Dynegy Inc.DYN

Morningstar Rating

Stock Research and Analysis

by Mark Barnett

The merchant generation sector has been on a wild ride during the past decade. Although the fundamental outlook for the industry had been improving in the past few years, Dynegy overextended itself at precisely the wrong time, as the overall economic outlook has soured dramatically. Read more

Bulls Say

With natural gas frequently setting the marginal price of power in Dynegy's key markets, its low-cost coal plants should be able to capture healthy profit margins.

The difficulty of siting new plants, especially base load coal, suggests that supply will have difficulty keeping up when demand rises. This should boost power prices.

In a carbon-constrained market, Dynegy's sizable fleet of low-emission natural gas plants should increase in value.

The transaction with LS Power for nine of Dynegy's power plants would help to shore up the balance sheet and eliminate LS Power's special voting rights. Read more

Bears Say

Dynegy's results are largely a product of highly volatile and unpredictable factors; power prices, commodity prices, and weather are nearly impossible to accurately anticipate.

Carbon legislation in almost any form would significantly lower the value of Dynegy's coal plants, which produce the majority of the company's income. Some plants could be closed.

In such a cyclical industry, management missteps such as poor hedging and plant overbuild can have a long-lasting negative impact on a company's fortunes.

Dynegy's coal plants require major investment in environmental controls that will produce no returns for shareholders.

Maintaining compliance with covenants will be a challenge if power markets remain weak. Read more

Strategy

Dynegy plans to remain a low-cost generator in the Midwest by burning cheaper Powder River Basin coal rather than better-burning but costlier Eastern coal. The company has contracted coal supply and transportation agreements for the next few years. Read more

Management

We have some reservations about Dynegy's management. In particular, we are concerned that Dynegy may be too aggressive in its growth strategy without paying adequate attention to returns on investment. However, we believe management's decision at year-end 2008 to reconsider plans for new coal plant construction was wise, given the difficulty of financing and the low likelihood of new coal construction anywhere in the United States, especially with aggressive new environmental regulation on the table. Read more

Profile

Dynegy generates and sells electricity into unregulated power markets across the United States. The company owns or has interests in just under 18,000 megawatts of capacity, including base load, intermediate, and peaking resources. Read more

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