Be a Better Bargain Hunter Than Warren Buffett, posted September 12, 2008 (NRG)

By Michael Brush
Exclusively for InvestorIdeas.com
September 12, 2008

It’s not often that you get to buy a Warren Buffett stock for 30% less than what he paid. With his cash hoard of over $30 billion Buffett is known to wait patiently -- for years sometimes -- for the best prices. And he usually gets them.

However, a recent Buffett purchase and a cheap holding of his just got even cheaper – giving you a chance to out-bargain even Warren Buffett.

I’m talking about NRG Energy (NRG), an electric utility which serves Texas, as well as several states in the Northeast.

Buffett loaded up on this electric utility last quarter. His position of 3.2 million shares showed up for the first time in an obligatory August 14 filing that revealed his holdings for the second quarter.

The Oracle of Omaha purchased NRG somewhere between $42 and $44 a share, by the looks of the chart. NRG recently traded for $31, or about a 30% discount to what Buffett probably paid.

The stock is down because of general market weakness since then, and some fears about NRG’s sector. One fear is that utilities might get squeezed by the high cost of certain types of coal at a time when electricity demand may be going down because of an economic slowdown.

A trifecta of buy signals

NRG looks compelling because of a triple-buy signal from smart investors and insiders. Besides the Buffett buying, there are two other bullish signals.

• Insiders recently bought a huge amount of the stock. Senior managers on the front lines who know the business the best – from the vice president for strategy to the general counsel and the finance chief, among others – purchased $1.4 million worth of stock recently at prices ranging from $31.40 to $32.35.
• The company itself announced earlier this month it has been buying stock, too. On September 4 NRG said that since its July 29 conference call, it bought back $130 million worth of stock. Another $30 remains in its 2008 buyback program. The company has a habit of returning cash to shareholders – a feature that not doubt attracted Buffett to the stock. Since 2004, NRG has returned approximately $1.9 billion in equity to shareholders.

The basics

NRG Energy is a wholesale power generation company with one of the largest and most diversified power generation portfolios in the U.S. – mainly in Texas and around Texas and in the Northeast, but also in the West.

NRG came out of bankruptcy a few years back. It seems to want to buy another utility called Calpine (CPN) -- a move that some investors fear because acquisitions so often do not work out well.

Recent performance

On the surface, it looks like NRG had a bad second quarter. Net income fell to $129 million from $149 million a year ago. But this is misleading. Net income took a big hit because of paper losses of about $500 million that the company had to book on energy hedges. These hedges should ultimately pay off, because they should offset changes in what the company can get for energy.

A better measure of performance might be energy revenue growth. It was up 30% in the last quarter to $1.37 billion. Earnings before interest, taxes and accounting adjustments grew 30%, to $683 million.

One thing that helps NRG: It has generating plants in New York City, Los Angeles, Houston, southwest Connecticut and San Diego. Transmission constraints in these areas create more volatile prices. NRG can take advantage of this by selling more power to regional electricity providers when demand and prices are high.

While other power providers like Exelon (EXC) have recently guided down, NRG has guided up on earnings before interest, taxes and accounting adjustments three times in roughly the past year – most recently in July.

The stock price weakness

So why has the stock been weak?

One fear is that either of the two presidential candidates will push for a carbon tax – which could be bad for utilities. But given the high cost of electricity, any carbon tax law will probably include provisions the help utilities deal with energy costs. A carbon tax law might also include incentives for electric cars, which would help utilities.

Investors also worry about the impact of an economic slowdown on energy demand growth. NRG says it has hedges in place to deal with a slowdown in demand.

“We believe the company has basically hedged its way through the current recession, given that most recession in American history have not exceeded 15 to 24 months in length,” NRG chief David Crane said in the company’s most recent conference call.

Another problem is that investors are worried that an increase in the price of Appalachian coal threatens to compress profit margins. But unlike other utilities, NRG might not face a big challenge here since it uses coal mainly from the Powder River Basin further west. It’s a different kind of coal, and the price hasn’t made the same move.

Longer term, NRG is also taking steps to move away from fossil fuel.

It also has thermal generation capacity, and earlier this year a subsidiary of NRG entered a joint venture with a subsidiary of BP (BP) to develop wind power in Texas. Plus last year, NRG filed the first application for a nuclear plant in 29 years. It wants to expand its South Texas Project nuclear plant, in which it has a 44% stake.

Of course, nuclear power plants take years to develop, and the new NRG plants might not come on line for eight or nine years. But that’s just the kind of time line Buffett knows how to deal with.

The bottom line: The markets are getting more turbulent, so only a fool would try to predict where NRG will be in the short term. A lot of “smart money” is betting it goes higher in the long term, however, and it may be worth taking their side.

Disclaimer
At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. Mr. Brush is an independent columnist for this web site. For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner: http://www.investorideas.com/insiderscorner/. InvestorIdeas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.

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