NRG Energy Inc (NRG) — Q1 2024 Earnings Call Transcript

Thank you. Good morning, and welcome to NRG Energy's First Quarter 2024 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 & 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 Dr. Larry Coben, NRG's Chair and Interim President and CEO.

Thank you, Kevin. Good morning, everyone, and thank you for your interest in NRG. I'm here with Bruce Chung, our Chief Financial Officer, along with members of the management team who can answer your questions. Let's start with the three key messages for today's presentation. First, our business performance in the first quarter was better than expected, and I’m pleased to reaffirm our financial guidance for 2024. Second, trends in electrification and the growth of Gen AI data centers indicate a significant increase in power demand. We anticipate that competitive markets will benefit greatly from favorable conditions, available resources, and the ability to quickly site projects. Finally, NRG is in a strong position to take advantage of the tightening supply and demand in our core markets. Our innovative consumer platform, diverse generation portfolio, leading business energy platform, and real estate assets provide a unique opportunity to generate substantial shareholder value, which I will elaborate on later. Now, moving to our value proposition for those new to NRG. We serve nearly 8 million residential customers and are the second largest energy and natural gas retailer in the U.S. Our company operates at the convergence of energy and technology for both homes and grids. We generate considerable excess cash, enabling us to grow earnings while delivering significant returns to our shareholders and maintaining a robust balance sheet. The strength of our business and financial outlook positions us well to benefit from what we believe is the beginning of an exceptional period for our industry. We are on track to meet our target of a 15% to 20% free cash flow per share CAGR, even as our rising stock price has led to higher share acquisition costs than expected a year ago. Recently, we have received questions regarding the expected growth in power demand and its implications for our industry and NRG. I want to share our insights on this. Based on various macro trends, signs indicate a fundamental shift in long-term power demand, marking a departure from a prolonged period of stagnant demand. For the first time in decades, we are witnessing growth fueled by demand rather than commodity prices. Expecting a significant uptick in demand is shared by many industry experts, driven by factors such as electrification, manufacturing, onshoring, LNG, cryptocurrency, and data center developments. Advances in Gen AI are further accelerating these trends, forming a new power demand super cycle. However, accommodating this growth will increasingly hinge on intermittent resources, creating an imbalance between dispatchable supply and demand. To clarify, entering this super cycle will require a multifaceted supply strategy, including preserving existing assets, developing new generation, and utilizing technology for demand management. This represents a transformative opportunity for both our sector and NRG. Moving to the next point, competitive markets where NRG operates are optimally positioned to reap the rewards from this growth. The competitive framework supports swift market entry, affordability, and resource accessibility, with Texas and parts of the Northeast identified as the most favorable regions. Texas is already a hub for large load growth in areas like cryptocurrency, LNG, and manufacturing, all of which have seen significant recent expansion and forecast strong growth ahead. Texas's supportive business environment, favorable regulations, tax incentives, and vast land availability strengthen its position in the era of generative AI and large load demand growth. Furthermore, our capacity to site projects swiftly compared to regulated markets and our strategic proximity to key infrastructure suggests Texas will continue to lead in load growth. I want to highlight some critical opportunities across our platform that can add value. Each of these represents potential upside beyond our growth plan established in June 2023, without depending on temporary funding sources. First, NRG uniquely combines residential energy and smart technology at scale with nearly 8 million customers, creating a trusted platform for innovative energy management—an important factor in a tightening market. Second, we are North America's second-largest business electricity provider and the largest natural gas provider by volume, offering tailored energy management solutions that help our clients optimize costs and meet sustainability goals. Third, our diverse Texas generation fleet allows us to maintain stable supply costs while insuring against volatility through strategically positioned assets. This positions us well to quickly benefit from rising power prices as demand increases. Finally, our real estate portfolio includes numerous potential development sites for large loads or power plants, with 21 sites comprising 21,000 acres that have existing or accessible grid interconnections. In summary, as we navigate the energy market, our business-to-business power and natural gas platform serves nearly 100 terawatt hours of electricity and almost 1.8 trillion cubic feet of natural gas each year. As demand grows, we foresee increasing electric and natural gas sales volumes. Our platform supports large load clients in achieving their goals through customized plans to stabilize energy costs and meet sustainability commitments, focusing on providing dependable services as a leading market participant. As for data centers, we're beginning to see preliminary signs of capacity increases in the near term. For example, one customer has approached us about tripling their capacity at an existing facility over the next three years, highlighting real-time demand growth. In Texas, our generation fleet's diversity—including 8.5 gigawatts of capacity and 1.6 gigawatts in long-term power purchase agreements—ensures stability while positioning us to take advantage of medium- to long-term margin expansion from higher power prices. Our analysis of the Texas market indicates significant potential for margin benefits as prices rise. In closing, we are very excited about the potential of our site portfolio, which includes 21,000 acres in competitive markets suitable for new large loads and power plant development. These sites offer critical infrastructure access and significantly reduced construction timelines, particularly important for data center developments. We are committed to maximizing the value of our site portfolio, and we'll provide updates on our findings later this year. Now, I’ll hand it over to Bruce for a review of the first quarter.

Thank you, Larry. Turning to Slide 14. Our top decile safety and strong operating performance resulted in first-quarter adjusted EBITDA of $849 million, exceeding the first quarter of 2023 by $203 million. This represents a 31% increase in our adjusted EBITDA from the prior year. $150 million of the year-over-year increase was the result of the inclusion of a full quarter's worth of Smart Home EBITDA. The remaining increase was attributable to outperformance in our East and West segments, driven by lower realized supply costs, partially offset by a slight decline in our Texas region due to mild weather. Our consumer energy and smart home platforms increased customer counts year-over-year by 8% and 6%, respectively. Most notably, we added 35,000 customers from the newly opened Lubbock market in Texas, representing a healthy share of the available customer base. This is a testament to the hard work of our consumer energy team over the past 2 years to position NRG and its brands as the electricity provider of choice in Lubbock. Similar to 2023, our Smart Home platform continued to demonstrate strong execution. In addition to growing customer count by 6% year-over-year, service margins increased 5% year-over-year, and monthly recurring revenue per subscriber grew 5% over the same period. It is clear that customers recognize the value of our Smart Home services as evidenced by our growth in the face of various macro headwinds affecting the consumer discretionary sector. Our diversified supply strategy continued to deliver, ensuring that we sustain the level of margin expansion we saw in 2023 while also providing the necessary coverage against potential volatility in the winter months. As we discussed in our last earnings call, our fleet performed well in the first quarter, demonstrating a 12% improvement in our in-the-money availability factor winter-over-winter. We have taken advantage of the mild winter in February and March to conduct our maintenance activities more proactively, and we feel confident about fleet performance heading into the critical summer months. Next, I would like to highlight some of what we have focused on as an organization through the first quarter as well as what we continue to remain focused on through the balance of the year. During the quarter, we concluded the $950 million accelerated share repurchase program we launched in November of last year. Through that program, we repurchased nearly 19 million shares at an average price of $50.43 per share, or almost 10% of the shares outstanding at the time that we launched the ASR. We remain committed to our capital allocation plan, and we are reaffirming our 2024 return of capital amount of approximately $1.2 billion, comprised of our common dividends, which we increased earlier this year and a further $825 million in share repurchases. As Larry discussed, we continue to advance our 1.5 gigawatts of brownfield development in Texas. We will be filing our Notices of Intent for the 3 projects to the Texas Energy Fund in the coming days, and we anticipate filing formal loan applications in early June when they are due. Our brownfield development portfolio comprises 2 peaking plants and 1 combined cycle project, with CODs ranging from 2026 to 2028 is shovel-ready and represents some of the most real natural gas-fired development opportunities in the ERCOT market. We have been developing these projects since 2021 and we believe that the advancements we have made on the permitting and equipment procurement fronts should position these projects at the front of the queue for consideration by the PUCT for funding out of the loan program. Next, we continue to remain on track to achieve our $550 million program of growth and efficiency initiatives across our business platforms. As I mentioned earlier, our consumer platforms continue to drive strong stand-alone growth, and we continue to see positive momentum in our ability to generate more margin per customer. A great example of this is the tremendous progress we've made in selling the Vivint protection plan. We started selling this plan shortly after closing the Vivint acquisition. And to date, we have about 15% penetration of the existing Smart Home customer base or over 300,000 active plans, with each plan generating approximately $9 of monthly revenue per customer. Finally, we are reaffirming our 2024 guidance for both EBITDA and free cash flow before growth. We have tremendous momentum in both our consumer and business platforms and the measures we are taking in our diversified supply strategy should set us up well for the balance of the year. Turning to Slide 15 for an updated view of our 2024 capital allocation. As you can see from the slide, there have been no substantial changes since our last earnings call in terms of the quantum of capital allocated to liability management and capital return. As you may recall, we had planned $500 million of debt reduction in our last earnings call as part of the 2024 capital allocation plan. As you can see from the slide, that has changed slightly given our efforts in Q1 to address our outstanding convertible notes. Through April 30, we repurchased $343 million of the outstanding principal of the convertible notes, resulting in $257 million of additional premium paid to retiring noteholders. Given the cash allocated to settle the convertible note premium, that reduced our net debt reduction to $243 million planned for the year. Our strong share price performance over the past year made the convertible notes one of the most expensive pieces of paper in our capital structure. Therefore, we believe that made the most economic sense to pursue a retirement of that instrument before it would get even more expensive as our share price continues to reflect our fair value. Moving a few columns over to the right, you will see that the share repurchase column is $865 million versus the $825 million we showed in our last earnings call. The reason for that is because we now include $40 million of cash allocated to settle tax matters related to our 2023 share repurchases and Employee Stock Compensation Plan. This would include the excise tax on share repurchases instituted as part of the passage of the Inflation Reduction Act. Previously, we had bucketed that allocated cash in other categories, but we decided to move those dollars into the share repurchases category in order to more accurately reflect what the cash is being used for. Finally, similar to our last earnings call, we continue to show $41 million of unallocated capital available for allocation in 2024, which we will evaluate the use of as we move along the year. With that, I will turn it back to you, Larry.

Thank you very much, Bruce. On Slide 17, I want to provide you a few closing thoughts on our 2024 priorities and expectations. We remain laser focused on execution and on delivering on our financial, operational and safety commitments. We are seeing a step change improvement in fundamentals across all of our platforms. We believe that this will put a spotlight on the scarcity of the critical products and services we sell and the durability of that platform. We are uniquely positioned to deliver significant shareholder value for years to come. Again, we are the only company to combine residential, energy and smart technologies at scale, with nearly 8 million customers and the necessary capabilities to create sustainable value through both tightening and loosening power market conditions. We operate the second largest business-to-business electricity and largest natural gas platform in North America, positioning us as a leader in premium services and tailored energy management solutions. Our integrated supply strategy provides incredible capabilities to stabilize near-term earnings while capturing medium- to long-term margin expansion opportunities from higher power prices. And we own a large land portfolio with premium attributes for what is to come in the super cycle of power demand. In my 20 years at the company and over 40 years in power, I have never been more excited about the future of our sector at NRG. The step change in demand should lead also to a change in the depressed valuations for NRG and its peers. These depressed valuations have resulted in double-digit cash flow yields such as ours. This revaluation will be good for NRG and others in our space, and it's very exciting times. I look forward to updating you on our progress along the way. With that, I want to thank you for your time and interest in NRG. We're now ready to open the line for questions.

Just Larry, on the curves themselves. There's, obviously, a lot of chatter in the industry right now about some large generators like nukes to go behind the meter. Is this something, I guess, that concerns you as you look at your length in the Eastern markets? So as you go out to the market to match load, are suppliers raising any kind of concerns there?

Shar, it's Rob. Like it doesn't raise any concerns for us as far as trying to purchase supply so that we can meet retail obligations. Even if they do go behind the meter, there's plenty of players in the East. It's a very liquid market.

Got it. Perfect. As you highlight the Texas fleet, how might the current EPA regulations impact your generation profile over the next couple of years? Is it just an increase in capital expenditures? Could we see a faster pace of gas development work beyond the 1.5 gigawatts that Bruce mentioned in shovel-ready proposals? I’d appreciate more insight on how these factors are interacting.

Sure. So when you think about the regulations that were promulgated, the first thing I would say, Shar, is that they're all going to be litigated, right? AG, states, ISOs, consumers, everyone has a view and a reason to make sure that these rules get set in place in a way that works for the system and provides reliable and affordable power over time. As far as specifics around us, some of the rules will have to see how they pan out at the end. But what I would tell you is that our decisions to invest around the gas fleet or the 1.5 gig that Bruce talked about earlier, have nothing to do with these regs. It's all about the opportunity that we see in the markets, and we'll continue to drive that way. Does that make sense?

Yes. That was perfect. And then, Larry, it sounds like you're having a really good time on the job right now. So maybe you're not in a rush. But is there anything as far as any updates on the CEO search? Or are you having too much fun?

I'm really enjoying my time here. It's a wonderful team and a fantastic company. The committee is continuing their work, and I believe they're still on the timeline I mentioned earlier, but there’s no hurry. I've encouraged them to take their time, and I will remain in this role as long as needed until they find the right candidate for the next CEO of NRG. With all the opportunities we've been discussing on this call, I really am having fun, and I believe it's important to enjoy what we do.

Perfect. Really big congrats to Elizabeth. She's been such a fantastic phase for NRG for some time.

So first, for the last maybe 20 years, you were trying to convince us that you are power price-agnostic. Clearly, not any longer. That's number one. So how do we think about it, this new backdrop, how it impacts your retail business versus wholesale business? Is this additional margin going to be realized by selling this more expensive power to the retail arm? So that's number one. Number two is, so this is gross margin. Is there like an additional O&M layer, we should think about or on maintenance, both on the cost side and CapEx side? Just to get a sense of how big an impact you will have on the EBITDA of the sway in power prices.

And let me have Rob talk a little bit about the CapEx and repair side. And then I'd ask Rasesh to talk a little bit about the margin side.

Angie, when considering the gross margin expansion illustrated in the chart and its impact on EBITDA, it's helpful to view it in two parts. First, regarding the plants that are currently operational, we have already accounted for them in our numbers. Any power increase that does not affect operating expenses for those running megawatts is significant. The additional operating expenses that will translate into EBITDA come from the increased operation of those assets. We've previously discussed how price changes lead to longer run times, resulting in higher operational costs. I would estimate that the translation rate would be around 80%, but feel free to correct me if I'm mistaken, Bruce.

Yes, we would probably see something like an 80% translation to EBITDA and then probably like a 75% translation of the free cash flow.

Does that answer your question?

Yes.

And then, Angie, on the retail margins, I mean, I think we've proven our ability to maintain strong retail margins over time. Increasing power prices really affect our competitors as well, and they historically proven to be rational in pricing. And so when you look at quarterly move up of the curve like we're experiencing now, it gives us ample time to pass that through to consumers. And in fact, energy prices have gone up almost 75% caused from 2017 to 2023. We've actually been able to increase margin over that period. And so we feel confident in our ability to do that.

Okay. And then one other question. So you're discussing the new gas-fired power plants. I was calculating some figures. Considering the increasing supply of renewable energy, it's likely that these plants won't achieve very high capacity factors, which implies that power prices must be significantly higher than what we observe in the forward curve to make the construction of new gas plants justifiable. I'm curious about your perspective on this. Even in Texas, with the peaking and combined cycle gas plants you are proposing, it seems challenging to believe that these assets would be economically viable at a constant price of around $60.

Angie, it's Rob again. I would tell you that the assets are economic. The way to think about the beauty of peakers, or CCGTs, is that they can flex meaning they can move. And they can capture the value in the hours that matter. We've been trying to transfer our portfolio to something like that for a few years now. And so when you see prices move, right, so as you see the curves go up, particularly in ERCOT, it doesn't mean that every hour goes up by that same amount. It's the very tight hours that go up those exponential amounts that you're talking about. Is that cleared up? So think about the afternoon in Texas in the summer. That is going to go up 5 or 6x versus morning of that same day may have gone up once. And peakers are the things that make money in that scenario.

Yes, Angie, I want to emphasize that all of these projects, even when not considering rising prices or various cost factors, align well above our designated hurdle rate. Additionally, everything I mentioned and what Rob discussed represents extra potential beyond that.

So but in light of that, I'm sorry, I'm asking a lot of line questions. But in light of that, the fact that the new build is materializing at these prices, wouldn't that suggest that there's a cap on the upside to power prices? Because that's usually what it suggests, right, that the new build materializes and that sort of deflates the tightness of power markets.

Angie, I think if you look at the tightness versus the 1.5 gigawatts, the tightness far exceeds it. And so yes, at some point, of course, if there's enough new build that might exclude the tightness. But if you look at the number of projects that are on the books, not just ours, but everybody's, the time it's going to take to complete those, I don't worry about that tightness being loosened in any significant way for the next several years.

Following up on Angie's first question, I want to clarify the difference between NRG in the past, when prices were low for an extended period, and NRG now in the current environment. I don't remember hearing about hedges rolling off and becoming suddenly vulnerable to low power prices. The integrated model and customer-focused approach were intended to mitigate the risks associated with low prices. So, why wouldn't I consider an integrated model again, especially with the possibility of retail margins decreasing due to higher power prices? How do we reconcile these two situations?

Steve, I believe this is primarily related to the significant shift in the market. Previously, price changes were driven by commodities and were more temporary, and we focused on maintaining stability. What you are observing now is a major transformation where the flexibility of our integrated model enables us to adapt and capitalize on higher prices. The model itself has not changed. We haven't discussed this before because we haven't experienced a shift of this magnitude. However, one advantage of the integrated model we have been implementing is that it positions us well to respond to price increases like this.

Got it. Okay. And then on the kind of sites opportunity and also on the new build generation. Could you give us maybe a little bit more color on how you're thinking about funding for those opportunities? And how much might come from NRG versus kind of third-party buying stakes or making the investment? Just maybe some kind of broader overlay how you're thinking about that.

Yes. So Steve, it's Bruce here. First, on the new builds. Obviously, from a funding perspective, we intend to access the Texas Energy Fund. So that's going to be 60% of the capital costs related to the new builds right there. The other 40% of equity, we feel confident that we can fund that from our own cash and cash flow, without impacting any of our capital allocation commitments, in terms of share repurchases and deleveraging. So from our perspective, we feel pretty well capitalized to be able to handle all of that by ourselves. Obviously, as we've always said, to the extent that these projects are getting built and there's a unique opportunity to potentially attract third-party capital at a very attractive proposition, then we would certainly give that some consideration. But right now, as we sit here today, we feel good about our ability to fund those projects on our own. As far as the 21 sites, it's still early days. How it is that, that ultimately translates into what sort of opportunities that results in are still to be discovered. And so don't really have a perspective on any capital need in that regard as we sit here today.

Okay. And just last quick one. Obviously, the higher stock price, you mentioned still reaffirming the 15% to 20% growth. So that, I assume means you're expecting a better numerator there in terms of free cash flow to support that? And what is driving that? Is that mainly the higher power prices?

I always have my opportunity to give you a warmer answer, but yes, regarding the first part of your question, I think we see continued execution against our $550 million growth and cost program. Additionally, based on the sensitivities we provided, we anticipate some upside as a result of the forward curve.

Can you provide a high-level overview of the 21 sites you mentioned? Specifically, how many potential gigawatts can you add over time, and how quickly can these gigawatts be added? The reason I ask is due to the significant increase in demand you mentioned, and I'm curious about the responsiveness to that demand.

It's a good question, Durgesh, and we are actively working on this, which is why we've established a new group focused on data centers. I don't have a definitive answer yet as we are still trying to determine the best approach. There is significant potential, but we have a lot of work ahead to figure out the most suitable options for each site. We need to assess whether it is more advantageous to develop a data center or a power plant, and whether colocation should be positioned behind or in front of the meter. We're dedicating considerable time to these evaluations, and while I hope to provide more insights in the future, it may take until the end of the year to do so. As you know, developing a power plant is quite a substantial undertaking.

That makes sense. I appreciate that, Larry. I know this is going to be another tough question, but can you share your thoughts on buybacks, considering how the stock has increased in valuation compared to investing in these opportunities, which have a tremendous run rate? How do you view that?

Let me start by reiterating what Bruce mentioned, which is that we are reaffirming our commitment to our capital allocation plan. It’s an easy decision when our stock is trading at a 25% free cash flow yield; however, we still believe we have enough capital for both our investments and to return capital to our shareholders. I don’t foresee any changes in the short to medium term. Therefore, we will maintain a disciplined approach to returning capital, especially considering the increases we have discussed, which will likely provide us with additional capital for investments. It's also worth noting that many investors are now interested in co-investing with us on similar projects. I believe there are many opportunities for beneficial projects regardless of our capital allocation principles.

Dave Arcaro here. Following up on one of the earlier questions. I was wondering, just on the ERCOT market and pricing in the market and the forward curves. Do you have a view from here on where ERCOT prices could go? Is there still room for upside? Do you think in terms of where the forward curve is currently pricing?

David, it's Rob. Yes. The markets can definitely go up. If you look at the large loads that are coming to the state into the system, ERCOT is already beginning to monitor and take a look at it. It's a lot. And you're seeing that price in. There is more upside in the curves from here.

Okay. Understood. As you begin to incorporate hedges and finalize some of your future EBITDA projections, is that perspective something you are including?

So when we think about our out-year EBITDA, remember that a big part of our hedging program is through the retail book, right? So as we sell to our 8 million consumers, that ultimately takes a lot of that value and translates it over through the retail revenue rates. We're always looking way out the curve, David. If I thought that something was really high and out of whack, then I would say that we could take something off the table. But we like the position, we like the trend and we like where our portfolio is.

Got it. And could you touch on what the competitive dynamics are that you're seeing in the retail energy business right now, in terms of any pressure from new entrants or pricing pressure in the market that might push margin one way or the other right now?

It's been a very stable performance. As you saw, we had strong performance in terms of customer growth year-over-year. We saw similarly good performance in load growth and our margins. And so we feel very good. I think there are a couple of new entrants in the market, but as we look at our outflow reports, we don't really see any meaningful traction there.

Can you provide an update on the capital allocation framework? Is there a specific price at which you would reconsider buybacks, or are you avoiding commenting on the value of energy security?

Brian, there is no price that we would necessarily sit here and tell you is the absolute line at which we would stop buybacks. We're always going to be looking at what is implied in the share price with respect to our free cash flow yield, and we'll make the determination from that standpoint. But as we sit here today, we see plenty of room to run for us to continue to be buying back shares.

As you consider investment opportunities related to power generation growth in your service area, are you focusing on new builds and partnerships? Do you prefer partnerships, or would you rather own the assets outright?

I think for us, it's just a maximization and optimization process. And so I don't think we have a preference, one way or another. It's related to cost of capital, operational flexibility. And at the end of the day, what falls best to our bottom line.

Okay. And given the economic outlook that you suggested was attractive for these new builds, are there any customer commitments or duration of demand that you're looking for the data centers to commit to, to underwrite some of these new builds?

It's Rob. The answer to that is no. The new builds that we talked about are not set up for data centers or forward to meet that load. The conversations we are in early days with around colocation or use of our sites. Those will be a case-by-case basis as to whether or not it's a long-term deal or not, right, with a data center or other large load. But that's going to come as we evaluate each opportunity. But the things we've talked about thus far are for our book and our portfolio.

And just one last question in terms of retail margin on electricity. The movement in ERCOT forward prices, do you think that will have any impact on the margin that you'll ultimately be able to realize on that part of your business?

Well, we've proven the ability to maintain strong retail margins through various curves. And so we have a very sophisticated analytic engine that gives us insights into the price sensitivity of customers. And when you have sort of these orderly shifts in power prices, we're able to pass them on to consumers over time. So we feel good about our muscle there.

Thank you all very much for joining us. I think you can hear the palpable excitement that we all feel here at NRG for the potential, and we look forward to continuing to deliver great results and executing on that upside in the days, months and years ahead. Thank you all.