Calpine Curbs Buybacks as Leverage Increases: Corporate Finance

Rising natural-gas prices are curbing Calpine Corp. (CPN)’s ability to fund stock buybacks as a drop in earnings for the U.S. electricity generator that uses the most of the fuel pushes leverage to the highest point since 2008.

Natural gas has increased 81 percent from a decade low last year, boosting demand for electricity from cheaper coal-powered plants. Houston-based Calpine reported lower second-quarter earnings last week on cooler-than-forecast weather in Texas, revealing that leverage climbed to 6.7 times, up from 5.5 times in 2009 a year after exiting bankruptcy protection, according to debt research firm CreditSights Inc.

Calpine, which used up $1 billion of stock buyback authorizations last quarter and hasn’t instituted a new one, has had negative free-cash flow in five of the last six quarters, leaving it without earnings to finance repurchases. Buybacks remain “an integral part of our capital allocation,” Chief Financial Officer Zamir Rauf said on a July 25 conference call to discuss the latest earnings with analysts and investors.

“The lack of another buyback is clearly due to the leverage spike,” Andy DeVries, an analyst at New York-based CreditSights, said in a telephone interview. Leverage, the ratio of debt to earnings before interest, taxes, depreciation and amortization, “is above where I’d like to see it.”

Most Leverage

A Calpine employee responding to a call to spokeswoman Norma Dunn said the company wouldn’t comment on its finances.

The company, which has the highest ratio of debt to equity among U.S. electricity producers with at least $500 million in obligations, according to data compiled by Bloomberg, has seen its shares decline 5.56 percent since the second quarter while companies in the Russell 1000 Utilities Index rose 2.99 percent.

The power generator, which has $5.3 billion in obligations, has trailed peers in the bond market, with its securities returning 1.2 percent this year, compared with a 2 percent gain for companies in the Bank of America Merrill Lynch U.S. Cash Pay High Yield Utility index.

Free cash flow is money available to retire debt, reward shareholders with buybacks and dividends, or reinvest in the business.

The company’s $1.1 billion of 7.875 percent, first-lien notes due in January 2023 traded at 109.4 cents on the dollar to yield 6.5 percent yesterday, or 5.09 percentage points more than similar-maturity Treasuries, according to Bloomberg prices.

Weak Demand

Calpine is rated B1 by Moody’s Investors Service and has equivalent B+ grades at Standard & Poor’s and Fitch Ratings. The single-B tier denotes companies that have the ability to meet their debt-service requirements as long as economic conditions remain favorable.

Power companies that sell electricity in competitive markets have been stung by weak demand and a plunge in prices in the wake of the 2008 economic slump. Dallas-based Energy Future Holdings Corp., the biggest power supplier in Texas, which was taken private in the largest leveraged buyout in history, is in talks to restructure about $40 billion in debt after struggling to generate profits. Power producer Dynegy Inc. emerged from bankruptcy protection last year.

Calpine’s natural-gas generators are running less often since the fuel’s price climbed. Second-quarter adjusted earnings before interest, taxes, depreciation and amortization fell 14.9 percent to $343 million on thinner margins because of higher gas prices and weaker demand, the company said July 25. It cut the top end of its full-year outlook to $1.875 billion last week from $1.96 billion in November.

Texas Weather

“The weak quarter was largely the result of Calpine’s hedging strategy, which bet on higher summer prices in Texas,” Paul Fremont, a New York-based analyst for Jefferies, said in a July 25 research note.

Calpine is the third-largest power producer in Texas, where prices fell in the second quarter because of mild weather and increased wind generation, Fremont said. Jefferies cut its 2013, 2014 and 2015 earnings forecast for the company by $50 million per year. Energy Future Holdings, the former TXU Corp., is the largest Texas power generator, followed by NRG Energy Inc.

Power generated from natural gas has declined on higher prices that have increased to $3.452 per million British thermal units, up from a decade low $1.907 in April 2012. That’s spurred demand for coal-fired electricity. Coal fueled 37 percent of U.S. power generation in May, up from 34 percent a year ago, according to U.S. Energy Information Administration data compiled by Bloomberg Industries. Natural gas made up 26 percent of power production in May, down from 32 percent a year ago.

Coal Price

Gas costs set energy prices in most industrial markets because plants fueled by it usually provide the marginal power needed to meet demand. The decline that culminated in the lowest price since 2002 dragged down coal, which cost as much as $130 a ton five years ago for Central Appalachian, the principal fuel for U.S. electricity generation, and ended yesterday at $53.49 in New York, a 5.5 percent decline since the low for natural gas, Bloomberg data show.

Without any coal-fired plants, Calpine is more susceptible to rising natural-gas prices than its competitors.

Weak growth and a supply surplus probably will keep energy costs down, restraining profits for the unregulated utility and power industry, Moody’s said in a July 30 report.

“It’s highly leveraged today, but we see it improving,” Shalini Mahajan, an analyst for Fitch, said in a telephone interview.

Leverage will improve as Calpine brings two new gas plants online in California this year that have long-term contracts to sell power to utilities. Calpine is adding generation next year in Texas, where power prices are expected to climb.

‘Shareholder Friendly’

Fitch expects the company’s leverage to fall to 4.5 times in 2017 from about 6 this year.

Calpine, founded in 1984, was created to compete for electricity sales with former local utility monopolies as the U.S. power business was deregulated. The company suffered after the 2001 collapse of Enron Corp. and a glut of new plants caused power prices to fall, forcing it to enter bankruptcy protection in 2005. It emerged in 2008 and has operations in California, and the U.S. Northeast and Southeast in addition to Texas.

In September, Calpine squandered goodwill it had built up with bondholders since bankruptcy by seeking to exercise a call option that would allow it to retire some of its debt before maturity. Investors responded by boycotting a note sale meant to finance the purchases at lower interest rates, leaving the company to get the money with an $835 million first-lien loan.

“They’ve moved toward emphasizing shareholder-friendly activities such as the share repurchase programs,” Peter Thornton, a Los Angeles-based analyst for KDP Investment Advisors Inc., said in a telephone interview. “There doesn’t seem to be any significant inclination to move leverage lower.”

To contact the reporters on this story: Matt Robinson in New York at Mrobinson55@bloomberg.net; Mark Chediak in San Francisco at mchediak@bloomberg.net.

To contact the editors responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net; Susan Warren at susanwarren@bloomberg.net

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