Some companies talk about shifting their business model, but it's often harder said than done. NRG Energy (NYSE:NRG) has talked for years about investing in renewable energy, and now we're starting to see some of the fruits of that labor.
Strategic acquisitions have played a key role in the company's transformation into a renewable energy company with NRG Yield (NYSE:NYLD) Now NRG Eenrgy can now push renewable assets down to a subsidiary with a lower cost of capital, fueling future growth.
Buying into the solar business
NRG Energy spent most of the last five years buying up major solar projects, among many other smaller projects. It bought SunPower's (NASDAQ:SPWR) 250-megawatt California Valley Solar Ranch, along with the 392 MW Ivanpah solar thermal plant, and co-owns First Solar's (NASDAQ:FSLR) 290 MW Agua Caliente Solar Project in Arizona with MidAmerican Energy.
Recently the company has become a solar developer, highlighted by the acquisition of Roof Diagnostics Solar, a builder of rooftop solar systems. This puts NRG Energy in direct competition with SolarCity (NASDAQ:SCTY) and SunPower in the residential market and is one of the first cases of a utility buying a solar installer. The impact on the industry shouldn't be understated.
The resulting impact is an increasingly green portfolio that is quickly developing at NRG Energy. In the fourth quarter of 2013, 6% of its production was from renewable energy, and production capacity more than doubled throughout the year from 340 MW to 800 MW. This year, the company passed 1,200 MW before the end of the first quarter.
The impact of regulation on utilities
NRG Energy is one of the best examples of what happens to a utility when it isn't protected by a monopoly. NRG's main business was selling power to other utilities; when that business came under fire from low-cost natural gas, renewable energy, and lower consumption, margins fell and NRG Energy had to find a way to grow. Renewable energy was the natural answer, and the company has been finding new ways to profit from wind and solar.
That hasn't been the case for many other utilities around the country. Pinnacle West's (NYSE:PNW) Arizona Public Service has been one of the most vocal renewable energy detractors, claiming that rooftop solar will raise the cost of electricity for everyone else. Duke Energy, Hawaiian Electric, Rocky Mountain Power, and many other utilities are also fighting solar because it upsets the status quo in energy.
What makes NRG Energy interesting as an investment is that it's embracing new energy and finding ways to profit from it, rather than fighting the change.
NRG's renewable energy plans are far from over. It will push more assets down to NRG Yield in the future and its growth plans include micro grid and energy storage. The first example of these plans will be on Richard Branson's Necker Island, which recently hired NRG Energy to build a renewable energy-driven micro grid for the island.
Should you buy now?
NRG Energy has been up and down in recent years, but in 2013 cash flow before growth initiatives was an impressive $1.28 billion. Guidance for 2014 puts the same cash flow measure at somewhere between $950 million and $1.15 billion, but keep in mind that NRG still has $16.8 billion in long-term debt.
The better option may be NRG Yield, which is matching renewable energy assets with cash-generating traditional energy assets. As those renewable assets generate income, more new renewable generation will be pushed down to the company to take advantage of tax equity financing rules. The result is a growing company and a nice 3.4% yield that should increase consistently over time.
Renewable energy projects are normally backed with guaranteed cash flows for 20 years, unlike power plants selling into the spot market, so it's an attractive investment financially. That's where my money would be in NRG's newly transformed business.
Travis Hoium manages an account that owns shares of NRG YIELD INC and SunPower. He personally owns shares of SunPower and has the following options: long January 2015 $5 calls on SunPower, long January 2015 $7 calls on SunPower, long January 2015 $15 calls on SunPower, long January 2015 $25 calls on SunPower, and long January 2015 $40 calls on SunPower. The Motley Fool recommends SolarCity. The Motley Fool owns shares of SolarCity. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.