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Morgan Stanley Calls Retail Energy Marketing A "Hidden Gem" In Research On Vistra, NRG

Says Strong Texas Retail Margins Are Defensible For Big Incumbents

Sees Potential For Vistra, NRG To Gain Market Share From Retail-Only Competitors

Calls Retail-Only Competitors, "Challenged"

March 25, 2019

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Reporting by Paul Ring • ring@energychoicematters.com

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In a research report initiating coverage of Vistra Energy (VST) and resuming coverage of NRG Energy, analysts at Morgan Stanley called retail energy marketing a, "hidden gem," for the companies, and said that, "[s]trong Texas retail margins are defensible for the big incumbents NRG and VST."

Morgan Stanley's analysts said that while investors have been concerned strong retail margins in Texas would drive new entrants and put pressure on margins and profitability, "we expect barriers to entry to remain high, and competitive advantages of the large incumbents to protect the current margin levels, due to several drivers: rising power price volatility, sticky customer relationships, strong brand value, the backing of a large fleet of power plants, and benefits of national scale."

Morgan Stanley's analysts noted that NRG and Vistra have been able to maintain strong margins and customer counts during recent years of low volatility in ERCOT. Given that new entrants have not been able to erode Vistra and NRG's market share or margins in such conditions, Morgan Stanley's analysts do not expect new entrants to seriously contend in a tighter and more volatile ERCOT market over the next few years

In fact, Morgan Stanley's analysts cited a potential opportunity for NRG and Vistra to gain market share from retail-only competitors, calling the environment for retail-only companies, "challenged"

Notably, Morgan Stanley's analysts, "expect Texas (ERCOT) [wholesale] power market strength in 2019 to extend into 2020 and see potential for upside in 2021 (contrary to the market's pricing of a rapid decline in power prices)."

Morgan Stanley's analysts wrote that, "[W]e expect reserve margins to remain tight as new build gas plants still require higher pricing than the current commodity curves reflect. As a result, we think prices in the market could be flatter over the next 3 years," as compared to the steep decline in 2020-22 that is currently being reflected in forward prices

Morgan Stanley's analysts do expect to see some short-term pressure on retail margins in light of rising forward power prices, but wrote, "We expect this to reverse and improve in 2021 and beyond with the current market backdrop."

Morgan Stanley's analysts also reiterated that, "Integrated retail + generation businesses bring advantages of cost efficiency and balance sheet flexibility. Benefits include transaction efficiency (improves hedging margins by avoiding bid-ask cost), collateral efficiency (avoiding ISO collateral requirements), cash flow stability (smooths EBITDA and FCF given countercyclical nature of the businesses), and lower risk of loss in periods of significant market price volatility. We see these as strategic advantages for NRG and VST, lowering their risk profiles and sustaining the competitive moat around the retail business."

The research was prepared by Stephen C Byrd, David Arcaro, CFA, Devin McDermott, Ethan C Ellison, Laura Sanchez, Gustavo Mena, and Janaki Narayanan

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