Dynegy Inc. and Mirant Corp. both saw results improve in the first quarter of 2006. While one company embraces commodity price hedging and the other avoids it, both are looking for growth opportunities in the months ahead, which could mean generation asset acquisitions in the offing.
Dynegy reported a 1Q2006 net loss of $4 million (1 cent/diluted share) compared to a net loss of $267 million (70 cents/share) for the year-ago period. During the first quarter Dynegy reduced debt and increased financial flexibility in anticipation of growth opportunities, CEO Bruce Williamson said.
First quarter 2006 results included after-tax charges of $9 million for legal expenses. The 2005 period included after-tax charges of $265 million related to a shareholder class action settlement and power tolling agreement restructuring.
During a conference call with analysts Williamson affirmed the company's commitment to operating as a commodity cyclical business, pinning its fortunes to the expected recovery of U.S. power markets. In markets where Dynegy has plants, natural gas generally sets the marginal price of power, and Dynegy has been a beneficiary of higher natural gas prices.
Projected 2006 earnings before interest, taxes, depreciation and amortization (EBITDA) rise along with natural gas prices. At a 12-month average gas price of $7.75/MMBtu, Dynegy's modeling projects EBITDA of $495-605 million, which could go as high as $660 million despite the first quarter downturn in gas prices, Williamson said. With gas at a 12-month average of $11.75/MMBtu, for instance, Dynegy projects EBITDA of $725-825 million.
Williamson touted Dynegy's "liability management plan," which, among other things, he says creates financial flexibility and better positions the company for growth.
"While our total 2006 cash flow and earnings will be negatively impacted by the costs related to our comprehensive liability management plan, the long-term benefits to our common stockholders outweigh the costs in the form of much greater financial flexibility, the elimination of restrictive debt covenants and liens and lower future interest costs as we expect these to be very important in terms of the next phase of our development, which is growing our portfolio," Williamson said.
Dynegy's strategy has been and continues to be to eschew hedging, selling power close to the time when it is produced and avoiding liquidity-sapping margin calls when power prices increase, Williamson said. Longer term, he said he sees growth coming in the independent power producer (IPP) sector.
"We continue to see the need for growth in the generation portfolio through acquisitions or consolidation in the independent power producer sector. While 2005 saw some industry consolidation, the U.S. unregulated generation market continues to stand out as an industry with many participants with limited market share. In Dynegy's case, we also possess a very scalable business platform that was originally designed for a larger asset portfolio, and a team that had demonstrated a track record of running and commercializing assets well while other members of the team dealt with restructuring and repairing the balance sheet..."
During the call, one analyst alluded to TXU Corp.'s April announcement that it would spend $10 billion in Texas on power generation capacity and asked Williamson about asset expansions.
"We would look at it from a standpoint if we think it makes sense economically to invest and what the rate of return can be and how that asset would be positioned in the market," Williamson said. "I'm not going to say we're going to do it because I think [TXU CEO] John [Wilder]was up 15% or so in one day. I'll buy him a drink when I see him in Vegas at the Goldman conference for that one. But we're going to do it based on the fundamentals if it's a sound investment opportunity."
Williamson also said Dynegy would be comfortable looking at a deal involving a merchant facility but noted that a transaction involving contracted power would add more certainty to the company's generation portfolio.
Unlike at Dynegy, the management at Mirant is comfortable with hedging, and the company's hedging program paid off handsomely in the first quarter, boosting net income to $467 million, compared to $11 million in the first quarter of 2005.
Adjusted net income for the first quarter was $142 million and excludes unrealized mark-to-market gains of $298 million along with other nonrecurring charges, mainly a $40 million gain on asset sales. Adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) for the quarter were $340 million, a $173 million increase over the 1Q 2005 level, attributed mainly to U.S. hedging activities.
"Our hedging strategy has been effective," Mirant CEO Edward Muller said. "We are substantially hedged for the year, which has produced more predictable financial results, mitigating milder weather experienced across much of the U.S. during the quarter. Our performance demonstrates the value created by our hedging program."
Mirant's hedging program is designed to minimize collateral requirements, thereby enhancing liquidity, according to 1Q presentation materials. Hedging is centered around the company's low-marginal cost baseload coal plants. Mirant retains "opportunity on intermediate and peaking assets" for market- and weather-related volatility.
During Mirant's 2005 earnings call in March, Muller was quizzed by one analyst about executive compensation and whether it is tied to company performance. Muller said then that compensation is tied to "financial measures" but would not go into detail. Wednesday's 1Q presentation, however, sheds more light.
For short-term compensation: "Each of Mirant's named executive officers is a participant in the short-term incentive program. Two-thirds of the corporate payout factor will be dependent on Adjusted EBITDA."
For long-term compensation: "Based on stock options and restricted stock units. CEO compensation: $1 increase in stock price is approximately $1 million."
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