Constellation Energy Group, Inc. (NYSE:CEG)

valuevulture999 (96.43) Submitted: 8/5/2010 11:08:39 PM : Start Price: $29.05 CEG Score: +9.95

"Mirror mirror on the wall who is the fairest of them all? Oh vulturevestor, for Constellation Energy is the fairest of them all..." CEG? Why do I want to own a utility company for? Especially one that nearly imploded 2 years ago. Well my dear readers, come with me and I will show you the deal of the week!

The Back Story

CEG is the 3 largest integrated power generation utility in the country. The industry leader is Excelon which happens to be my favorite company in this industry. They have the best cost profile and best safety record that all other players are judged. unfortunately Excelon is not cheap nor a value play. But CEG however is an interesting opportunity. Since I am a value investor, I'm not interested in Snow White. I am only interested in the cleaning girl who can turn into Cinderella. CEG's power is generated mainly from gas and coal which accounts for 58.8% of their generating capacity followed by nuclear at 30%, Hydro electric at 3.3% and the remainder from the renewable sources. Their business is broken into 3 main segments: Merchant energy (crown jewels), Regulated Electric and Regulated Gas. The most important part of their business is their Merchant energy group which contains all their generation assets which sells their power at spot prices. This group also includes customer supply which is service and transmission. The regulated Electric and gas belong to Baltimore Gas and Electric.

What happened to them?

Well back in 2007-2008 we were in the brink of a complete economic meltdown with a definite threat of a second depression. CEG got caught on the wrong side of their own commoditites trading. It was a perfect storm of a crashing real estate market (future energy demand), falling energy prices, uncontrolled derivastive risks. All 3 factors nearly killed them. If they declared bankruptcy they would have been the largest national utility failure since ENron. Warren buffest always said that derivatives were financial weapons of mass destruction. Unfortunately CEG didn't mind their business enough and paid a dear price. Their stock fell to the pojnt where ot attracted the attention of David Sokol of Midamerican Energy (owned by buffet). They absolutely loved their seets and mad an agreement to buyout all of CEG. That was until Electricite de France(EDF) came along and over bid buffet by 30% for only 49.99% interest of the Nuclear assets only. If you look at EDF's latest earnings report, it looks like CEG got the better part of the deal.

Why should you care?

If there is one type of business I absolutely love it's infrastructure; especially one you must buy to power what you would call civilization. The nice thing about this business is the high barrier to entry. You can't start a nuke plant overnight. Ever since the French cash infusion they have made important progress in reducing debt and thereby increasing their liquidity by 91%. They have continued to shed noncore assets in 2010 by selling their geothermal assets as well as their Mammoth Lakes Geothermal assets. They are raising cash to break ground on a new nuclear facility , but theyneed a loan approval from the DOE to make it happen. Southern companies has already been approved on their application. Ever since Obama became president the entire enegy industry has been waiting for the beginning of a new nuclear renaissance. Since cap & trade and the carbon tax are politically dead this year people are still waiting. CEg is currently selling at 30% discount to book value and 55% discount to annual sales. The ebita ratio is 5.13. The utilities as a group has not participated in the rally. The shares are worth at least $44.68 just on book value. IT'S WORTH $63 ON SALES. They are just unloved. but this stock is a screaming buy!!!

What I would like to see

I think there things mgmt can do to increase shareholder value. One is to sell or eliminate noncore businesses in their customer supply segment of their Merchant Energy group. Another is to spin off Baltimor Gas & electric as a separate entity since it only contributes less than 24% of revenue but consumes 23% of the expenses. This can be either be issued as an IPO, sold to a private investor or structured as an MLP. They could use this cash and acquire nuclear generating assets fromother companies such as NRG which didnt have a good quarter. CEG needs to build scale in nukes if they want to play with ther big biys. Carbon tax will come but it's just a matter of when. By doing this they can become a pure play Merchant energy company. They can either grow or be acquired by someone else. Regardless of outcome the shareholders win. The stock currently pays a 3% dividen which is not too bad given where treasury rates are right now.

Things to watch out for:

Like many other investments there are risks to this. Watch out for low energy prices, high interest rates, worsening economy, strict environmental regulation. Remember that 58% of their power comes from the dirty fossil fuels. All of these will negative affect this company.

Happy Hunting folks!