On July 6, 2017, NRG Energy (NRG) stock was trading at an EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) multiple of 11.5x. It has a five-year historical EV-to-EBITDA ratio of ~11.0x. Utilities have an average valuation multiple near 10.0x.
Considering the historical average and industry average, NRG Energy stock seems to be trading at a fair premium.
The EV-to-EBITDA ratio indicates whether a stock is undervalued or overvalued—regardless of the company’s capital structure. Specifically, EV refers to the combination of a company’s debt and market capitalization less its cash holdings.
Where do peers stand?
It should be noted that many S&P 500 utility giants seem to be trading at a large premium. Southern Company (SO) and NextEra Energy (NEE)—the top utilities by market capitalization—are trading at EV-to-EBITDA ratios of 12x.
Regulated utilities present an attractive proposition
Compared to merchant power stocks, regulated utilities (XLU) appear to be more expensive. However, they seem to present a more attractive investment proposition going forward. Merchant power stocks can be relatively risky due to their volatile earnings, which ultimately lead to volatile stock movements.
On the other hand, regulated utilities (SO) (DUK) tend to have relatively stable earnings, which facilitates smoother stock price movements. Also, they pay healthy dividends as an additional stream of returns compared to merchant power stocks. Dynegy and Calpine don’t pay dividends, while NRG Energy pays trivial dividends.
Read NRG, DYN, CPN: How Are Merchant Power Stocks Positioned? to compare merchant power stocks from an investment perspective.