With the US economy looking more and more like it is headed for a recession, investors will likely take positions in more defensive sectors such as consumer staples, health care, and utilities. In my opinion, this makes stocks like Mirant Corp. (NYSE: MIR) look attractive at current valuations.
Overview
In a nutshell, the company sells electric power, capacity, and services to a variety of customers in the Mid-Atlantic, Northeast, and California. A quick scan of company history reveals a checkered past, as the company entered bankruptcy in 2003. However, after further review, it appears that a solid management team was put in place in 2005, including Yale Law alumnus Edward Muller (who was brought over from Edison Mission Energy).
Opportunity
Based on research by the US Energy Information Association, demand for electricity will continue to grow in 2008 and 2009. Further, the core operations of the company are situated right smack in the middle of key regions which have problems meeting the growing demand for power (such as the Mid-Atlantic). This has been a key driver of EBITDA, which increased a whopping 51% in Q3 ‘07 vs. Q3 ‘06! I also like that the company is making strategic divestitures and returning proceeds to shareholders through buybacks.
Metrics
I like what I see from a metrics perspective. The stock’s trailing twelve month (TTM) P/E of 7.3 is well below the utility industry P/E of 18.7. More importantly, TTM Price / Free Cash Flow is an attractive 10x vs. the industry average of over 40x. TTM margins are above average across the board (e.g., EBITDA margin = 31%). Debt / Equity is a conservative 0.48, and Return on Equity (one of my favorite data points) is a solid 29% vs. the industry benchmark of around 15%.
Risk
Power generators are often at the mercy of commodity prices such as oil and natural gas. These prices will likely remain high for some time. In addition, while necessary and extremely important, costs of environmental compliance can impact bottom lines as well.
Summary
With a near team recession possible and energy demand continuing to grow, MIR looks like a reasonable buy at its current valuation. We’ll keep a close eye on this stock moving forward.