1 week Ago
Constellation Energy Corporation ( NASDAQ: CEG ) is well known for its nuclear energy production, which it sells to grids like PJM and directly to co-located data centers. Both routes have been the source of tremendous growth for the company. Given the growth rate, it may appear that CEG’s 24X forward multiple is cheap, but I believe that a significant portion of the growth will reverse due to factors outside of the company’s control.
Explosive growth Constellation’s GAAP and normalized earnings were negative as recently as 2021, but are anticipated to grow to $9.69 and $9.47, respectively in 2026.
That is impressive growth, and would typically go for a multiple much higher than 24X. However, at least $1.25 of the earnings growth per share is related to one-time factors that are likely to reverse.
Specifically, I am referring to the perfect storm of events that has made CEG’s sales to the grid wildly profitable. Perfect storm Energy production and demand are always in flux, and it is the grid’s job to make sure demands are met so as to reliably supply power with minimal outages. To ensure sufficient power, grids will often buy energy from utilities and other producers.
The price at which this incremental energy is bought is usually benign, but three factors made the latest auction quite different. Environmental regulations are encouraging coal plants to slowly shut down over time, which is reducing power generation from what has historically been a staple of power in America. There will be enough other forms of power to replace the decommissioning coal plants, but new plants take time to set up and delays have made openings not always sync up with closures.
Thus, during this transitional period, power supply is below ideal levels. As you can see below, the net change in capacity for PJM, (the largest grid) has been negative over the last five years. With overall electricity demand flat or even down over most of the last couple of decades, the decommissioning process was not expected to cause any shortages, but two new demand factors have materially increased overall electricity demand.
Static supply combined with a previously unexpected demand surge has made power availability tight. The situation is further exacerbated by interconnection backlogs. For a new power source to connect to the grid, it needs to be approved.
Projects used to get through the approval process quickly because there were relatively fewer and larger projects, making it easier for reviewers to look at each one. However, solar, wind and battery projects often come in smaller packages and from more diffuse locations. As such, both the number and complexity of review requests surged, resulting in a backlog of projects.
Depending on the location, the backlog is as long as 71 months. That is an absurd amount of time to get a project approved. The economy changes so much during that length of time that many of the projects originally proposed are no longer viable.
The cost of capital may have changed, or any number of things could have changed. Thus, less than 20% of proposed projects actually get completed. It is quite a problem.
The interconnection approval process has become a bottleneck in energy generation. The Federal Energy Regulatory Commission or FERC is addressing the issue with Order 2023 which directs reviewers to look at projects in batches rather than serially. In theory, it should materially improve the efficiency of the review process and reduce backlogs.
That said, it will take quite a while for new processes to manifest in efficiency, so there will likely be a window of a few years in which the bottleneck persists. With all that background, the perfect storm consists of reduced supply from decommissions, delayed new supply from the regulatory bottleneck and unexpectedly surging demand. All of this has combined to create a scarcity which is forcing the grids to pay astronomical sums for power.
In the previous year’s auction, PJM paid $28.92 per MW-day. In the latest auction, they were expected to pay $197.
40. That estimate came out before the auction, and analysts broadly underestimated the acuity of the shortage. It cleared at a whopping $269.
92, nearly 10X last year’s price. In certain areas, such as in Dominion’s ( D ) turf, the price was as high as $444.26/MW-day per a report from S&P Global.
“PJM's Baltimore Gas and Electric Co. (BGE) and Dominion Energy Virginia (DOM) transmission zones — which are transmission capacity constrained, limiting their ability to import power — cleared at even higher prices of $466.35/MW-day for the BGE zone and $444.
26/MW-day for the DOM zone, the 13-state grid operator said. Constellation as a massive beneficiary Certain types of power are better for the grid. Since grids are intended to provide 100% reliability of power, they want continuous energy rather than intermittent forms of energy like solar and wind.
Battery backed solar and wind may be significant grid capacity providers someday, but batteries are still in nascency as a major contributor. Nuclear is at a premium for its supreme reliability and with its large nuclear fleet, Constellation is well positioned to sell to the grid. It is therefore a huge beneficiary of the 10X pricing on the power it sells.
The company estimates the unusually high pricing is going to add 25 cents per share to 2025 earnings and $1.25/share to 2026 earnings. Incremental earnings are calculated as compared to $100/MW-day pricing, which would be more normal.
This extra $1.25 is a large portion of CEG’s growth estimates heading into 2026. Note that peer Vistra ( VST ) has similarly explosive growth, also coming from selling to the grid.
Extrapolation leads to overvaluation The market likes to draw straight lines. Growth is often extrapolated where it shouldn’t be so as reports came out anticipating the rapid growth ahead for CEG, the market got excited. The stock went parabolic.
At first, the 24.6X earnings multiple might not seem high, but a significant portion of CEG’s growth is the result of a one-time factor that will likely reverse. It was a perfect storm that caused the PJM auction to clear at $270.
Over time, the market will equilibrate. New energy production that was previously delayed will come online and as supply and demand balance, prices will return to normal. It is worth noting that new forms of energy production are in some cases cheaper, and the incremental cost of energy production has not risen.
Thus, the increase in prices is not representative of the stabilized price, which will move toward the incremental cost of production. I would anticipate future auctions to clear closer to the historically normal $100/MW-day. Depending on how long the bottleneck lasts, maybe there will be one or two more auctions at really high prices, but that is not what one should base an earnings multiple upon.
The extra $1.25 of earnings CEG is projected to get in 2026 will come back out. So while 2026 consensus earnings are $9.
47, stabilized earnings are closer to $8.22. In my opinion, the stock is overvalued on the basis of one time gains being extrapolated as recurring growth.
That said, I don’t see shorting as a good strategy here because the overvaluation is mild and CEG is a good company with strong long-term prospects. CEG recurring growth drivers Like other energy producers, CEG is positioned to benefit from what appears to be secular demand growth for power. Grid auction prices will fluctuate, but CEG does have a more sustainable growth angle in the form of co-location with data centers.
Historically, power generation has been centralized with power demand diffused over a large area. Single entities rarely drew more than 100MW of power, which made the transmission model quite simple in which generation would feed into the grid, which would then feed the spread-out demand. Many of the data centers being planned are going to draw as much as 1GW, which is more than the traditional grid is set up to provide to a single location.
If supplied from the grid an excessive amount of extra transmission would have to be built out, which is quite expensive. Co-location can reduce the transmission burden. A power plant can directly supply a proximal data center campus, forgoing the expensive transmission buildout.
The data center can get power at reasonable rates (profitable for CEG) and the grid does not have to push transmission buildout costs onto ordinary customers. Since the gains come from cost savings, there is a potential price point at which all parties involved come out ahead in co-location as opposed to traditional grid transmission for large single draw facilities such as mega data centers. Co-location is still in the early stages and contradicts the traditional model, which is making its growth delayed once again by regulatory approval.
Given the financial merits, I think it will eventually get more widespread approval and become a substantial growth arm for CEG. Until then, CEG is a moderately growing, strong company with a slightly overvalued stock. The REIT market has gotten egregiously underpriced making it a great time to get in to the right REITs.
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Dane Bowler is the Chief Investment Officer and a registered investment adviser at the 2nd Market Capital Advisory Corporation. He has over a decade of experience running a proprietary portfolio with a specialization in REITs. On-site property tours and critical analysis of REIT management help inform his selection process.
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