While shares of NRG Energy (NRG -2.27%) bounced around a bit last year, the stock only managed to eke out a 0.4% gain. Meanwhile, given its meager dividend, the total return wasn't much better at 0.7%. The company significantly underperformed the S&P 500, which generated a 31.5% total return.
With the stock delivering such poor relative performance last year, investors might be wondering whether this energy company is now an attractive buy. Here's a look at the case for an against buying shares of NRG Energy these days.
The bull case for NRG Energy
NRG Energy has spent the past few years repositioning its business. It has sold several assets, which have helped shore up its balance sheet, giving it the financial flexibility to invest in growth. It finished up its transformation last year, which sets 2020 up as an inflection point for the company.
The electric and gas company expects to allocate about 50% of its free cash flow on expansion-related initiatives in the future while returning the other half to investors. It plans to significantly increase its dividend, from its previous annual rate of $0.12 per share to $1.20 per share this year, which will boost its yield from 0.3% to about 3.2%. It also expects to use some of its cash flow to repurchase shares. The company's capital allocation plan, which will grow earnings while at the same time reducing its outstanding share count, should enable it to increase its reset dividend by 7% to 9% per year after 2020.
The company's growth-focused investments should begin paying dividends this year. In its view, its earnings will increase by about 2.6% from the midpoint of its current forecast ranges, while free cash flow will grow by roughly 6%. Given that outlook, the company currently trades at around eight times both projections. That's a low value, especially since other companies operating in the power sector trade at more than 20 times earnings after their stocks surged last year.
The bear case for NRG Energy
Electric and gas companies have traditionally offered investors high dividend yields. That's because the typical utility pays out about 70% of its earnings each year on average. They use the 30% they retain, along with additional debt and stock sales, to finance growth. NRG Energy, on the other hand, is taking a much different approach. Instead of catering to income-focused investors, the company is aiming to generate higher total returns by retaining more cash to fund growth as well as returning money to investors through share repurchases instead of a bigger dividend. The concern is that the company's lower yield could turn off income-seeking investors, causing its stock to perpetually trade at a discounted price.
Another thing that differentiates NRG Energy from others in the sector is its focus on the retail electric and natural gas segment, which markets energy directly to consumers. The company recently bolstered this business by acquiring Steam Energy, which has more than 600,000 customers in nine states. Retail earnings, however, can be more volatile since demand can fluctuate with the weather and prices, and customers can easily switch to new service providers.
Verdict: Not compelling enough for income-seeking investors
NRG Energy isn't like most utilities. Instead of operating the poles, wires, and pipes that distribute electric and gas to consumers, it focuses on selling those commodities directly to retail customers. Therefore, its earnings could potentially be more volatile. Add that to a capital allocation program featuring a lower dividend payout, and the stock isn't overly appealing for income-focused investors who favor lower risk options.