Calpine's Trading Gains Look Shaky

Peter Eavis

07/26/01 - 06:52 PM EDT

Has Calpine (CPN Quote - Cramer on CPN - Stock Picks) become overly reliant on trading gains?

Second-quarter financials, released Thursday, showed that a good chunk of the San Jose, Calif.-based power producer's prodigious growth in gross profits came from trading.

What's wrong with that? A lot, according to the bears. Their take: The Calpine story rests on the company finding long-term buyers for power generated by its low-cost, gas-fired turbines -- not on the ability of its traders to cash in on energy volatility. Calpine's stock, though down 35% since the beginning of May, could fall further if the market comes to believe the company is dependent on mercurial trading income. The company trades around 19 times expected 2001 per-share earnings of $2.

Calpine dismisses this line of thinking. Calpine Energy Services chief Paul Posoli says it's wrong to see Calpine as a generator with a speculative trading shop tacked on. He comments that Calpine's fast-growing generating capacity and gas-producing sites put it in an excellent position to trade in energy markets. This trading allows the company to optimize profits from its productive assets, Posoli claims, adding that trading could consistently add an incremental 15% to Calpine's gross margin, which is computed by dividing gross profit (revenue minus cost of sales) by revenue.

Calpine made 39 cents in second-quarter earnings, an impressive 95% increase on the year-ago number -- and 8 cents above analysts' estimates. The stock moved up 3% to $36.89 Thursday.

So what caught the skeptic's eye in the second-quarter numbers? On a conference call Thursday, Calpine said that it booked about $90 million in trading profit in the second quarter, compared with $9 million in the first quarter. A year ago, Calpine had a negligible trading operation and thus almost nothing in the way of gross trading revenue.

Reported second-quarter gross profit jumped 10% from the first quarter to $304 million. But if the trading gains are stripped out of the first and second quarters, gross profit actually fell 20% sequentially, to $214 million. Second-quarter gross margin would've been 13% rather than 19%.

That's not a fair way to look at it, says Posoli. Had Calpine applied accounting guidelines regarding hedging contracts identically in both quarters, the first quarter would've shown a much higher number for trading income, he explains. Posoli didn't say exactly how much higher than the stated $9 million it would've been, but on the call he implied the sum was just below $90 million. Why the change of accounting practice in the second quarter? The growth in hedging volume, as well as advice from auditors, Posoli says.

However, this explanation has little bearing on a comparison of the 2001 second quarter with the same period in 2000, since the company didn't have much trading back then. One approach implies that Calpine has become much more reliant on trading over the year.

Let's start with the $304 million of second-quarter gross profit. Next, strip out the $68 million in trading income from power generation, as well as $97 million of gross profit from the oil and gas operations. The result is $139 million. This number could be seen as a rough estimate of nontrading profits from power generation (including fuel expense). Doing the same exercise for the second quarter of 2000 yields $102 million. It's arguable, then, that nontrading generation gross profits went up 36% over the year.

Not a bad rate. But a bigger jump might've been expected, given the 67% increase in the amount of power sold and the 10% increase in Calpine's average selling price for electricity.

Calpine says it has three meetings scheduled in the coming weeks for analysts and investors. Expect this subject to come up again.