A "Green" Utility Back from the Dead

12/14/2009 11:42 am EST


George Putnam

Editor, The Turnaround Letter

George Putnam III, editor of The Turnaround Letter, says Calpine exited bankruptcy with modern plants using “green” energy sources, giving it competitive advantages.

Calpine (NYSE: CPN) is a large electricity producer with 77 generating plants capable of delivering nearly 25,000 megawatts of power to 16 states. Founded in 1984, Calpine has built all of its plants over the past 25 years, making them among the most modern in the country.

Moreover, all of its plants use either natural gas or geothermal energy, making Calpine one of the lowest-cost and “greenest” electricity producers around. However, Calpine’s modern generating plants were costly to build, and the company financed much of the construction cost with debt.

Calpine was buffeted by the volatile energy markets in the first part of this decade, and it was eventually forced to file for bankruptcy in late 2005. The company took advantage of Chapter 11 to restructure its balance sheet, and it emerged from bankruptcy early in 2008.

Natural gas is in abundant supply in North America and is cheaper and more environmentally friendly than other fossil fuels, such as coal and oil. This gives Calpine a cost advantage today, which is likely to become even greater if environmental restrictions become tighter.

The company has enormous operating leverage. While its plants represent a huge fixed cost, the expense for each additional unit of electricity produced is relatively small. With most of its plants running well below capacity, Calpine has the potential to boost earnings and cash flow dramatically if it can sell more electricity.

As the economy improves and demand for power increases, this should give Calpine the opportunity to do just that. The company would also benefit from extreme weather conditions that increase electricity usage.

Calpine’s facilities would be enormously expensive to reproduce today—not to mention the environmental permitting and other roadblocks [that need] to be overcome in building new power plants.

If the stock market doesn’t recognize the value of the company’s assets, an acquirer might. Calpine rebuffed a takeover bid from NRG Energy (NYSE: NRG) in May 2008 for about $23 per share. As energy demand picks up again, Calpine might attract another suitor at an even higher price.

The biggest risk for Calpine remains its balance sheet. While the company restructured its debt in Chapter 11, it still has a lot of leverage. However, Calpine has been able to manage its debt load since coming out of bankruptcy—including a recent refinancing—and we expect it to continue to do so.

By buying Calpine, you are getting premier generating assets at a cheap price. As the demand for electricity picks up, Calpine’s cash flow and earnings should improve, which should catch Wall Street’s attention. We recommend buying Calpine stock up to $18. (It closed Friday below $11.50—Editor.)

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