(By Balaseshan) Deutsche Bank analyst Keith Stanley downgraded rating on shares of NRG Energy Inc. (NYSE:NRG) to "Hold" from "Buy" following recent strength and deal excitement. The brokerage raised its price target to $20 from $19 on updated disclosures.
Stanley said the stock has now rallied significantly from the April low on a combination of rising gas prices, excitement over summer optionality in ERCOT, and now the benefits of the GenOn Energy Inc. (NYSE:GEN) acquisition.
The analyst views the GEN deal as value neutral to key financial metrics on a recurring basis, while diluting NRG's upside optionality in the ERCOT market. He views merger synergies as achievable and found NRG and GEN's standalone 2014 financial projections to be encouraging.
That said, following recent strength and given still uncertain gas and power markets, Stanley no longer sees material upside in NRG stock and moves to the sidelines. His core thesis on NRG stock has focused on its significant FCF generation even at relatively low long-term gas prices, with upside optionality from its concentrated exposure to the attractive Texas market.
The analyst said management has long emphasized the premium valuation it believes solar (low-cost debt), retail (high cash return), and ERCOT generation businesses warrant. However, the acquisition effectively dilutes these "premium" businesses for GEN's concentrated position in the PJM market, which is oversupplied relative to Texas, has slower demand growth, and arguably less medium-term upside optionality.
In exchange, NRG gains geographic diversity and a broader platform for retail growth, but likely without clear accretion to key financial metrics on a recurring basis (i.e., excluding GEN's hedges).
The analyst said NRG stock has risen 36% since the April low as gas market fears have subsided, ERCOT market reforms have moved forward, and now on the back of cost savings from consolidation with GEN. Post merger, NRG remains a highly leveraged power generator, with further material upside over the near term likely dependent on a second leg in the gas rally or summer heat in Texas.
Stanley values NRG by applying his baseline 8.0 times EV/EBITDA multiple to his 2014 open EBITDA on a standalone basis. He values solar using a discounted cash flow (DCF) analysis. He remains comfortable valuing NRG on a standalone basis given his view the GEN deal is roughly neutral to long-term value.
NRG is trading down 4.00% at $18.74 on Tuesday.