Constellation Energy: A Key Player In Clean Energy Generation (NASDAQ:CEG)

Investment Thesis

Constellation Energy Corporation (NASDAQ:CEG) is a distinct player in the electric generation and retail/wholesale energy supply market, primarily due to its substantial carbon-free baseload electricity generation from nuclear power plants. The company stands to benefit significantly from the Inflation Reduction Act, particularly the new nuclear production tax credits, which offer substantial support for more than 85% of its annual electricity generation. I believe that the current market valuation of Constellation’s shares does not adequately reflect the potential benefits from nuclear production tax credits and any potential shifts in decarbonization policies, considering its environmentally friendly energy profile. I am positive about the company and assign a buy rating to the stock.

Constellation A Big IRA Beneficiary

Constellation, a significant independent power producer heavily reliant on nuclear energy for more than 85% of its annual generation, stands to benefit from the Inflation Reduction Act’s new nuclear-production tax credit, which offers up to $15 per MWh from 2024 to 2032. However, the actual profit increase might be lower than anticipated because some of its nuclear reactors already receive state subsidies, rendering them ineligible for additional PTCs until those subsidies expire.

Constellation’s strong performance compared to the S&P 500 Utilities Index underscores the value of nuclear power as a dependable, carbon-free electricity source. The Inflation Reduction Act, effectively set a floor price for gross-receipt prices at $40 to $43.75 per MWh, while allowing for potential upside pricing. As the largest merchant-nuclear owner, Constellation stands to gain significantly from the PTC, as it will provide revenue certainty for more than 85% of its annual generation once state subsidies expire. Excluding the recently acquired STP plant, Constellation estimates a combined PTC of $150 million for Calvert Cliffs, LaSalle, Limerick, and Peach Bottom in 2024, based on market power prices as of the end of September.

While tax credits for regulated renewables and nuclear generation lead to lower rates for customers, they also benefit electric utilities. Regulatory delays, which can extend for months or even years, allow utilities to retain the proceeds from monetizing the credits until their rate cases are approved, temporarily bolstering their cash flow. In contrast, independent power producers like Constellation and Vistra retain 100% of these earnings and cash-flow benefits because they exclusively own nonregulated facilities. Some utilities, including NextEra, own nonregulated renewables through subsidiaries, enabling them to keep the tax benefits from those assets.

Financial Outlook & Valuation

I believe Constellation may return $1 billion of unallocated capital to shareholders through stock repurchases by the end of 2024, given a small pool of merchant nuclear M&A targets and the uncertainty of its planned $900 million investment in a pink-hydrogen (powered by nuclear) facility. The company has the strongest balance sheet among US independent power producers. The company’s 2022 leverage of 1.8x was well below that of Vistra, NRG, and AES. Constellation’s low leverage gives it significant flexibility to fund renewables and hydrogen investments without stressing liquidity. Still, a more aggressively shareholder-friendly capital allocation policy or funding for its STP acquisition could drive leverage significantly higher.

Constellation’s unique portfolio of assets, with nuclear accounting for over 85% of its annual generation, underpins its valuation premiums to large-capitalization, independent-power-producer peers — a 2024 EV/EBITDA multiple of about 10.5x, vs. approximately 6,5x for Vistra and 7x for NRG. Shares of Constellation trade more in line with clean-energy developer AES, as Constellation’s nuclear is supported by either state or federal financial aid, providing earnings visibility akin to those of long-term contracts. The Inflation Reduction Act’s production tax credits (2024-32) effectively set a 2024 nuclear-power price floor of $40-$43.75 a megawatt-hour. About two-thirds of Constellation’s nuclear generation receives state zero-emission or carbon-mitigation credits. PTCs will kick in for them after state programs expire in 2025-29. I believe that the shares do not reflect the potential for nuclear production tax credits, a shift in decarbonization policy, or a carbon-free profile. Hence, I assign a buy rating to the stock.

Investment Risks

I believe that the merchant generation business faces limited or no natural growth opportunities because companies operating in this sector essentially accept prevailing prices in a market characterized by commodity-like dynamics. Historically, merchant power generators have attempted to expand by either constructing new power plants or engaging in acquisitions. Constellation has expressed its willingness to explore the possibility of developing new carbon-free power generation facilities or acquiring such facilities from external parties. Moreover, despite Constellation’s strong recent operational performance, the company’s extensive portfolio of nuclear power plants could potentially expose it to certain risks. These risks include scrutiny and criticism from the Nuclear Regulatory Commission, substantial expenditures for repair or remediation efforts, and in an extreme scenario, a nuclear incident. It is important to note that there hasn’t been a significant nuclear incident at a US nuclear facility since the Three Mile Island incident in the late 1970s. Nevertheless, a nuclear accident could have a substantial impact on the market value of Constellation’s shares.

Conclusion

CEG is uniquely positioned to capitalize on the long-term trend toward decarbonization. I consider nuclear to be an important part of the future power generation mix, as the countries trends toward net zero carbon by 2050. I am also encouraged by growing policy support, as evidenced by the federal PTC along with subsidy regimes in several states. I believe the current multiple does not fully reflect the potential for nuclear production tax credits and any shift in decarbonization policy and the carbon-free profile. I am optimistic about the company’s positioning and assign a buy rating to the stock.