Tag Archives: marketplace

Calpine Corporation’s Price Decline Is Unwarranted

Summary The company’s long-term story remains unchanged and highly favorable. The recent sell-off likely the result of sector rotation out of utilities. I increased my exposure to the shares by 50%. Calpine Corporation (NYSE: CPN ) shares have gotten pummeled in recent months and now sit at 52 week lows near $17.50/share. Shares are down significantly since I first recommended the company on Seeking Alpha back in February of 2015 , but I still maintain a long-term bullish outlook. This is one company that I agree with sell-side analysts on and I’ve been vigorously beating the drum in favor of. In my opinion, there isn’t a company better positioned for macro trends in United States energy production over the next ten-twenty years than Calpine. This is a shame as retail investors have shunned the company, with the almost all of the shares held by insiders or institutions. This is woeful compared to peers and I think retail investors are turning a blind eye to the company’s prospects for capital appreciation. The lack of a dividend, as opposed to the company’s share repurchase plan, in my opinion is the single biggest obstacle that retail investors need to get over when considering an investment here. Especially for tax-advantaged accounts, Calpine can give utility-sector exposure to improve account diversification while simultaneously providing an excellent growth vehicle long-term. Long-Term Tends Remain Intact Increasingly stringent environmental regulations in the United States are not going away anytime soon, despite heavy lobbying from the coal industry and some outdated utility players. 63% of Americans now believe in climate change according to a recent Yale study on the subject. Such a large voting bloc can’t be ignored going forward and any attempts to strip down/repeal current EPA mandates are likely to be met with fierce voter opposition. Unfortunately the facts remain that America’s coal fleet is incredibly old; the average coal-fired power plant was constructed in the 1970’s. Bolt-on fixes to reduce greenhouse gas emissions on these plants are going to become increasingly more expensive and subject to diminishing returns. On the same coin, new construction of coal plants, which are highly capital intensive and require decades for payoff, are unlikely in the current regulatory environment regulating CO2 and other gases. Likewise, we aren’t shutting off coal and switching to wind/solar/hydroelectric overnight. We simply don’t have the technological capacity or the investable capital to meet our current energy needs with these processes yet. Renewable energy’s share of power generation is highly likely to continue growing quickly over the coming years, but the time when renewables constitute the majority of American power generation is likely many decades away. * Historical natural gas price chart 2008-2015 By comparison, plants fired by natural gas, which constituted 95% of Calpine’s power generation in 2014, are set to the biggest beneficiaries of the production switch. Cheap natural gas from the American shale revolution likely isn’t going away anytime soon and will continue to be an amazing source of cheap power input for natural gas plants. While fracking is also a highly contentious environmental issue, opinion is more divided here than with opinions on the coal industry and climate change and may be symptomatic of a lack of understanding of the process rather than the actual science behind it. A federal ban or hamstringing regulation is highly unlikely at this point and states where fracking occurs are treading carefully given the boost the process has given local economies. Reducing Debt, Freeing Up Cash flow Calpine holds a stigma after dealing with a bankruptcy in 2005. Natural gas prices were sky-high, competition was stiff with new plants coming online the company’s markets, and the company’s $22B debt load was simply unsustainable. The company now has more assets than it did pre-bankruptcy and the debt load much smaller at $11.84B, so investors should not have little fear of a repeat. * Calpine Investor Presentation Additionally, average yearly interest expense has come down significantly during this timeframe, saving the company hundreds of millions over the past few years as the company takes advantage of the low interest rate environment. As the debt comes down over the next few years, this frees up capital for the company to continue to purchase shares at an elevated rate or invest in new acquisitions that will generate substantial additional earnings (like the Fore River purchase from Exelon in August of 2014). 1Q 2015 Results, Rest-Of-Year Outlook First quarter was in-line with management guidance. This sported a tough year/year comparable because of the polar vortex, which provided an extremely healthy boost to first quarter results last year (adjusted EBITDA in the east region was down from $269M to $125M y/y). Of note is management’s reaffirmation of 2015 adjusted EBITDA (basically EBITDA plus debt extinguishment, one-off maintenance, operating leases, and stock-based compensation) of $1.9-2.1B. For investors used to EBITDA, EBITDA is forecast to be $1.5-$1.7B. This places estimates of 2016 EV/EBITDA firmly in the 10-11x range, which is honestly in-line with broader market peers. The difference here is this is severely discounting Calpine’s advantages. Its fleet is young (average plant age of 14 years), giving the company an advantage over aging peers. As we’ve noted, it has no projected expensive regulatory overhang from EPA emission mandates. It operates in some of the strongest power markets in the United States (California, Texas, and the Northeast). Of note are the share repurchases. Total spent on repurchases totaled $236M through 4/30/15. Pushing this through the rest of the year (although perhaps management may elevate purchases due to lower prices at current levels) and it is likely that Calpine will retire $700M+ worth of shares at current rates. If prices remain at current levels, this could end up retiring 10%+ of the float in one year, just from free cash flow (free cash flow for 2015 is projected at between $800-$1B). Conclusion Calpine remains a strong buy and I’m unsure of what has driven the current selloff other than sector rotation, which has been a driving theme of 2015 as utilities have swung out-of-favor due to the impacts of a looming fed rate hike, which impacts utilities in regards to value of the dividend yield (no impact on Calpine as it pays no dividend) and the possibility of higher interest costs (approximately 50% of Calpine’s debt is variable rate, generally tied to LIBOR + a fixed rate). Most investors would be well-suited to include Calpine in their investments, especially younger investors that have a long timeframe to allow the secular trends to play out in the company’s favor. Even short-term traders may be interested, given the company is going to perform strongly in the back half of the year where it traditionally has not, giving the company an opportunity to trounce year/year comparables. Disclosure: I am/we are long CPN. (More…) 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.

VNQ: Profit From The Improving Middle Class

Summary Vanguard REIT Index ETF is positioned to benefit from legislation that may materially improve income and employment prospects for the middle class. The strategy of making employees “exempt” and working them longer hours to generate less than minimum wage is reducing demand for apartments. If income improves for these employees or if more employees are hired it should result in more competition for apartments and higher rents. The rents should increase faster than costs which will drive growth in FFO and earnings. The Vanguard REIT Index ETF (NYSEARCA: VNQ ) is one of the best investment options for investors seeking risk adjusted returns in a tax advantaged portfolio. The ETF offers low expense ratios and excellent diversification of REIT holdings. I believe it is positioned to deliver great returns over the next several years even if we see some increases in interest rates. One of the potential catalysts for it is a bill that would make it more difficult to exploit “salaried” status to force employees to work at or near minimum wage while being classified as a manager. The pending legislation may stir up some fierce political pandering and positioning. Sorry, I believe politicians refer to it as “debate”. The legislation I’m referring to was referenced in a recently released fact sheet . The bill would significantly expand the number of workers eligible for overtime pay. Nearly five million workers would be covered. What Won’t Quite Happen If nothing else changed and the companies simply paid the overtime that is currently avoided through “salaried” compensation, the simple result would be increases in labor expenses and compressed profit margins. At the same time, I would expect increased levels of sales as more money would go to middle class and lower class workers with a high propensity to consume . In short, the money would go into their pockets and then into the cash register at another establishment. If the legislation is passed intact, with no enormous loopholes, the companies impacted by it will surely work to minimize the impact. Despite their best efforts, I believe the companies would still be forced to either pay out higher wages to the impacted employees or reduce their hours to prevent “paid overtime” which is substantially less desirable for the company than “unpaid overtime”. If hours are reduced by hiring more employees because regular hours are less expense than overtime, the result would be lower levels of unemployment. If a thorough cost analysis showed that savings in other areas such as recruitment and intangible benefits made overtime superior to hiring, then the total pay for the impacted employees might increase significantly. The “Middle Class” Perhaps I’m being generous by using the term “middle class” when the bill will help making as little as $24,000 per year that were being classified as “exempt” and worked for upwards of 50 to 60 hours per week. However, the upper end of the protected class is significantly higher at around $50,000 per year. In lower cost of living areas this is solidly middle class in my opinion. Excellent News An increasing level of employment and income among workers in the middle class and below would be extremely favorable for apartment REITs that are already benefiting from solid rental numbers. With the underwriting process on mortgages being fairly strict since the financial crisis there has been a significant increase in the proportion of Americans that have chosen to rent. There is another hidden market though, the boomerang babies. There are many individuals that for lack of income moved back in with their parents after college. Improving employment prospects and higher pay for positions that were previously classified as “exempt” bode well for the average income in the younger generations. Propensity to Consume With low labor costs I expect corporations to spend a significant portion of earnings on repurchasing stock and paying dividends. Dividends are often reinvested and repurchased stock increases the ownership stake for existing shareholders but fails to put any cash in the hand of the shareholders absent a decision to sell some of the shares. Because these uses of cash do not put cash in the hands of consumers that are eager to spend it on immediate consumption, they are not sources of cash that would drive up rent. On the other hand, an increase in income for the middle class and below would drive up demand for independent housing. By independent, I simply mean housing that is not occupied (and owned) by their parents. Great Cost Structure The costs of the equity REITs should not increase as rapidly as the revenue may increase from higher rents. I believe the apartment REITs will see increases in revenue that are mostly carried down to the bottom line increasing EPS and FFO (funds from operations). For shareholders of the equity REITs this is a bullish development because it means the REITs should be paying higher dividends. This argument is bullish for the entire industry and makes a diversified play on the industry like the Vanguard REIT Index ETF an excellent choice. Other Sectors The Vanguard REIT Index ETF holds other kinds of REITs as well. An investor in the fund gains exposure to a diversified REIT portfolio and while I would favor seeing a larger concentration in apartment REITs the other REITs stand to benefit as well. The sector I like less on this news is the personal storage REIT sector where companies may see lower levels of business as consumers are capable of acquiring more housing and reducing their consumption of storage space. On the other hand, there is a legitimate case that many consumers receiving cash will spend it on junk and need a place to store that junk. If consumers do decide to buy more junk that they don’t need it would be a very bullish development for the equity REITs. I’m sure some people will think that I’m being too harsh when I refer to the purchases as “junk they don’t need”, but how often do you really access the items in storage? If they were used on a frequent basis it wouldn’t make much sense to keep them in storage. Growth in junk is a major factor in the demand for storage space. Conclusion I’m personally holding a substantial position in equity REITs which includes a substantial position in VNQ. With prices having fallen over the last few months I have stepped up my purchases in the sector and made it my major investment area for new funds. Despite my strong allocation to the sector, I would love to see prices fall further. Whenever the shares get cheaper the yield gets better and I’m able to buy more for the same price. Who is scared of weakness in share prices? Not me. I’m currently holding between 22% and 23% of my portfolio in domestic equity REIT investments and raising that percentage each month. Disclosure: I am/we are long VNQ. (More…) 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. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

Prediction Is Difficult. Especially About The Future

In the immortal words of the physicist Niels Bohr, “Prediction is very difficult. Especially if it’s about the future.” I rarely make firm market forecasts. But I do like to look at broad valuation numbers and see what they imply about future returns. You know the refrain: Past performance is no guarantee of future results. But the following returns estimates, courtesy of data site GuruFocus , give us a little historical perspective. GuruFocus bases its estimates on three factors: Expected economic growth, based on the average growth over the last business cycle. Expected dividend returns, based on the average dividend yield of the past five years. Change in market valuation (the assumption is that the ratio of market cap-to-GDP will revert to its average over a full market cycle, or 7-8 years). So, what do the numbers suggest? (click to enlarge) I’ll start with the good news. Several world markets are priced to deliver solid returns over the next eight years. In particular, Singapore, Australia and Spain are priced particularly attractively, with implied future returns well over 10% per year. Now, keep in mind that Singapore’s economic growth is highly dependent on trade flows between China and the West, Australia is highly dependent on selling commodities to China, and Spain is at the center of the eurozone sovereign debt crisis. All of these countries have murky near-term outlooks, and the projections for economic growth based on the past might not be realistic for the future. But once the dust settles, all might make for attractive “fishing ponds” for investment. Now for the bad news. The US market – where you’re most likely to have the bulk of your assets invested – is priced to deliver annual returns of approximately zero over the next eight years. And it’s not just the market cap-to-GDP ratio that suggests this. As I wrote recently , other metrics, such as the cyclically-adjusted price/earnings ratio (“CAPE”), point to similarly disappointing returns going forward. And allocating your funds to European or Asia-Pacific funds might not help you much. Germany and Japan, which tend to dominate European and Asian-Pacific funds, are priced to deliver equally disappointing returns going forward. So, what’s the takeaway here? In order to avoid lousy returns over the next several years, you’re going to have to invest differently than you might have in the past. You’re going to have to look more aggressively overseas, and within the overseas universe, you’ll need to underweight the most common international markets. This article first appeared on Sizemore Insights as Prediction is Difficult. Especially About the Future Disclaimer: This article is for informational purposes only and should not be considered specific investment advice or as a solicitation to buy or sell any securities. Sizemore Capital personnel and clients will often have an interest in the securities mentioned. There is risk in any investment in traded securities, and all Sizemore Capital investment strategies have the possibility of loss. Past performance is no guarantee of future results. Original Post