, the fact of the matter is that the company’s capital structure has changed to include about 75% debt, which is certainly a lot. Thus, as the number of financial covenants begins to mount up, the company will become limited in the activities it can conduct, including further acquisitions. The company will have to be careful to ensure that the amount of debt that it takes off will not cripple its operations. Positive aspects of the company is that it has been generating large amounts of free cash flow recently, which the company can either use to reinvest back into the company or distribute it to shareholders in the form of share buybacks or dividends. In fact, the company began a share buyback program for $250M, which the company has already completed half of, so it appears that the company is committed to keeping shareholders happy. The amount of free cash flow that the company has historically generated has been negative, so this is definitely a positive trend for the company. Furthermore, cost reductions have resulted in margins that are beginning to stabilize, which could also boost free cash flow in the mid-term. All-in-all, it appears that the company has an uncertain future. However, the shares have dipped all the way back to their original price in 2013, so now could be a good time to buy. The fact that the company’s margins are getting better and that the company is beginning to generate substantial free cash flow is always a good sign. Be on the lookout for any further share dips to buy on.

Dynegy: Below $20 It Is Once More Highly Attractive

Summary For 2016, it expects EBITDA to fall between $1,100 to $1,300 million. For 2016, management expects Free Cash Flow to fall between $300 million to $500 million. Management has impressed me over time with opportunistic acquisitions and its PRIDE initiative. No need to worry about dumb acquisitions, instead expect debt retirement and stock repurchases. Over the next several years, I expect Dynegy, with its strong insider ownership, to surprise to the upside. My previous contribution to Seeking Alpha regarding Dynegy (NYSE: DYN ) dates back to May 6, 2014. It is part of the Seeking Alpha PRO library Dynegy: With The Market Appreciating The Ameren Assets, No Reason To Hold , but it is also available to Off The Beaten Path subscribers . Since that time, there has been only one piece of analysis and that is a shame really because this is a very interesting company. After the stock was recently sent back down to the mid-twenties, I bought some shares and, of course, it continues to decline and is now perhaps an even better opportunity. DYN data by YCharts To bring you up to speed to the recent results, these are not very good and management lowered its guidance for the year. Dynegy’s management now expects a 2015 Adjusted EBITDA range $825 million to $925 million and a Free Cash Flow guidance range at $140 million to $240 million. For 2016, it expects EBITDA to fall between $1,100 to $1,300 million (previously, the company guided for $1,600 million) and Free Cash Flow to fall between $300 million to $500 million. The company’s results have disappointed due to mild summer temperatures. On top of that, commodity producers have sold off. Something I am painfully aware off. Finally, there is Dynegy’s downward revision of guidance, which is a disappointment, although we should take into account that management tends to be conservative with its guidance. With the current guidance in place, Dynegy is still attractive at just 7.75x EV/EBITDA. Recent developments The company is shutting down its Wood River facility that is not producing good returns in a market that is distorted because of the presence of regulated utilities. The company is continuing with its very successful PRIDE cost-cutting program that has worked very well so far in making the company a leaner and meaner operation. Management deserves some credit with Flexon coming on board in 2011 under very difficult circumstances. In 2012, Dynegy left its corporate headquarters in the Wells Fargo Plaza in Houston pictured below and went to occupy much more modest digs at 601 Travis Street. (click to enlarge) Source: Gabor Eszes More importantly, under Flexon, operating cost per megawatt has declined by 70%, primarily by wheeling and dealing to build economies of scale by picking up assets opportunistically but also through cost cutting. Insiders hold approximately $28 million of shares and are buyers. Flexon himself holds about 2x his salary in shares, which I would love to see him increase by open market purchases. My general impression of the management team, garnered from earnings calls, K-10 and investor presentations, is quite favorable. They appear to be capable, straightforward and often stress the importance of shareholder value creation. An attitude evidenced by the company recently accelerating its share repurchase program. With the recent weakness in the shares, this program, and the PRIDE initiative over delivering this, was stepped up, and the company is now quickly closing in to having utilized the entire $200 million authorized amount of share repurchases. Given the Free Cash Flow that is being thrown off by the operation, a strong team is quite relevant. Over 2016, there will be between $250 million to $450 million of capital, which has not been committed yet, to allocate. Flexon is talking to the board about the capital allocation decision but went ahead and told us where his priorities lie on the recent earnings call : Steve, I said I want to talk to the board about. I think what they will need to be looking at is looking at our leverage, looking at our share price, looking at our various opportunities. But I would certainly say that one of the things that’s clearly on the table is part of that it’s maybe more so than what we looked at this year is making sure we have got the balance sheet positioned the right way and we are continuing to trend in the right direction. So, I would say it’s a combination of looking at where is our high yield debt trading in the marketplace? There are some opportunities for some open market repurchases. They have potentially, potentially some more share repurchases. I mean, I think probably the main two priorities, because anything else around the portfolio tends to be – we are not a buyer of single assets, that’s kind of the way that I view that for this company. We bring the ability to integrate platforms into our platform in a very cost effective measure. Buying a single asset does not create synergies and I think it actually puts pressure on the balance sheet ends up using liquidity, putting incremental leverage. Next thing you know, you are refinancing down at the project level or asset level creates a balance sheet with cash traps. So, I would view it’s really a decision between – at this point, my main two priorities for that was probably between the right balance between debt and equity. The way I read this, Dynegy is most likely to start retiring debt but may opportunistically buy back shares. However, Flexon is acutely aware that sending liquidity from the parent holding down into IPH to pay off debt is not necessarily in the best interest of Dynegy’s shareholders or bondholders and does not appear to be interested in taking that road: Bob Flexon – President and Chief Executive Officer When talking earlier about the – any potential repurchases up at – with the available cash that’s at the Dynegy level. So that would be Dynegy level, parent level, decisions around debt versus equity would not be at the Genco level. We continually say that the parent company is not sending cash down into the IPH complex. So then the solutions for Genco and IPH will come from within IPH and Genco. I previously found little to like at Dynegy after the Ameren acquisition had been fully priced in; the price per share even topped $35 for a while, but the risk/reward is now much more compelling at below $20 per share. If you put in management guidance, the company trades at 7.74x EV/EBITDA. However, management tends to guide conservatively, capital is likely to be directed towards debt retirement and share purchases, and the likelihood of value-destructive acquisitions is very low. Therefore, I think even that low multiple understates the value that can be found in Dynegy.