Constellation Energy Corporation (CEG) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Constellation Energy's Business Update Conference Call. [Operator Instructions] As a reminder, this call may be recorded. I would now like to introduce your host for today's call, Emily Duncan, Senior Vice President, Investor Relations and Strategic Initiatives. You may begin.

Thank you, Lisa. Good morning, everyone, and thank you for joining Constellation Energy Corporation's conference call on short notice this morning. We're excited to discuss our announcement that we're acquiring 44% of the South Texas Project power plant. Leading the call today are Joe Dominguez, Constellation's President and Chief Executive Officer; and Dan Eggers, Constellation's Chief Financial Officer. They are joined by other members of Constellation's senior management team who will be available to answer your questions following our prepared remarks. We issued a press release this morning, along with the presentation all of which can be found in the Investor Relations section of Constellation's website. The release and other matters, which we discussed today -- during today's call contain forward-looking statements and estimates regarding Constellation -- its subsidiaries and the South Texas Project that are subject to various risks and uncertainties. Actual results could differ from our forward-looking statements based on factors and assumptions discussed in today's material and comments made during the call. Please refer to today's 8-K and Constellation's other SEC filings for discussions of risk factors and other circumstances and considerations that may cause results to differ from management's projections, forecasts and expectations. Today's presentation also includes references to adjusted EBITDA and other non-GAAP measures. Please refer to the safe harbor statements on Page 2 of the presentation for additional information. I'll now turn it over to the CEO of Constellation, Joe Dominguez.

Thanks, Emily, and good morning, everyone. Thanks again for getting on, on short notice. Today, we're very excited to announce that we're acquiring NRG's stake, an excellent asset, the dual unit South Texas Project outside of Houston. We are acquiring it at a very attractive price. We've been very clear since separation that we take a disciplined look at M&A opportunities. And we factor in -- the quality of the asset, the age of the asset, how well the asset has been maintained and the security of its fuel supply. And if you've listened to our calls since we started this business, you know that we have a type. We have a very strong preference for newer dual unit sites, STP meets each of those criteria and will deliver immediate value to our owners as it's integrated into our fleet. For those of you unfamiliar with the project, we've laid a little bit of this out on Page 3. STP is the third largest nuclear plant in the country, and one of the best operating assets in the country. It produces about 21 terawatt hours of reliable, affordable, carbon-free electricity. Upon completion of the transaction, we'll own 44% of the plant or approximately 1,164 megawatts. STPNOC will continue to operate the plan. We look forward to working with our co-owners, CPS Energy and Austin Energy and to sharing our experience to continue to create even more value for our shareholders. Turning to Slide 4. STP increases our clean carbon-free generation by approximately 9.5 terawatt hours, enhancing our leadership position. And it puts us closer to our 100% clean generation by 2040 climate goal. Like our fleet, STP is best-in-class in operations. It's identical to our Byron and Braidwood stations, so we understand the machines inside and out. During our site visits, we were able to verify that the plant is very well maintained. It has no exposure to nuclear fuel risk with supply lined up through 2028. It's also one of the newest nuclear plants in the United States. To put this in context, the only plant in our fleet that is younger than STP is our Limerick station. And with continued policy support, the units will run well past mid-century for at least an additional 46 years, approximately twice as long as new renewable energy installed today. The nuclear PTC provides economic stability to the plant while allowing it to participate in market upside, just as it does for the rest of our fleet. And as you all know, load is growing in Texas at an aggressive rate. And the plant will support our existing retail business in the state and allow us to expand. Simply put, this is exactly the kind of asset we were contemplating when we set out our grow -- set out to grow our nuclear portfolio. It adds value immediately and it gives us geographic diversification in a growing market. The bottom line here is we couldn't be happier to add the asset and to have the opportunity to work with our new partners. I'll now turn it over to Dan to walk through some of the financial details.

Thank you, Joe, and good morning, everyone. STP has a great plan. We're excited to acquire NRG's 44% share at an attractive effective purchase price of $1.4 billion. The acquisition will provide immediate value to our shareholders in the first full year after closing. We expect the plant to contribute approximately $190 million of EBITDA on average over the next 3 years, but it will vary due to the refueling schedule of the plant. One of the reasons we prefer dual unit sites is their ability to produce strong cash flows. STP is one of the largest dual unit sites and is run very well. We expect to see EBITDA to free cash conversion rate of 60% to 70% on average. The structure of the transaction is unique and creates substantial tax benefits for Constellation and NRG since it is an all-cash deal for an asset. We'll be able to immediately deduct a large portion of the purchase price because of the bonus depreciation rules. After considering the net present value of this deduction of more than $300 million, we are effectively paying approximately $1.4 billion for the assets. This transaction is credit neutral and has no impact on our strong investment-grade credit ratings. The recurring free cash flows from STP provide additional room in our balance sheet, therefore, we're able to support an incremental $500 million in long-term debt. The remainder of the purchase price will be funded using approximately $1.25 billion of cash and planned debt issuances. And since we will receive more than $300 million in tax benefits, we are only using approximately $900 million of our $2 billion of unallocated cash for 2023 and 2024. The transaction requires approval from the Nuclear Regulatory Commission and the Department of Justice. Given the NRC's familiarity with our company and the lack of any market power concerns, we expect to receive all regulatory approvals this year. We'll be filing applications for approval in the next few weeks and expect to close the transaction in the fourth quarter of this year. Turning to Slide 8. We only plan to update this waterfall annually. But given the size of this deal, we thought it'd be useful to refresh. The acquisition of STP fits firmly into our capital allocation and growth priorities. We remain committed to our authorized plan to repurchase $1 billion of shares. And as you can see on the chart, we have completed $400 million of share repurchases so far. After funding the transaction, we set of approximately $1.2 billion of unallocated cash flow for 2023 and 2024 that can be used for additional growth or return to shareholders. This attractive transaction will provide immediate value to our shareholders upon closing while providing continued optionality for additional growth opportunities and life extension. We are very excited about growing our carbon-free clean energy footprint and being a co-owner in one of the best plants in the country. Thank you all for your time today, and I'll turn the call back to Joe.

Thanks, Dan. Only part of STP enhances the unique value that Constellation provides to its owners. We own nearly 25% of the U.S. nuclear fleet producing the most carbon-free energy in the country, nearly twice as much carbon-free energy as the next generator. And its dispatchable firm clean energy, the most important electric resource in the world today. These plants can run at least 80 years, a useful life that's longer than any other carbon-free generation resource that exists. We're the best operator of nuclear plants in the country. and we look forward to sharing best practices with our new partners. We provide power nearly 1/4 of all competitive C&I customers in the U.S. including 3/4 of the Fortune 100. This puts us in the best position to meet the growing man for customer-driven carbon-free energy and sendable products, particularly as many of our customers grow in Texas. Our balance sheet strength is an advantage over others in the market. We have unique opportunities to create additional value for our shareholders, the increasing value of the PTC over time through the inflation adjustment that's embedded in the law. Our strong free cash flow allows us to fund a growing dividend, robust organic growth where we find compelling double-digit unlevered returns, M&A like this one. And when we cannot find those opportunities, we're going to return capital to you. Lisa, I'll now turn it over to you for questions.

[Operator Instructions] Our first question today will be coming from David Arcaro from Morgan Stanley.

Maybe first question, could you speak to your thoughts on potential synergies, maybe first of any synergies in the EBITDA number that you laid out here? And I know that you're a minority interest partner here, but are there opportunities to influence and potentially introduce some synergy opportunities going forward?

There are no synergy opportunities in our numbers. STPNOC is going to continue to operate the asset. But we do expect to be able to share through -- with our owners, some of the best practices. So for example, we run Byron and Braidwood exactly the same technology. We get in and out of outages pretty much every outage at around 21 days. The outage time for this asset right now is 31 days. I think we could share learnings there to kind of close that gap. But right now, there are no synergies in that number. Those are -- nor is there anything in the number for reducing the outage time. These are just opportunities ahead of us.

Okay. Got it. And curious how you're thinking about future potential growth opportunities specific to this asset, are there upgrades that could be pursued in the future hydrogen opportunities. Wondering if there's a future growth from there?

We're thinking through that stuff, but nothing concrete at this time. At this point, we're just -- we're looking forward to completing the transaction and getting in there, working with our owners and exploring opportunities.

And our next question will be coming from Steven Fleishman.

So I have a couple of questions. So first, the -- there's a difference -- it seems like you're saying these assets produce $190 million of EBITDA, NRG's multiple implies are $150 million of EBITDA. I know maybe you can't really comment on theirs, but could you just give us more flavor how you're coming to your $190 million of EBITDA?

Steve, we're basically doing a PxQ based on where the market is less the STPNOC operating costs that will be allocated as a co-owner.

Okay. And so that's just around the clock pricing and...

That's right.

No retail premiums, no other stuff?

There's -- there are no synergies in our number. There are no retail premiums in our number. There is no value associated with behind-the-meter opportunities there or anything else or improvements in outage time things I referenced before.

Okay. And I assume it's kind of hard for you to try to explain that difference.

Yes. No, I don't know. So for example, we used historic capacity factors. If you change the capacity factor expectation, you might arrive at a different number. But look, I think that's better for them to explain. This is what we know based on our diligence.

Okay. Okay. And then just to clarify on the buyback potential. So per your slide, you've done $400 million. You have $600 million left on the current authorization. And then despite paying $1.5 billion for this, you're still saying there's $1 billion to $1.4 billion unallocated?

That's right.

Okay. And then that difference is basically because you have more -- because you have more EBITDA, there should be more kind of financial capacity. Is that explaining that?

Let me ask Dan to walk through it.

Yes, Steve, if you think about the $175 million, right, there's going to be north of $300 million of cash tax benefit coming back to us from bonus depreciation. So take that $175 million down to a little over $1.4 billion effectively right. We have $500 million of debt capacity created by the acquisition of the asset based on keeping our metrics where they are, we then fund the rest with cash available because there is a modest or there is a pickup in cash generation from STP also going into available cash. You come out to that $1 billion to $1.4 billion available. The only thing I'd point out is, obviously, we kind of updated where we were on the first quarter call for 2023 and 2024. We did not -- we're not changing that base free cash flow forecast from our year-end call. So any uplift from better performance that we're seeing is not captured in there yet either.

Okay. And then just in terms of thinking about the ownership structure and such, so -- could you maybe just go through that structure and how decisions are made? And kind of how you might be able to impact in some ways, kind of operations and such from the standpoint of not having majority control?

Yes. So Steve, the way the ownership structure, and we obviously looked at how this ownership structure has worked historically. It's worked very well. The owners need to have over 60% approval to approve budget and other things. So you need the owners to work together. And historically, they've done exactly, and they've worked together very well. What we'll be able to do is share some of our ideas through our ownership group and inform the operator of those ideas. And these are things that will make money for everybody and enhance the value of the asset. So that's how we intend to work with our co-owners and kind of influence operations.

And our next question will be coming from Shar Pourreza of Guggenheim.

James for Shar. Just -- much of our questions have been answered already, but I guess building on the last question. Do you see any opportunity, I guess, to buy any of the raining stakes in STP down the road?

James, today, we're just -- we're talking about this. I think everybody knows we're interested in continuing to acquire the right kind of asset and so that will apply universally really. But today, we're really focused on this transaction and we like the price and offer a lot. We love the opportunity and the asset, a great deal. So I'll just leave it there.

Yes. Okay. And then does the new length, I guess, change your current views on the ERCOT fossil assets at all?

No, not really. As I look at what's going on in ERCOT. The focus there is really on dispatchable energy, and we've seen kind of historically some of the challenges that they've had. This asset not only meets that criteria for dispatchable energy, but in addition to that, it's clean. So it's a really unique asset in that market. It's one of the first markets I think that is focusing very hard on dispatchability and load following capabilities of assets. And obviously, this is a perfect example of an asset that does exactly that and does it with clean megawatts. The other assets we have in Texas, we have a couple of the newest combined cycles in the market down there. Also set the criteria of being dispatchable and very reliable units. We like those a lot. We're not rethinking those.

And our next question will be coming from Paul Zimbardo of Bank of America.

Just to follow up briefly on Steve's question on the adjusted EBITDA you're disclosing on the PxQs. Is that based on the forward curves? Or is that based on a PTC level?

We were using, Paul, the forwards that we saw during the quarter when we were working through the deal, the PTC value, I think, is probably going to catch in '24 from what we had and then '25 and '26 a little bit above the PTC threshold depending on your inflation assumption.

Paul, the asset trades in the market right now, right around the floor value of the PTC. So it's a little above or a little below, depending on the year you select. There's not much room between those things.

Yes. Okay. No, that's exactly what I saw looking at the screen as well. And then on the tax benefits, I know you described it as NPV. What's the timing on realizing those? Is it more upfront or longer term?

Yes. Most of it, Paul, will come in 2024. Our expectations, some will drift into '25 just on how quickly we can consume the credit and some minimum payments we've got to make, but the bulk of that comes back real fast.

Okay. Excellent. And then just sneak last one on quick. I know you described as a world-class operator. Is it fair to assume it's kind of comparable to the overall Constellation cost structure? Just you describe more quartile the plant that would be helpful.

I don't have the quartile information. The difference, of course, Paul, it's run at world-class levels. Obviously, the back office that we have is covered by a lot more megawatts. So the cost structure is going to be very different for STPNOC, right? They have to allocate 100% of the back office cost to this asset, whereas we spread it across 23 units. So there's going to be some major differences between those things.

And our next question will be coming from Durgesh Chopra of Evercore.

Congrats on this deal. Just in terms of -- you've targeted sort of teen returns on allocated capital. So just monkey math here, $190 million divided sort of $1.4 billion gets like a 14% return. So this is kind of in line with your targeted level of returns. Am I thinking about it the right way?

Yes. But I think you are thinking about it the right way. But it's not just the temporal numbers. It's the long life of this asset, and how well it's maintained. All of those things play into our determination of the return level here. The fact that this is such a young asset and could operate for so long, obviously is going to drive the NPV value of the transaction and the expected return.

Understood. That's helpful color. And then just in terms of how this is going to be reported in your books, is there debt on these assets that you'll incorporate? I'm just thinking about the enterprise value of the transaction.

No. The purchase price, we talked about the $175 million is the full number and then the $1.4 billion after the bonus depreciation. So you should be thinking about that as the fully encumbered price that we'll be paying.

Got it. Okay. And then one last one real quick. So obviously, there is a Bloomberg article and Joe, you had an interview where you talked about the hydrogen project and that's on hold. And now you announced this transaction. Could you -- I mean, I guess, the way at least -- I was thinking about it is now here you have a certainty in getting your investment returned. And there in hydrogen, you're waiting for clarity from treasury. The question really I am asking is, could you still pursue the hydrogen project or now that you've allocated roughly $1.5 billion here that's in the back burner?

No. No. The allocation to the hydrogen project is in our analysis that's reflected here today. So that's -- it's on the back burner until we hear where Treasury is. We expect treasury to support the implementation of the hydrogen work that we've kind of laid out here. But to me, they're kind of disconnected. They're both excellent opportunities -- in both opportunities that we said we would pursue simultaneously since the beginning of this business.

Durgesh, if you look at our waterfall in the deck, we have that growth CapEx bucket in there. That's still what we showed you at year-end, which would have the spend for the '23-'24 period for hydrogen still in that number.

Got it. That's very clear, guys. So those are 2 separate opportunities. I appreciate the time.

And our next question will be coming from Angie of Seaport.

So first, does this unit actually -- both of the unit qualify for PCM benefits. So are these considered dispatchable resources?

Yes.

Okay. That's easy. Number two is, have you had any discussions with either DPS or often about an acquisition of the remaining stake? I understand you talked about the ownership agreement and et cetera, but any willingness from these 2 parties to sell at this point?

Angie, I think today, we're just really focused on this transaction, and aren't going to comment beyond that.

Okay. And then just again, even just using the 190 number that you're indicating, I mean, the implied cost of operations of the [indiscernible] seems to be slightly higher than that of your portfolio. So -- again, assuming that there's no change in the operator, I mean, isn't there a way to extract additional synergies? And again, I do know that you mentioned about the shortening of the outages, the refueling outages, which on its own should improve the economics. But anything else?

This unit in terms of its operating costs are -- is an exceptional value. I mentioned a bit earlier that when you look at our fleet, one of the things that makes it unique is, of course, its size and the fact that we can get engineering staff and the back-office staff of folks that need to support the plant and we're able to spread that like peanut butter across a lot of different units. So it's hard to compare a single site operator to a multisite operator. Again, that's one of the unique advantages we have. But right now, we don't have any synergies in these numbers. We don't have any improvements in operations or costs. And I think I need to leave it at that for now. We'll talk to our owners and explore opportunities to improve both the cost structure and the operations of the assets. And I'm confident that those discussions will lead to improvements.

And our next question will be coming from -- of KBCM.

Congrats on the deal. A couple of questions here. First, I was wondering if there was an opportunity for you guys to become an operator at some point down the line here?

Detecting a theme this morning. We -- at this point, really, we just want to talk about this transaction and not really get into hypotheticals about what might happen next week. We think there are opportunities down the road, but we have to have those conversations with our co-owners, and it would be wrong for me to kind of speculate on those things until those conversations take place.

Got it. And is the operator wasn't earning any additional fees or any incremental stake in the economics for being the operator?

No.

No. Okay. And then my other question was the -- I guess I'm not familiar with the history of this asset as well. How was it doing IRA pre PTCs in like in a purely merchant environment? Was it ever sort of impacted negatively by lower power prices in Texas and the volatility there to a point where the economics of it could be called into question or was it only gonna be profitable?

As far as I'm aware, it's always been a plant that was anticipating operating through its license life. Others might have better information on that. But it's always had this very low cost structure, and that's why the cash conversion is so attractive in this deal because of its low cost structure. And it was able to endure as a result of that low merchant prices before the policy change.

You are right. Our team has been through that plant like we go through anything in the deal diligence process, and they were very comfortable with the material condition of the plant, how it's been operated and maintained, which is important to us when we look at any acquisition.

Thank you. And that does conclude today's Q&A session. I would like to turn the call back over to Joe Dominguez for closing remarks. Please go ahead.

Well, first of all, Lisa, thanks to you for handling the call for us this morning. Folks, this is exactly what we've been hunting for since we began this business. We're really excited today. We think there are future opportunities as well, and we look forward to updating you as those opportunities mature. But thanks again for joining on short notice. And Lisa, with that, I'll close the call.

Thank you, and thank everyone for joining today. You all may disconnect and enjoy the rest of your day.