Is Calpine Really Worth 50% More?

24/7 Wall St. always tries to put analyst calls in context, and we also try to show the other side of the coin if one is available. Readers may want to consider that the Argus price target of $29.00 is $1.00 higher than the highest analyst target from traditional brokerage firms, and it is $4.00 higher than the $25.00 consensus analyst price target. For the other side of the coin: Zacks, another independent research outfit, added Calpine to its Sell List just in the past week.

Argus described Calpine as having solid fundamentals and favorable valuation. The firm expects Calpine to benefit from its ability to provide flexible and efficient power generation, and from its presence in supply constrained markets like Texas, California and the Northeast. The firm sees Calpine as being able to increase its output in these markets while also benefiting from improved pricing.

Calpine’s natural gas generation fleet is believed to be well positioned to take market share from coal-fired plants. Argus even thinks that Calpine is misunderstood by investors because it returns capital to shareholders via buybacks rather than by dividends. The firm sees Calpine as having a healthy free cash flow yield of 11.6%.

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Argus noted:

We believe that Calpine is well positioned to benefit from its primarily natural gas-fired plants, and from its ability to provide flexible and efficient power generation… In addition, we note that legacy baseload coal-fired power plants are facing pressure from increasingly strict environmental regulations, as well as from low power prices, which have fallen along with the price of natural gas. … As such, Calpine’s natural gas generation fleet appears well positioned to take market share from coal-fired plants.

Several other issues were noted as well. Calpine is believed to be on track to generate 8% growth in adjusted free cash flow per share in 2015. The firm thinks that Calpine remains undervalued, due in part to investors preferring dividends in the space — although that means buybacks may do better than dividends in rising interest rates. Argus further thinks that, despite performance improvement, it hasn’t been reflected in the stock price and it has maintained a lower valuation versus peers.

Argus went on to raise its 2015 earnings per share (EPS) estimate to $1.07 from $0.99, and the firm sees it having 2016 EPS of $1.09. Calpine’s enterprise value is trading at 9.5 times expected 2015 EBITDA and is valued at 8.6 times adjusted recurring free cash flow.

With more megawatts being retired and with stricter environmental regulations as an industrywide issue, Calpine is expected to take advantage of these retirements by focusing on natural gas-fired plants in competitive markets that are supply constrained. Argus said:

Calpine’s fleet is one of the youngest in the industry and has one of the smallest greenhouse gas footprints. Its plants produce 90% fewer emissions and are 40% more efficient than older generating facilities.

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The biggest issue for most investors here is that lack of a dividend versus buybacks. Most investors buy utilities knowing that they get paid to own the stock via dividends, and with buybacks it keeps requiring more share buying versus selling — and companies generally cannot control who sells shares. Calpine has a short interest of roughly 11.6 million shares.

Calpine shares were up 1.2% at $19.25 on Monday morning, against a 52-week range of $18.68 to $24.37. Again, this $20.00 Argus target is $1.00 higher than the highest of traditional brokerage firm analysts and is $4.00 higher than the consensus target of $25.00.