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Retail rising: Competitive power's 'integrated' customer focus takes hold

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Retail rising: Competitive power's 'integrated' customer focus takes hold

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A fan snaps a photo outside NRG Energy's namesake NRG Stadium in Houston, Texas, where its Reliant Energy retail unit is headquartered. The company is positioning itself toward an "integrated competitive power" model.
Source: Associated Press

This is the first segment in a two-part series exploring competitive power's retail growth strategy and the sector's frenzy for retail portfolio acquisitions.

After declaring the independent power producer model "obsolete" in early 2017, NRG Energy Inc. President and CEO Mauricio Gutierrez has begun offering investors the "integrated competitive power" model as its replacement.

Power sector executives and advisers told S&P Global Market Intelligence that the strategy, scheduled to be explained at an investor day presentation March 27, would enable NRG and others following this approach to move further into the retail power sector as a way to reduce their exposure to wholesale market volatility.

Under the integrated competitive power model, large independent power producers look to match each megawatt-hour generated by their wholesale fleet with an accompanying megawatt-hour of load supplied to retail and commercial energy customers. This strategy represents a kind of counter-cyclical revenue hedge where, if regional power market prices decline and stunt wholesale revenues, retail customers would be likely to consume more power at lower rates, driving retail revenues higher to offset weaker wholesale margins. Conversely, increasing market prices could drive wholesale revenues higher, while retail margins taper off as customers use less power at higher rates, creating what has been characterized as an imperfect, yet viable, hedge against price volatility.

With the universe of publicly traded competitive power companies thinner than ever, management teams face intense pressure to provide investors with more stable earnings and cash flows. So when NRG and Vistra Energy Corp. gave investors insight into their 2018 outlooks, both explicitly signaled strategic interest in bringing their wholesale generation and retail loads into closer alignment, beyond core Texas operations, stoking the prospect of acquisitions of third-party retail energy companies doing business in Northeastern and mid-Atlantic energy markets.

According to senior power-sector executives and advisers speaking with S&P Global Market Intelligence, the timing of this newfound strategic and financial appetite for retail and commercial energy books by large competitive power companies aligns with strategic reviews underway at Spark Energy Inc. and potentially elsewhere across the retail energy landscape, setting up an environment ripe for M&A. Whether those acquisitions come to pass depends on the divergent wholesale profiles of incumbent generators as well as their ability to compete head-to-head with an expanding market of financial and international suitors all while avoiding overpaying for retail portfolios.

NRG declined to comment for this article ahead of its 2018 analyst day presentation. Vistra also declined to comment.

Targeting the retail hedge

As if to underscore its recent corporate transformation, NRG shuffled its board of directors to achieve what NRG Board Chairman Larry Coben described March 7 as "a more customer-focused approach." That pronouncement arrived on the heels of a notable shift in NRG's financial performance: earnings from its Reliant Energy retail subsidiary eclipsed its wholesale earnings for the first time in 2017.

Vistra CEO and President Curt Morgan struck a similar note, reminding investors Feb. 26 that the company's "emphasis on the retail customers" was a key tenet behind its merger with Dynegy Inc. to create the country's largest integrated power company. Vistra COO James Burke said the company's "retail teams are already evaluating various growth strategies to further enhance our integrated presence."

NRG and Vistra management teams both point to geographic regions where they operate wholesale capacity in excess of their retail holdings, orienting toward PJM Interconnection and ISO New England states as targets for retail ambitions, but the near-term strategic imperative for each company to further absorb new retail in those regions may differ significantly. Vistra's pending acquisition of Dynegy will make approximately 60% of the combined company's wholesale earnings come from PJM and New England, a significant shift for Vistra to wholesale exposure outside the Electric Reliability Council of Texas.

NRG may already be poised to serve more retail load than its slimmer wholesale fleet will generate, which could temper its appetite for more retail in the near-term.

An S&P Global Market Intelligence analysis shows that NRG's retail load could exceed its generation by a healthy margin when accounting for output lost to planned asset sales. A combined Vistra/Dynegy, in contrast, would need to prospectively double its retail load to achieve parity with its pro forma generation when accounting for retirements and asset sales, building on Dynegy's modest retail footprint outside Texas.

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Investment threshold

The concentration of NRG's and Vistra's retail operations in Texas suggests both companies will remain focused on expanding their retail footprints in Eastern markets. With excess retail in Texas, NRG may have enough earnings flexibility to view investments in both new mid-merit generation assets and retail books in eastern markets as equally attractive; pursuing one and subsequently backfilling the other, according to two industry sources, while progressing toward its 3.0x net debt-to-adjusted EBITDA target in 2018.

For Vistra, perfecting the integrated model comes with ambitions focused not only on better aligning its generation fleet but potentially tapping a wider investor universe to stoke liquidity around its debt and equity securities, inviting a balance between retail growth and achieving its 2.5x net debt-to-EBITDA target leverage ratio by 2019, following close of the Dynegy acquisition.

"The investment community, as well as the rating agencies, have gotten more comfortable with our integrated business and the resilience of it and the stability of the earnings," Morgan told analysts, striking an optimistic tone for an industry that has historically grappled with financial distress. "I think we may want to turn our attention to a discussion about whether we can get an investment-grade integrated power company again."

Acquisitive retail growth for NRG and Vistra could hinder further debt reduction and share buybacks but potentially position both to deliver longer-term dividends drawing on retail cash flows. Both companies have identified sizable sums of capital available for allocation. NRG said it has more than $600 million available for growth investments in 2018, which it would allocate so long as a given investment generates a 12% to 15% unlevered return on a pretax basis over five years, according to the company's March 1 investor presentation. Vistra expects to have as much as $2.5 billion in excess capital through 2022 upon closure of its Dynegy deal.