I like the equity and the Homer City pass-through notes. My price target for the equity is $51 based on the value of the regulated utility, Tax NOL’s for EME and corporate drag. I believe the unregulated generation subsidiary, EME, will have positive value, even if it is in the form of tax NOL’s ( I am including $3/ share of tax NOL’s in my price target).
I estimate the debt/ kW for the Homer City pass-through notes is $760/ kW after factoring in environmental expenditure, whereas the replacement value is approximately $1,500/ kW, and therefore it makes sense to buy the PTC’s.
- My sum-of-the-parts analysis indicates a significant discount for EME despite the fact that debt at the EME level does not have recourse to the parent, EIX. (Please see my sum of the parts analysis attached below).
- On a related note, EIX management could use the upcoming maturities of credit facilities to re-negotiate terms that could help keep the EME option value alive. The credit facilities mature in June 2012 and the unsecured notes in June 2013.
- The regulated utility SCE has above-average ratebase growth of 6-8% due to transmission expenditure to meet new RPS mandates. I believe it deserves to trade at a premium to its large-cap regulated peers.
- PJM Capacity auctions for 2015/2016 should provide a lift in my opinion, as I expect clearing prices to exceed $200/ MW-day, a significant premium over 2013/14 and 2014/15 capacity prices.
- The possible restructuring of EME could unlock valuable tax NOL’s. I estimate the tax basis is approximately $2.5 billion. Therefore, I estimate the value of EME is at least $3/ share.
- Major ratecase regarding cost of capital coming up in 2012 and also negotiations with EME unsecured creditors are likely to cast a shadow over valuation and investor interest. Therefore, I believe this stock is more suitable to those investors that can stomach some volatility.
- Most sell-side analysts are already positive and its not clear what is required to revive investor interest in the story. There are 17 analysts covering this stock and as of February 5, 2012, the average rating is accumulate.
- The discount to other large-cap utilities could continue till such a time there is a change in management.
- PJM Capacity auctions for 2015/2016 should provide a lift in my opinion, as I expect clearing prices to exceed $200/ MW-day, a significant premium over 2013/14 and 2014/15 capacity prices. As a reminder results are expected in May 2012.
- Better than expected earnings at SCE, possibly after the resolution of the cost of capital case.
- Resolution of EME debt overhang by 2013.
What to buy in the EME structure? The only securities that I like are the Homer City pass through certificates maturing in 2019 and 2026 because they are covered in a liquidation scenario; I estimate debt after environmental capex of $760/ Kw versus market value of $1,500/ kW. The Homer City Funding 8.137 of 2019 last traded at approximately $90/ 10%.
I do not like the EME 7.5% unsecured notes of 06/15/2013, which is probably the most popular trade in the capital structure. Please email me if you are interested in discussing any of these trade ideas further.
Disclaimer: I am long EIX stock but do not intend to trade it over the next 48 hours.