EFTA00606159.pdf

North America Credit Research J.P.Morgan 16 February 2012 Short Circuit IPP February Monthly This is our initial high yield utility monthly. In it, we update our thoughts on US Credit Research the HY utilities we cover, provide credit and industry data and graphs, and Dave Katz. CFA AC summarize recent company and industry news. Over the last month, the Utilities sector underperformed the high yield index, returning 1.37% to HY's 2.74%. In the present monthly, we include an estimate of key IPPs sensitivity to a Bayina Bashtaeva SI/MMBtu change in natural gas prices. Assuming constant heat rates, and due to their differing generation and hedge portfolio, we estimate that Edison is the most exposed, followed by GenOn and then NRG. Surprisingly, as a J.V. Mogan Securities LLC percentage of LTM EBITDA, TCEH is not as exposed as some other credits. • We estimate the impact on future revenues of changes in the PJM 2015/16 capacity auction prices. The most exposed credit (as measured by the revenue effect of a $25/MW-day price change divided by LTM EBITDA) is GEN (13%). GEN is followed by EME (8%), DYN (3%), CPN (2%), and NRG (<1%). • We reiterate our Overweight on NRG credit and update our NRG financial model in advance of earnings. We estimate that the company generated $384 million of EBITDA in 4Q11. We expect NRG will address the lower natural gas price environment and how it will impact, if at all, its timeline to refinance the 2017 notes and the company's shareholder friendly actions (i.e., dividends and share repurchases). We model a pick-up in shareholder friendly activities; this assumption may prove conservative if the company does not refinance the 2017 notes and given that NRG may flex the activities down to help guard cash. Despite these assumptions, and using the current natural gas forward price curve (NGA <CMDTY> <GO> CCRV <GO>), we expect gross recourse debt • leverage would increase from 4.2x to 5.3x at the end of 2013, before falling to 4.3x at the end of 2014. We believe NRG Energy is set up to survive an extended period of low power prices. We are downgrading our recommendation for Edison Mission Energy to Neutral. We also update our Edison Mission Energy financial model. We believe Edison Mission is one of the most exposed credits in the high yield IPP universe to natural gas price declines. Using the current forward, while assuming that natural gas price decreases result in heat rate increases, we estimate that the company generates $77 million of adjusted EBITDA in 2012, $309 million in 2013, and $582 million in 2014. We estimate that the company would have $580 million of liquidity at the end of 2014, but this presupposes a full refinance of both the EME credit facility and the Midwest Generation credit facility. It also assumes that the 2013 notes are successfully refinanced. Although we value Edison Mission's assets on a $/KW basis, we still believe that the recovery has likely fallen over the last few months and that the notes now trade ahead of recovery value whereas we believe they traded at or around recovery value just a few months ago. Further, over that period, given the fall in power prices, we believe the likelihood of a recovery scenario arising, has increased. These factors arc behind our downgrade of the credit. See page 58 for analyst certification and important disclosures. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this repot. Investors should consider this report as only a single factor in making their investment decision. EFTA00606159 Dave Kat. CFA North America Credit Research 16 February 2012 J.P. Morgan Table of Contents NRG Energy update 3 Edison Mission Energy update 6 Natural gas price sensitivity 9 PJM capacity auction 11 Industry news 13 Recent company news 14 In Case You Missed It: HY Utilities Reports 18 Utilities credit tracker — STW 19 Utilities credit tracker — YTW 20 Utilities credit tracker — dollar price 21 Comparative company analysis 22 Relative value analysis 23 Fuel Mix by Company 28 Domestic generation capacity rankings 30 Rankings 31 Individual bond trading history 32 Working Natural Gas Total Estimated Storage 42 Working Natural Gas Change in Estimated Storage Data...43 Natural gas futures prices ($/MMBtu) 44 Coal Production 49 Weekly Electricity Output 50 Electricity Output 51 Total Degree Days 52 Average Cooling Degree Days 53 Average Heating Degree Days 54 Generation Share Forecasts and Implied Capacity Factors 55 Estimated Generation by Fuel Type 56 Estimated Capacity Additions, 2007-2030 57 2 EFTA00606160 Dave Katz. CFA North America Credit Research 16 February 2012 J.P.Morgan NRG Energy update We have updated our NRG financial model in advance of earnings. We estimate that the company generated $384 million of EBITDA in the fourth quarter of 2011. Based on the current forward curve, we estimate NRG will generate $1.75 billion in 2012. We expect a more modest EIBTDA of $1.5 billion in 2013 as the company's hedges fall off. We expect EBITDA of $1.8 billion in 2014. On the conference call, we expect the company will spend time laying out how, if at all, NRG's strategy has changed in the current low natural gas price environment. We expect management will address its plans to refinance the 2017 notes. The notes became callable on 15-Jan-12, and can currently be called at a price of 103.688. On prior conference calls, management stated that it would refinance the 2017 notes in early 2012 so that all of its senior notes would have essentially the same covenants. The non-2017 notes and the credit agreement have a restricted payment basket that grows by adjusted EBITDA minus 140% of interest expense. This should build much more rapidly than the calculation under the 2017 notes, which is based on 50% of net income. We believe the company is likely to be fairly interest rate sensitive with regard to any new debt issuance. As such, we expect the notes are only now approaching trading levels that imply the company would undertake a refinance. Although we believe that the company has over $3 billion of secured debt capacity, we do not think that NRG would issue secured debt to refinance the 2017 notes. We believe our model is conservative from the point of view of a credit investor. We assume that the company refinances the 2017 notes and then completes $400 million of share repurchases and $30 million of dividends in 2012. We assume $400 million of share repurchases and $80 million of dividends in 2013. We believe these assumptions are conservative because in a low natural gas price environment, we would expect management would pull back somewhat on shareholder friendly activities. However, even with these assumptions, we still estimate that the company's liquidity ends 2013 at $1.5 billion, down from $1.9 billion at 3Q11. We expect gross recourse debt leverage would increase from 4.2x to 5.3x at the end of 2013, before falling to 4.3x at the end of 2014. Net recourse leverage would increase from 3.6x at the end of 3Q11 to 4.8x at the end of 2013, before dropping to 3.9x at the end of 2014. We believe NRG Energy is set up to survive an extended period of low power prices. As we have indicated above, we believe the company has the relatively easy option of decreasing shareholder friendly activities to guard cash. As such, we reiterate our Overweight on NRG Energy. 3 EFTA00606161  EFTA00606162 fill king m 2l 1101 55 PE ®,« 4" "g xrd, an I ■ 1 it I: iv Igtia O els to9 *El I ig If ila RU A lig EC M.IE zlf EMI;It Egg 3 6. I iI I ill  North America Credit Research 16 February 2012 J.P.Morgan NRG Energy, Inc. 414440.4/ )4W17,14.4 — his ANA — Bad 40 Ansi — Ma Ansi ACES Anal Aar Own DOM —a COON 4,01. Fstrie 5.4nor lino. Sine 100 Pr arn NO Sill "11 Arno We. ~Ma Man. mob AIM 'YEW Ili= ilia )IC.,-,) 14.4b.14 firer NSW I —1:17312 µIS so IS 11.0 12.13, µ1O lina 4/.1 col TV" PS/9 SI gi 1„n µT 144 PO U. 1. In V. 11 V 1,3 P1 4 In 445 1444 SW Po 141 so µ nix slois µM> WU CM Ilan Ono on 11014 SIAll SIN. Slab RN Urn COS *As pa CIO PAS Pa STAN U.N. UM 16/04 PM Pan a1µ PAS nAS UM lull 1µN Mat Kis 10.03 IWO PM OM PS, NM NAM Na Nab Kr INAS 11 V V N 1/ It 1,1 PI In4 IT/ PN tbl 112 411 SI PM WI INT DU SW PO CO MI 044 co co WI co Sc. IM SO Sc. 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CFA North America Credit Research 16 February 2012 J.P.Morgan Edison Mission Energy update We updated our Edison Mission Energy financial model in advance of earnings and following the downward move in the natural gas forward price curve. As we indicate in the Natural gas price sensitivity section of this report, Edison Mission is the most notable credit in the high yield IPP space that does not provide an estimate of the effect of a $1/MMBtu change in natural gas prices. Further, we believe the company is unlikely to provide 2012 EBITDA estimates in conjunction with its earnings release/call given that the 2012 Southern California Edison General Rate Case remains open. As such, analysts am unlikely to have clarity into the impact of recent fonvard curve price changes in the short-term. Using the current forward curve (accessed in Bloomberg by NGA <CMDTY> <GO> CCRV <GO>) and assuming that natural gas price changes result in heat rate changes, we estimate that the company generates $77 million of adjusted EBITDA in 2012, $309 million in 2013, and $582 million in 2014. We estimate that the company would have $580 million of liquidity at the end of 2014, but this presupposes a full refinance of both the EME credit facility and the Midwest Generation credit facility. It also assumes that the 2013 notes are successfully refinanced. If the company were so inclined, it could likely refinance all three of these facilities as secured debt. Using 2013 EBITDA, this would imply secured gross leverage of 4.9x. Still, the ability to refinance has likely become more difficult as natural gas prices have fallen. Further, a refinance of all three as secured debt would layer the non-2013 notes. We value Edison Mission's assets on a $/KW basis (see our initiation linked here for our original valuation), and do not feel that valuations should move in anything approaching a 1:1 relationship to natural gas prices. However, we do feel that as natural gas prices fall, the recovery value of the company's assets falls as well. Recovery values also fall as it becomes more likely that the existing notes are layered. Thus, we believe it is more easily posited that Edison Mission's bonds now trade ahead of recovery value whereas we believe they traded at or around recovery value just a few months ago. Further, over that period, given the fall in power prices, we believe the likelihood of a recovery scenario arising, has increased. As such, we arc don ngrading our recommendation for Edison Mission Energy credit to Neutral from Overweight. 6 EFTA00606164  Dave Katz CFA North America Credit Research 16 Fetruary 2012 J.P.Morgan Edison Mission Energy X /044NOAL SU1101110 Mal /Na MYY 40.41 MW Ma/ /Nul Achd Admol miIu1 Mal Meta bond. NOK blets E•1444 0104 ANS Rate 5.4444 Dont« fil 04. FJ %se fa Va 4,4144 IN, 1010 3110 41% 015444 .00 230 »0 14104 554 444, fil rat f,4 ,4or MI VIT 7011 NE2109 V1041 000 H$011 WON.% NT Mt 3045511 100•11 1454el I 11.00in M3411 4002 ne MIS no 2,44 0 144511. Little 11040145% y4 2e( 10E2SCO 11514 12111 UR? 1451 1.13 101 Mt 1242) 1514 la 1411 1144 11.124 V MI 12214 by) 12111 12231 02% .Hit 4" .11 SIS ul YS .I4i 1Y% .151.4 an MN .10s. 4.0% n2)% • ls% 714.% .14% . 5 5% 14% lui 164 1142 17$ WU 01 Im 12)? 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