NRG Energy Inc (NRG) — Q4 2022 Earnings Call Transcript

Thank you, Josh. Good morning, and welcome to NRG Energy's Fourth Quarter 2022 Earnings Call. This morning's call will be 45 minutes in length and is being broadcast live over the phone and via webcast, which can be located in the Investors section of our website at www.nrg.com under Presentations and Webcasts. Please note that today's discussion may contain forward-looking statements which are based upon assumptions that we believe to be reasonable as of this date. Actual results may differ materially. We urge everyone to review the safe harbor in today's presentation as well as the risk factors in our SEC filings. We undertake no obligation to update these statements as a result of future events, except as required by law. In addition, we will refer to both GAAP and non-GAAP financial measures. For information regarding our non-GAAP financial measures and reconciliations to the most directly comparable GAAP measures, please refer to today's presentation. And with that, I'll now turn the call over to Mauricio Gutierrez, NRG's President and CEO.

Thank you, Kevin. Good morning, everyone, and thank you for your interest in NRG. I'm joined this morning by Alberto Fornaro, Chief Financial Officer. And also on the call and available for questions, we have Elizabeth Killinger, Head of Home, Rob Gaudette, Head of Business and Market Officer, and Chris Moser, our Head of Competitive Markets and Policy. Starting on Slide 4 with our key messages for today's presentation. We have made significant progress in advancing our strategic priorities in 2022. And while our financial results were lower than expected, our business is well positioned in 2023. Today, we are reaffirming our 2023 financial guidance ranges. The Vivint Smart Home acquisition is on track to close by the end of the first quarter. Today, we are providing further disclosures around revenue synergies to ensure you have additional tools to properly value the transaction. Finally, the core of NRG is strong, supported by favorable fundamentals. The acquisition of Vivint enhances our ability to achieve our free cash flow before growth per share targets. Now turning to Slide 5 for the financial and operational results of 2022. Beginning with our scorecard for the year, we executed well across our strategic priorities. We delivered our second consecutive year of record safety performance. For me, it always starts and ends with the well-being of our people. I want to thank everyone at NRG for staying focused during a challenging year. Our retail group took deliberate actions to manage price volatility and delivered record customer retention and extended the average term of a new customer to 2 years. Also, our bad debt remained below historical levels despite higher inflation and tightening financial conditions. Our plant operations performance was below expectations, primarily impacted by the outage at the Paris facility right before the summer. We are taking additional steps to strengthen our supply and mitigate operational risk during specific conditions. The direct energy integration is nearing completion and on track to deliver our run rate synergy targets in 2023. We executed on our test and learn program during the year, which culminated in the announcement of the Vivint Smart Home acquisition. We also continue our portfolio optimization with 2 gigawatts of coal retirements and asset sales. Finally, on capital allocation, we executed $645 million of share repurchases out of the $1 billion program. We will execute the remaining amount when cash is available and when we have full visibility to achieve our targeted credit metrics. We also increased our dividend by 8%. Since it was reestablished in 2020, we have raised our dividend more than 25% and returned almost $1 billion to shareholders this way. I view our dividend as an integral part of our return on capital policy. Moving to financial results. We delivered $435 million of adjusted EBITDA in the fourth quarter bringing our 2022 full year result to $1.754 billion, below expectations. For the fourth quarter, we highlighted in our last earnings call that reaching the bottom end of the financial guidance included a little over $100 million of optimization opportunities. Specifically, making our natural gas units available to capture value during periods of high power prices. This opportunity did not materialize as mild weather during the quarter resulted in power prices much lower than expected. We were also impacted by winter storm Elliott in late December primarily from PJM capacity performance payments, where we risk-adjusted downward our bonus payments pending additional information from PJM. Alberto will provide more information on our financial results. Turning to Slide 6, our 2023 outlook. We are reaffirming our 2023 financial guidance. We see improving fundamentals in our business, including more stable supply costs driven by lower natural gas prices, fewer supply chain issues for coal and chemicals, more favorable retail market conditions in the East, and economic resilience in our customer base. In the East, we see an opportunity for customer growth given rising rates from public utilities, enabling competitive retailers to demonstrate the value of our services to customers on an equal playing field. In Texas, the Public Utility Commission proposed market design improvements that will result in more dispatchable generation and greater reliability of the grid. I want to commend the Texas Governor's office and legislature for taking swift action to enhance grid resilience while ensuring the integrity of the competitive market. Also, retail competition will open in Texas in the fall, in a city with more than 100,000 electric customers. We look forward to having the opportunity to earn and serve customers in that area later this year. In 2023, we will continue executing on our strategic priorities focusing on strengthening our core business while growing innovative products and services, as you can see on the right-hand side of the slide. We continue our focus on optimizing our portfolio to better serve our customers. To that effect, we are targeting $500 million in net cash proceeds from asset sales by the end of the year. Having completed our test and learn phase in 2022, we are now focused on the next phase of our strategic roadmap, growing the business. This includes completing the direct energy integration and increasing the number of customers that purchase multiple products from us. Today, we have sold more than 1 product to 15% of our customers. We are making good progress on cross-selling and will provide additional disclosures as we integrate Vivint. To support this growth, we will continue to strengthen our power supply by expanding our capital-light PPA program for renewables to dispatchable generation at some of our existing sites. Finally, we are on track to close the Vivint acquisition in the first quarter with all regulatory approvals received and no shareholder required. We expect to close financing soon and have begun day one integration efforts. I want to provide additional insights on how Vivint enhances our core energy platform and brings additional capabilities at scale on Slide 7. Vivint is a leader in smart home solutions with nearly 2 million highly engaged customers with an average life of 9 years. Their system brings together automation, security, and residential solar under a single proprietary technology and data platform. This business is highly complementary to our core energy offering. We will use their smart home ecosystem to connect all our currently isolated products and services, including green power, batteries, EVs, and other products into a seamless experience that is highly engaging and personalized. This engagement will provide tremendous insights into pricing, customer experience, and new solutions that create greater brand loyalty and longer average customer lifetime. As we leverage the smart home ecosystem, we expect to optimize energy demand inside the home, providing valuable services to the wholesale markets. In other words, NRG will be the bridge between the home and energy markets with a unique ability to optimize and monetize value between the two. Vivint will also complement our existing energy product offerings and sales channels by adding home automation, security, and residential solar at scale including a proven acquisition engine with a solid track record of growth and nearly 2 million customers. On the right-hand side of the slide is the virtuous cycle that we have discussed in the past. By leveraging our existing platform, we can access meaningful cost synergies. This economic advantage, coupled with better insights and more personalization, results in a better experience for our customers. All of this translates into a deeper understanding of how consumers interact with their homes, additional margin, and better retention on our core products, and the cycle repeats as we grow, creating a more valuable business. Now I want to disclose the value of opportunities that this combination represents on Slide 8. We have identified 3 main areas of value: growing and optimizing our network of customers, leveraging the platform to achieve cost synergies, and improving the value of our core energy customers. With respect to the growth opportunity, we are targeting $300 million of incremental free cash flow before growth by 2025. We are encouraged by the preliminary work we have done on both sets of customers and look forward to fully optimizing once the transaction closes. As you can see on the left-hand side of the slide, there is some overlap in our core energy markets, but it's relatively small. This is important because Vivint already has teams ready to be deployed in our core energy markets and because the addressable market opportunity for new customers will be even greater. We expect to achieve this growth target in several ways as we target Tier 1 customers, which we define as single-family homeowners with high credit scores within select urban areas. We will focus on 2 immediate and actionable opportunities: cross-selling existing products into our combined customer network of 7.5 million customers, and selling bundle offers to new customers outside of our network representing 15 million potential households. In addition, we will grow dividends organically in line with historical levels. These opportunities will be enhanced by optimizing our combined sales channels and best practices, leveraging the strength of both NRG and Vivint. The capital required to achieve this growth is expected to range $500 million to $600 million over the next 3 years. For gross synergies, we have identified $100 million to be achieved by 2025, primarily from combining 2 public companies. For these, we expect $160 million of one-time costs to achieve. Finally, on our existing core energy customers, cross-selling means we can have direct access to our customers in the East and the opportunity to expand margin and extend customer lifetime value. In total, we see a $400 million opportunity by '25 and a larger opportunity beyond given the size of the smart home addressable market. I am confident in our ability to deliver these targets as we have a strong history of integration and synergy achievement. Just to remind you, since 2016, we have achieved significant value on integration synergies, cost reductions, and enhancement programs. This effort will be led by the same team as the transformation plan and direct energy integration. I look forward to providing you a more comprehensive update later this year during our Investor Day. Now turning to Slide 9. We want to give you an update on our pro forma outlook and how the dividend transaction supports our growth targets. On the left-hand side of the slide is a free cash flow before growth pro forma walk from 2023 to 2025, including the expected growth contribution from Vivint that we just discussed on the previous slide. This illustrates the earnings power of the company and will be further unpacked once the transaction is closed. On the right-hand side of the slide is the expected capital allocation through 2025. As you can see, the combined platform provides the financial flexibility to have a balanced approach between growth and return of capital while maintaining a strong balance sheet. The acquisition of Vivint and, more specifically, the growth opportunity that it represents will better support our per share growth targets while materially high-grading our earnings quality and customer lifetime value. So with that, I will pass it over to Alberto for the financial review.

Thank you, Mauricio. I will now review our 2022 results. During our third quarter call, we mentioned that increased profitability in the fourth quarter would allow us to achieve an adjusted EBITDA at the lower end of our full-year guidance for 2022. This higher profitability was partially due to insurance proceeds from Limestone Unit 1 and the Paris facility, along with additional synergies and cost reductions, as well as the potential for generating extra gross margin from our planned gas fleet usage. Our forecasting relied on forward market curves, which at that time showed higher power prices for the fourth quarter, making the utilization of the gas fleet economical. Unfortunately, actual prices in the fourth quarter dropped significantly below expectations. In Texas, peak prices were 45% lower than anticipated, leading to reduced profitability from our generation fleet. Toward the end of December, winter storm Elliott caused a sharp drop in temperatures from December 20-24. During the storm, the flood surge was much higher than expected in both ERCOT and PJM, resulting in spikes in power prices. Our gas generation fleet in Texas, which was mostly idle during the fourth quarter, had to respond. However, the significant gap between actual and expected demand meant that the fleet could not fully meet the additional demand, leading to the sale of extra power in the market at higher prices. In the East, increased load resulted in a PJM reliability event for our units without prior notice. Several larger units, which take longer to start up, were reserved for this event, impacting capacity performance due to the lack of notice. The combination of lower-than-expected prices at the start of the quarter and the effects of winter storm Elliott resulted in negative variances to our EBITDA expectations. The adjusted EBITDA for the fourth quarter was $435 million, falling short of our guidance by $196 million. We estimated that the lower prices in much of Q4 reduced the expected contribution from our gas generation by around $115 million. Additionally, we estimated that winter storm Elliott had an $80 million negative impact, primarily due to capacity performance issues in PJM and increased power purchases in ERCOT, somewhat offset by expected capacity performance bonds for the Paris plant. For the full year, our adjusted EBITDA was $1.754 billion, which was $346 million below the midpoint of our guidance at the beginning of 2022. Two main factors influenced this result: the extended outage at Parish which caused a $220 million loss in margin, partially offset by $52 million in business interruption proceeds, and the $80 million impact of winter storm Elliott. We also faced an additional $44 million in pension expenses due to a decrease in financial asset prices in the latter half of the year and some increased operational and maintenance expenses. Other contributors included $15 million in reduced earnings from the divestiture of Watson and $16 million in growth expenses. In 2022, our free cash flow before growth reached $568 million, with the shortfall relative to our third quarter guidance mainly driven by the EBITDA shortfall and two working capital factors. First, the insurance proceeds for Parish and Limestone that we anticipated for 2022 were recorded in the fourth quarter but actually received in January 2023, resulting in a $100 million increase in receivables by year-end. Second, our working capital took a hit due to rapidly falling gas prices in the quarter, which affected our payables more swiftly than our receivables. Looking ahead to 2023, we are reaffirming our full-year guidance for both adjusted EBITDA and free cash flow before growth. Before discussing the available cash for allocation in 2023, I would like to update you on winter storm Yuri and our direct energy synergies. The net impact from winter storm Yuri in 2021 was $380 million. Throughout 2022, we managed to increase mitigant proceeds which reduced the total net cost to approximately $259 million. For the coming years, there will still be some cost recoveries linked to Yuri, but they are expected to be minor, so we will not be updating on these fees anymore. Regarding direct energy synergies, we realized a total of $84 million in synergies in 2022 while incurring related integration costs of $74 million, bringing the total synergies achieved from the acquisition to $259 million. We are confident in achieving the remaining synergies, which relate to specific projects scheduled for completion in 2023. Hence, we will stop providing quarterly updates on our direct energy synergy progress but will deliver a final summary at year-end. Now, moving on to our 2023 capital allocation update. We have excess cash from 2022 totaling $40 million at year-end, along with $209 million from the sale of Astoria, amounting to $249 million overall. For Vivint, we continue to utilize the pro forma full-year figures from our December call. The projected free cash flow before growth for the year is $1.73 billion, which includes energy stand-alone guidance of $1.62 billion plus pro forma EBIT of $110 million, factoring in the anticipated effects of debt financing. Additionally, we foresee $300 million in cash available from Vivint. We are targeting a net inflow of $500 million from asset sales, with investments rising by $29 million due to early realization of winter storm Yuri impacts in 2022. On the far right, we expect a total of $434 million available for future allocation, which will fund the remaining share repurchase program once we have complete visibility on achieving our 2023 target credit metrics detailed on the next slide. Lastly, we maintain our commitment to a strong balance sheet. This slide remains unchanged since our last update as we focus on achieving our target credit metrics for 2023 and investment-grade metrics by late 2025 to 2026 through a combination of debt reduction and growth. With that, I’ll hand the call back to Mauricio.

Thank you, Alberto. On Slide 15, I want to briefly outline our 2023 priorities and expectations. First and foremost is delivering on our core energy business goals. We will continue to strengthen our integrated platform and further optimize our portfolio. Second, we are focused on closing the Vivint acquisition, integrating the business, and delivering on our synergy commitments. Finally, we will stay disciplined on our capital allocation plan as we execute our strategic priorities. I am excited about this next phase of our evolution and look forward to providing you a comprehensive update at our Investor Day later this year. So with that, I want to thank you for your time and interest in NRG. Josh, we're ready to open the line for questions.

Listen, I wanted to talk to you guys about the '25 outlook and just clarify this. As it pertains to the original conversation around, call it, $12.50 a share, is this an implicit increase in expectations or roughly in the same ballpark? As I look at sort of what's implied on the numerator and denominator, seems like there could be a slight increase there. I just want to come back and clarify that as best you guys see it. And I have a quick follow-up.

Yes. I mean let me see if I understand the question. The pro forma that we show here could source in line with the free cash flow before growth targets that we provided you at Investor Day of 15% to 20%. So as you mentioned, what Vivint does is complements our share buyback and capital allocation program with a very attractive growth engine that we articulated in the call today. Now, the Vivint transaction, I'm expecting that it's going to produce $400 million of free cash flow before growth, on top of the 2023 pro forma or guidance for NRG. So when I think about the 2025 pro forma, I will say that I'm very comfortable with the energy pro forma now that we have communicated the contribution of dividend, I will tell you that we have pretty good line of sight to deliver on that commitment of 15% to 20% growth.

Excellent. Just to clarify, I know you mentioned an Analyst Day. Would you expect to move the 2025 projections forward at that time, or could we receive updates sooner with the closing? Additionally, we've observed some recent litigation that may affect the situation. Can you explain how that could be impacting the process right now?

Yes. So I think what you should expect is at Investor Day, we'll provide you the 5-year plan that will go beyond 2025. I think that's the right time to articulate it obviously, the close and in subsequent weeks after the close and most likely on the earnings call, we will provide additional clarity in 2023 with respect to the event, right? So with respect to the litigation that you're mentioning, we actually have looked at that, evaluated it, and we see very little risk in terms of closing the transaction. So keep in mind that this is not only for our industry, this is for all SPAC across all industries. And I see this more as just a clean of process than anything else. So the risk of impacting the closing of the transaction, I would say, is minimal.

So maybe first on the '23 guidance. I mean it seems like it's a pretty good setup for the year. I mean power prices have fallen, you should have an advantage with gaining market share on the retail side, especially in the East, given the collapse in power prices and natural gas prices, there's been an improvement in working capital, there is the cost to replace the power for the WA Parish outage should have come down, and yet you kept the guidance range. So what's the offset to these positive drivers?

Yes, I'm glad you went through the details because when I consider 2023, I believe it will be more conservative than 2022. This is true not only for what we control. The assumptions we’re using in our forecasts are more cautious. Additionally, this is the second year we’ve increased maintenance capital expenditures for our plans, which should lead to greater reliability. There are several favorable factors supporting our guidance. You've already noted the market dynamics in the East, where utility prices are significantly higher, providing us a great opportunity to capture market share. The decline in gas prices is also beneficial for managing our retail margins. Overall, this outlook is encouraging. However, it's only February, so I want to ensure we have a few months’ data and better visibility for the year ahead before making further adjustments. I am confident we can meet our guidance, but I believe we are being a bit conservative with our numbers. That cautious approach seems wise considering the volatility and extreme weather we’ve experienced in recent years.

That's good, especially after this whole year. Okay. And then on the PJM capacity penalties. So it's my understanding that the disclosures that the generation companies were provided by PJM on Slide 8 only talked about penalties. So any sort of bonus capacity payments haven't been disclosed or calculated. So I know that, that's a '22 issue. But just talk to us about how you accounted for those offsets to the penalties on the capacity side.

Sure. I'll let Alberto cover.

Yes. From the penalty perspective, it is relatively straightforward because we have considered our records to assess the potential penalties that could be imposed. On the bonus side, there are many variables, including possible bankruptcy, which can affect the amount that will be distributed. With the limited information available, we have estimated both the best-case and worst-case scenarios and selected a level we are comfortable with. Ultimately, we have adjusted the bonus based on the risks we may encounter throughout this process. We will have more clarity in the coming months, but we are confident in our approach.

Yes. It's reasonable to say that we have considered penalties and need additional information from PJM regarding bonuses. Consequently, we have adjusted the risk for that.

Okay. And then lastly, so when you announced the event, there was a plan to execute on share buybacks to a pretty meaningful $360 million. I mean, looking at the share count, you haven't done it. I understand that there is a plan for '23 to finish that $1 billion of the share buyback allocation. So just talk to me about the timing, why it hasn't happened yet. Were you waiting for the proceeds from Astoria? Is it somewhat of a reflection of the weak free cash flow generation for '22? And again, just roughly about when we should expect those buybacks to happen.

Yes, that's correct. I expect it will happen this year, and in line with our capital allocation principles, our priority is to first meet our credit metrics. Once we have clarity on achieving that and as we receive cash throughout the year, we will move forward with the share repurchases. I assure everyone that we will carry them out, but we need to first ensure that we meet our credit commitments and have sufficient cash available. That's our current approach.

Deferring the buyback does not reduce the amount of financing needed for the Vivint transaction.

No.

I was wondering if you could elaborate on what assets might be considered for sale and what the potential timing might look like in terms of executing any processes related to that?

Yes, David. We have been optimizing our portfolio for several years, and I believe we have a solid track record in this area. I see our assets as either core or non-core. Core assets are those that support us in serving our customers effectively, while non-core assets do not fulfill that role, and we consider monetizing them. Additionally, if any asset is deemed more valuable to another business, we will assess that and explore our options. This process is ongoing. We sold some assets last year and plan to continue doing so. Today, I wanted to give you more details on the amount we are targeting for this year, and we will proceed with this throughout 2023. Regarding timing, it will depend on reaching agreements, but we will keep you informed as soon as we have updates.

I would like you to discuss fleet reliability and resilience. Specifically, could you explain your strategy for improving the risk profile of the business during extreme heat and cold events? Are there additional investments you could make in your fleet to enhance their resilience, or is there more you could do to strengthen the supply side?

Yes, David. When considering reliability and resiliency, I view our supply strategy to support our retail load in three main categories. The first is our owned generation, the second is medium-term power purchase agreements, and the third is supplemented by market purchases. Currently, we source about 50% of our megawatts from our own generation and the other 50% from third-party resources or purchases. In terms of our own generation, we have taken two key steps. First, we have adopted a more conservative approach in our forecasting and in how we hedge against potential issues, which enhances our self-insurance. Second, we have invested more in maintenance capital expenditures to improve the reliability of our units, particularly in areas where we have encountered problems during high-demand situations. These measures help mitigate the operational risks associated with our units. Additionally, we trade various operational and counter-party risks, including credit risk. While this makes our megawatt supply more stable, we must also monitor the financial health of our partners. This strategy allows us to diversify our risk rather than relying solely on generation-related operational risks. This was a significant lesson learned during winter storm Yuri. I am confident in the risk adjustments we've implemented. Lastly, regarding our hedging strategies, we are adopting a more cautious approach, leaning longer than in previous periods to better manage scarcity during peak load times. It's important to note that we cannot completely eliminate risk without incurring excessive costs, so we have been deliberate and strategic in our planning.

I appreciate the time. Just a question on the 2023 kind of base pre-Vivint, what are you assuming in there, I guess, obviously, you're expecting a big recovery from '22 and some of the issues, just but what are you assuming in there for outages, any lingering outages, and then the related insurance money? And then also are you including any asset sale gains or losses in the guidance for '23? I think you've sold Astoria already at a decent price. Can you talk about that?

Yes, we have successfully sold Astoria. Regarding our guidance for 2023, I would describe it as a more conservative forecast compared to previous years. This reflects our operational productivity at the power plants and how we're managing our retail load. We also faced certain dynamics in 2022, such as supply chain issues related to coal and chemicals, which have mostly resolved. Currently, we are seeing stable natural gas prices that help us manage our retail margins better. In the Eastern market, we believe we can gain market share in our retail business. Overall, I can say that the guidance for 2023 aligns with what we shared at Investor Day, adjusted for the asset sales we previously outlined. Our current position reflects our strategic portfolio optimization. I am confident that our guidance is consistent with what we have communicated, and we are adopting a more cautious stance moving forward. We will keep you updated throughout the year, but please remember that we are still early in the year. Let me know if there’s anything else we need to address.

I mean Parish, part, like outage cost insurance and asset sales. Could you identify what's in the guidance for those?

Yes. So in the guidance, obviously, we have the Parish that is not in the first half of the year because it's on average. What I will tell you in Parish, and I think that's probably the largest risk. The progress that we have made is pretty significant. As a matter of fact, I think just last week, we've had the generator now on site and has been listed and put in the deck. So we're making really, really good progress on what I'm seeing today, I'm confident that we will come back on time. Obviously, the commercial team is monitoring very closely that with the plan. If there are any delays or there is any acceleration that we either mitigate the risk in the market or that we take advantage if it comes in earlier. But in fact, that's already embedded in guidance but Alberto?

Yes, to clarify about the Parish outage, there is no impact in 2023 because the availability of the plant was covered by business insurance. In 2022, we received slightly more than the business insurance amount. We are currently recalculating the margin, but overall, the loss margin is still fully hedged by the insurance we will receive, so there is no change from our previous guidance provided in the third quarter.

And then asset sales?

The upsell includes Astoria, which occurred in January. For now, we are not making any adjustments until we receive further news.

Astoria has been considered because it should have happened at the end of 2022. It occurred just a few days into 2023, and we took it into consideration in our guidance.

It's fairly small at the full impact. Consider that we have a tool for the remaining short period. So it's very, very small.

Okay. Great. I appreciate it.

Thank you. Thank you for your interest in NRG, and I look forward to updating you once we close the transaction on Vivint. Thank you.