Constellation Energy Group: Post-IRA, Possible M&A and Price Stability Much Better Going Forward
Updated: Aug 24, 2022
With recent tailwinds such as a beat and raise quarter along with the passage of the Inflation Reduction Act (IRA), we’re taking the time to update the developments from Constellation Energy Corp (CEG), a nuclear based utility we initially highlighted in early May (link here).
The recent passage of the IRA will provide additional tailwinds for the company. The corresponding production tax credits (PTCs) will make the company’s nuclear assets even more enviable while also providing for a higher floor price and uncapped upside. How does the PTC work ? - The bill allows for a maximum credit of $35.00/MWh at a theoretical power price of $0/MWh (or at least a $15.00/MWh credit if certain "prevailing wage requirements" are satisfied from existing nuclear plants). The credit reduces to $0/MWh for power prices exceeding $43.75/ MWh. Recall that CEG currently owns approximately 25% of the total US nuclear fleet while also providing for between 10%-15% of US clean energy generation. The entire nuclear fleet is outside of the regulated realm so the entire fleet can qualify for the PTC. All that said, given that the PTCs allow for additional clarity and stability on LT (and higher) pricing, we feel that the company should re-rate higher and reflect higher multiples more suited for renewable power producers with LT PPAs versus merchant generators. Moreover, with higher clarity on pricing, additional value can be created with capital allocation decisions – perhaps additional acquisitions from the nuclear space or from the renewable space. In any case, clearly the re-rating has already started in the run-up to the IRA decision (CEG is +42% since July 18). The LT fundamentals and prospects for additional M&A only look brighter from now on. Owing to a recent IPO this past January, CEG is still a relative newcomer compared to its more traditional utility peers. As can be seen below, on the valuation front CEG still trails its peer group in certain categories.
On the earnings front, late last week CEG announced better than expected Q2/2022 financial results highlighted by adjusted EBITDA of $603M which topped consensus estimates calling for $557M. Despite cost inflation in materials and labor, the beat was helped by higher energy prices coupled with lower fuel costs. Not only was FY/2022 EBITDA reiterated at between $2.35B-$2.75B, so were the gross margins of $7.30B. For FY/2023 however, gross margins were raised from $7.95B previously to $8.15B now. This was the second gross margin guidance increase YTD and it further illustrates the on-going strength in power prices. Note that for FY/2024, 70% of CEG’s power portfolio is hedged, expect additional hedges to be entered into in for 2024 and the following years. Note as well that during the quarter, the company’s nuclear fleet was performing at a 94.2% capacity factor while the natural gas fleet performed in line with expectations despite the record heatwaves in Texas.
We continue to see Constellation Energy Group as a still underappreciated company which is only now starting to make the rounds for investor presentations and research coverage seeing as it only began trading in January. Drawing on themes of energy independence, ESG and the transition to a low carbon future, we think that CEG can be the flagbearer in all of these domains. We expect a re-rating higher as the story becomes better known.