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Last week Constellation Energy (CEG) announced the acquisition of NRG Energy’s (NRG) 44% stake in the South Texas Project Electric Generating Station (STP), a 2,645MW dual unit nuclear plant located near Houston. In the cash and debt deal, CEG agreed to pay $1.75B for the asset, or net of accelerated depreciation and tax credits, $1.42B. Given $190M in FY/2023 EBITDA uplift guidance, the purchase price implies a gross ~9.2x EV/EBITDA multiple or a ~7.5x EV/EBITDA post depreciation and tax credits. Both multiples imply an accretive transaction given the Constellation’s current ~10.5x 2023 EV/EBITDA multiple (and not to mention high FCF conversion). Moreover, management emphasized that any potential synergies have been excluded from the forecasts. There undoubtedly will be a degree of cost savings seeing as CEG will be operating the plant. The market approved of the deal as shares of CEG ended the day (June 1) by advancing +5.8% on back of the news. For even longer term context, shares of CEG have advanced by +115% since spinout listing (from Exelon Corporation (EXC)) in early 2022 and by +25% since the late March 2023 lows.
The STP asset is a relatively young (~46 year remaining life), two unit pressurized water reactor which was commissioned in the late 1980s. The plant's other co-owners are Austin Energy (16%) and City Public Service of San Antonio (40%). The acquisition of this high quality asset is further execution of CEG’s consolidation strategy which further expands the total generating capacity from its market leading nuclear fleet. Post transaction, CEG will maintain a ~$1.0B+ cash war chest for further acquisitions or return of capital via dividend increases (current yield 1.3%) or share repurchases.
We continue to be very positive on Constellation Energy given the game-changing tailwinds from the recently passed IRA Production Tax Credits (PTCs) coupled with the fact that Constellation Energy’s entire nuclear generating capacity (~24,000 MW - the largest in the US) is 100% unregulated.
1) Nuclear IRA Provisions: Though the Inflation Reduction Act provides provisions for wind, solar, hydro, nuclear, natural gas and even hydrogen development/production, nuclear generating capacity is the only one which is both zero carbon and baseload capacity. In short, looking specifically through the nuclear lens, the IRA provides for a maximum credit of $35/MWh at a theoretical power price of $0/MWh. The PTC provides support of up to $15.00/MWh for units when revenues are between $25.00/MWh and $43.75/MWh while preserving the ability of the unit to participate in upside from commodity markets. The credit reduces to $0/MWh for power prices exceeding $43.75/MWh given the pricing mechanism is structured as a contract of difference framework. Depending on the company, nuclear generating capacity will have a minimum floor price for (in the least) the 10 next years. This level of certainty will spur both further investments and life extensions for many aging nuclear reactors. Coupled with the fact that natural gas prices have been rising in North America, the IRA pricing floor will ensure that nuclear will once again become economic LT. As evidence of the IRA’s pricing support, we have already seen numerous nuclear power plants announce life extensions while others which were slated to close, will continue to operate for years to come.
2) Unregulated Capacity: This category comprises Independent Power Producers (IPPs) / merchant generators. These are essentially electric generators with no assigned service territory that produce and sell electricity into wholesale power markets at market based wholesale rates (or based on power sales contracts). This is unlike the regulated utilities which have been granted monopoly power in pre-defined territories, and must sell at state-regulated rates. Another differentiation feature is that traditional regulated utilities usually provide bundled services to consumers – that is generation, transmission, distribution and any other ancillary service. IPPs do not own any transmission assets nor do they sell to retail customers. The concepts between regulated versus unregulated can come down to rate based growth (regulated) versus competitive power (unregulated).
Our current preference for unregulated nuclear utilities stems from the fact that the IRA’s PTCs essentially provide the benefits of regulated utilities’ stability and cash flow certainty, without the constraints of being regulated operationally and financially. Unregulated utilities are not as constrained by the heavy burden of regular debt and equity funding required to build and maintain power plants to meet future load growth and offset planned retirements. Growth is much harder as a regulated utility as risk adjusted returns need to be found in a more limited pool of assets found in states with advantageous or incentive based (or supportive) rate making. Every facet of bundled electricity (again, this means generation, transmission, distribution and service) must always be considered as a regulated utility. In addition to pricing upside, unregulated businesses have much more potential M&A upside and have accordingly demonstrated much higher growth rates historically. In our view, the key to a successful utility is relatively simple:
1) Increase capex in order to grow earnings (keep investors happy)
2) Capex spend for resiliency and reliability (keep regulators happy)
3) Minimize opex to keep rates in check (keep consumers happy)
For an unregulated business, point 2 is much less of a concern or burden. As such capex via M&A is much more active (case in point, STP acquisition). For this reason (and as demonstrated by Constellation’s outperformance over the last year since IPO), unregulated nuclear businesses are now benefitting from cash flow visibility/stability for the next decade+ while also having more options on the M&A front.
The bottom line is that we see strong downside support given the pricing guarantees as provided by the PTC over the next 10 years coupled with the unregulated nature of CEG’s nuclear fleet. As illustrated above (graph given CEG forecasts), it is estimated that the Federal nuclear PTC would enable Constellation’s plants to earn between $40-$44/MWh of revenue across a wide range of power market environments. It is expected that the PTC would effectively lock in a floor level of revenue in the low-mid ~$40s/MWh. The PTCs are single handedly the largest reasons as to why numerous nuclear power plants have been announcing life extensions while others have been delaying plans to decommission.
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