Citigroup is making a very negative call on Mirant (NYSE:MIR), downgrading the shares to Sell with $13 target:
California Retirements Are A Negative — The recently announced retirements of Potrero and Contra Costa and likely retirement of Pittsburg units 5 & 6 will result in either lower EBITDA (Potrero) or cash outflows to replace the plants (Contra Costa – Pittsburg). We have reduced our 2011E EBITDA estimate by $(15) million to reflect the retirement of Potrero, and we subtract $(365) million of NPV from our valuation due to high likelihood that Contra Costa and Pittsburg (both use once-through cooling) will eventually need to be replaced.
Reducing Target Price To $13.00 — In our view, Mirant trades too high on Open EBITDA valuation multiple relative to its peer group. This high valuation is apparent in our EBITDA estimates – as Mirant’s hedges roll off by 2011, its Adjusted EBITDA declines year after year. In addition, Mirant burns primarily CAPP coal – a fuel type that has a high degree of $/MWH correlation with natural gas prices. This limits Mirant’s ultimate sensitivity to natural gas, in our view, and accordingly limits its valuation multiple as well.
Downgrading To Sell — The bull case on Mirant is 1) cyclical trough exposure to the Merchant sector, 2) a solid balance sheet versus competitors, and 3) its high EBITDA sensitivity to gas. But we believe: 1) the stock is currently trading expensively on EV/Open EBITDA and implied gas, while consensus seems too optimistic on 2011 EBITDA, 2) its CAPP coal reliance means its natural gas sensitivity is less than its peers' on a $/MWH basis, 3) the recent California power plant retirements seem to have been ignored by the market, and 4) its adjusted EBITDA value significantly declines into 2011. Given these factors and our new target price of $13.00, we are downgrading MIR to 3H.
Action: Well-founded out of consensus call, just the way I like. I expect MIR to be under pressure today, falling below the $17 level as investors are forced to take a second look on their expectations.