NRG Energy Is A Decent Option For Your Portfolio (NYSE:NRG)

Introduction

We see in the markets a change in the preference of investors across the board. Capital is shifting from a growth stock to value stocks, as investors are preparing for a different business environment with higher inflation and higher interest rates. This is the time for investors to react and add stocks to their portfolio which will benefit from the trend.

The utility sector is prominent in the value stock sector. Utilities offer investors a safer investment, sometimes regulated, with the constant demand for the product. In this article, I will look at NRG Energy (NRG) which is a utility company that is not regulated, which increases the risk due to possible competition, yet the growth is also not tempered.

I will analyze the company using the graph below, which represents my methodology for analyzing dividend growth stocks. I am using the same methodology to make it easier for me to compare analyzed stocks. I will look into the company’s fundamentals, valuation, growth opportunities, and risks. I will then try to determine if it’s a good investment.

Fundamentals

Revenues have been climbing steadily over the last five years, with a very impressive yet one-time increase in 2021. The increase was due to severe winter storms which increased the prices of electricity. Revenues in 2022 are expected to decline by roughly 30% according to the consensus of analysts as seen on Seeking Alpha. Afterward, sales are forecasted to show modest low single digits growth going forward which is in line with other utility companies. Growth is achieved organically as more power is consumed, but also through M&A. NRG has acquired over the years many several peers including Reliant Energy, XOOM Energy, Green Mountain Energy, Stream Energy, Discount Power, and Cirro Energy.

EPS has grown at a much faster pace over the last decade. As seen in the graph below the company enjoyed a significant spike in earnings due to the winter storms. Going forward the company in its latest earnings report stated that it plans to keep growing at mid-single digits growth rate. Growth is achieved by improving margins, revenue growth, and share buybacks which will be prioritized higher by the company after strengthening its balance sheet.

The company has just raised the dividend by 8%. Investors should expect similar raises going forward as the company expects to maintain this growth rate in the medium term. The company’s dividend is safe even when ignoring the abnormal EPS this year. The payout ratio is safe at around 40% and following the February dividend increase the yield will reach 3.5% which is both attractive and safe.

The number of shares outstanding has also been dropping over the last five years. In addition to the dividend growth, the company is also planning to use excess cash flow for buybacks. Buybacks make a lot of sense at the current valuation and it allows the company to return capital efficiently. The company will use excess cash flow after the dividend increase for buybacks, and if it cannot find suitable investment it will return more excess capital using buybacks.

Valuation

The current P/E ratio is attractive as it sits below 11, which in my opinion is attractive for a company that is growing even if moderately. Paying 11 times the 2022 earnings for a company that sees its long-term growth around 7-9% is an attractive valuation, and I believe that from the valuation standpoint NRG is an attractive investment.

The graph below from Fastgraphs emphasizes how attractively valued NRG is at the current valuation. The company is trading for less than 11 times its earnings while the average valuation of the company is 16.66 times earnings. Historically the company grew at a faster pace of 9%, but this is not enough to justify such a discount in my opinion.

To conclude, NRG combines decent growth for a utility company with a decent valuation. The company enjoys revenue growth which is fueling EPS growth, which will fuel dividend growth and additional buybacks. The valuation is attractive with a P/E ratio below 11. With a 3.5% yield, the company seems like an attractive investment.

Opportunities

The company has shifted its business model from IPP, an independent power producer to an integrated power company. It means that the company is not only a B2B company that sells energy, but it reaches the end clients allowing it to achieve vertical integration, and lower its sensitivity to fluctuations of energy prices as it sells directly to consumers.

A stronger balance sheet is another long-term opportunity. The company had to cut the dividend when its debt to EBITDA level was above 10. The company since then has improved the balance sheet, lowered risk, and paid the debt. Lower debt levels make the company less sensitive to interest rates increase which will increase the interest expenses. It also gives more flexibility for future M&A activities.

Diversification is another important opportunity. The company is diversified across states serving ten states and D.C. The diversification allows NRG to look for different markets to grow in, and it also mitigates risks of regulations or natural disasters which can be harmful to utility companies. Diversification serves as a long-term opportunity because each of these markets can be targeted for additional M&A and organic expansion.

Risks

Utility companies are sometimes treated as bond alternatives. You get a company with a wide moat, that requires significant capital to compete with. However, this is also a risky play as investors have to deal with some “bond risks”. As interest rates go higher, treasury may become more attractive, causing a decrease in the share price. If rates are much higher, the 3.5% growing dividend may not be enough to compete with a 3% treasury bill with zero risks.

The second risk for dividend growth investors is the short dividend streak. The company has only raised the dividend for three years since it has cut it. The cut itself is also pretty fresh. I see how the company dealt with its debt load, and its commitment to return capital to shareholders, and it is a good sign that can be very promising. Yet it cannot be compared to companies that are dividend aristocrats with a much longer streak.

The third risk is the fact that the company is not regulated. A regulated utility grows slower usually, but it is also a safer investment. Investors should take into account that buying this utility means that they may suffer from additional volatility compared to investing in companies like Consolidated Edison (ED). This is a risk in the current business environment where volatility is on the rise.

Conclusions

NRG Energy is a solid company. The company’s sales are growing slowly, fueling EPS growth which is fueling both dividends and buybacks. The company is focused on returning capital to shareholders. Moreover, the valuation is attractive with the P/E ratio far below the average valuation. NRG is a growing company at an attractive valuation.

The company offers several opportunities due to its wide reach across the United States, and its fortified balance sheet. The risks shouldn’t be ignored yet in my opinion the company is well-positioned to deal with them. Therefore, I believe that with a safe dividend yield of 3.5%, an attractive valuation, and limited risks, dividend growth investors should consider NRG Energy for their dividend growth portfolio.