Description

Vistra Corp (NYSE:VST) Long Thesis:

Thesis:

• VST is cheap vs normalized earnings power, trading at less than 5 times free cash flow before growth investments despite long-term revenue stability.
• Increases in commodity prices this year have led to record gross margins for power generators and VST is actively locking in these windfall profits through 2025.
• The company is aggressively returning capital to shareholders through stock buybacks and insiders have made recent open market purchases.

Business Summary:

Vistra Corp is one of the largest competitive electricity production and retail power distribution companies in the US, primarily concentrated in the Texas market. VST owns power generating assets, primarily combined cycle natural gas, that sell power on a wholesale basis, and distributes and bills retail customers for electricity, but does not own transmission assets.

Valuation:

VST is attractively valued to normal profit levels which the company has stated are just over $3 billion in adjusted EBITDA with 70% of that typically converted to free cash flow before growth investments (FCFbG). Vistra’s 2022 guidance does not take into account recently elevated power prices and is currently $2,810 - $3,310 million for adjusted EBITDA and $2,070 - $2,570 million for FCFbG. At the current stock price of $21.66 this would put Vistra at less than 7x EBITDA and 5x FCFbG.

When releasing Q1 2022 results, the company noted that the summer months remain critical to performance on their 2022 guidance. We believe given the record heat and power demand so far this summer in Texas, combined with historically elevated power prices, could provide upside to mid-point guidance despite much of 2022 being hedged (90%+ as of Q1 2022).

Insider Buying:

Several insiders purchased VST shares in June. James Burke, the company’s current CFO, and effective CEO on 8/1/2022, purchased 50,000 shares at an average price of $22.84. Two directors, Brian Ferraioli and Scott Helm also purchased shares during the month with Brian purchasing 8,100 shares at $22.50 and Scott purchasing 30,000 shares at $22.91.

The purchase by Scott Helm is especially noteworthy as he was a founding partner of Energy Capital Partners, a private equity firm focused on energy infrastructure that’s taken companies such as Calpine private. Additionally, Brian Ferraioli has historically timed his purchases of VST stock well, with an average 1-year return from purchase of 45%.

Brian Ferraioli VST stock purchases backtest:

Power Market Improvement:

Vistra has an unprecedented opportunity to lock in exceptionally high cash flows for the next 2-3 years due to the large increase in power prices so far this year. Natural gas generators represent the marginal cost of supply in most power markets in the United States, which means that electricity prices tend to be tightly correlated with natural gas prices.

A widely used measure of natural gas power generator profit is the spark spread which is measured by taking the price of power (as measured in dollars per megawatt hour or $/MWh) minus the product of the price of natural gas ($/MMBtu) multiplied by the heat rate (the assumed efficiency of the natural gas generating unit as measured by how many MMBtu of gas are required to produce one megawatt hour of electricity, with the default typically used as 7 MMBtu/MWh). The market measured spark spread for power in ERCOT (the Texas electricity market) has increased dramatically so far this year, not only for spot prices but for forward prices as well.

Below is a chart of Texas spark spreads from VST’s Q1 2022 earnings presentation as of 3/31/2022:

Replicating VST’s disclosed ERCOT exposure and around the clock spark spread (90% ERCOT North, 10% ERCOT West, 7.2 MMBtu/MWh heat rate, $2.50/MWh in variable O&M costs) demonstrate that spark spreads have improved in the company’s favor for prices far into the future.

Below is our estimate of the change in VST’s ERCOT spark spreads since the beginning of the year, as well as since the end of last quarter.

Estimated Change in ERCOT Calendar Spark Spreads: 

While some of this improvement in generation profitability will be offset by VST’s retail distribution business, the company is still net long power and stands to benefit from the improvement in power prices. Each quarter the company provides a sensitivity table to determine the potential benefit or loss from market moves in power and natural gas prices. The 3/31/2022 update is included below:

Since 3/31 spark spreads and power prices have continued to move in the company’s favor. VST has not yet provided 2023 guidance but will likely do so after getting through the summer with their Q3 earnings call. During the company’s Q1 call, management discussed a range of $3.5-$3.7 billion in EBITDA for the years 2023-2025, above consensus estimates at the time, but we believe there is material upside to these numbers as the YTD move in market prices for 2023 and 2024 imply the potential for more than a $1 billion benefit to EBITDA for each year. Management is currently taking advantage of these prices, as well as the increased liquidity in the power derivatives markets, to lock in the windfall with higher than historic levels of hedging through 2025.

As mentioned earlier, in Vistra’s Q1 presentation, the company noted that “summer months remain critical to performance” where 2022 results might land relative to guidance. Even with most generation hedged over the near term, in any given quarter power demand can have a large impact on earnings, largely driven by power demand, which is dependent upon the weather. So far this summer, Texas has experienced record demand which should drive upside to this year’s numbers, even with 90%+ production hedged.

Catalysts:

In October 2021 VST authorized a $2 billion share repurchase program and as of 5/3/2022 has used $1,195 million to repurchase a total of 53.97 million shares (equal to 11% of the outstanding shares at the beginning of the repurchase program), with $805 million remaining under the program for 2022. The current pace of buybacks has been equal to 8% of total volume traded.

The company expects to return $7.5 billion over 5 years with this weighted towards share repurchases. The dividend target is set as a fixed dollar amount, which is currently $300 million. This equates to a current yield of 3.1% and the repurchase program serves to naturally increase the dividend. 

Despite the step move higher in Vistra’s earnings power, the company’s shares have traded with a tight correlation to regulated utility stocks. This is even more unusual as traditional utilities will likely face difficulty passing through billed price increases greater than costs in the current commodities environment, leading to lower ROEs. Recently, VST’s 30-day correlation to the XLU utility ETF approached an all-time high, which has held back the stock.

We believe the release of VST’s Q2, and especially Q3 results, which should include 2023 guidance, should lead to a rerating in VST shares. Additionally, we believe that capital returns alone are enough to generate a 20% IRR over a multi-year holding period without any multiple expansion.

Risks:

• Renewable generation competition: A large amount of wind generating capacity has been constructed in Texas, with strong growth in solar power. Renewable power has a zero-marginal cost of production which lowers median power prices. However, as they become a larger percentage of total power production it leads to more volatile energy prices which creates opportunity for natural gas generators like Vistra.
• Commodity prices: Forward electricity price curves tend to follow natural gas prices, and may decline.
• Weather: While natural gas prices already tend to move with weather (colder winters are favorable for natural gas prices), demand for power in Texas typically depends on how hot the temperature is in the summer. Especially mild Winters and Summers could harm profitability.
• The company has large existing hedges for 2022 that could result in higher capital requirements if power prices continue to rise. If this issue became large enough it could reduce capital available for buybacks over the near term.

Catalyst

We believe the release of VST’s Q2, and especially Q3 results, which should include 2023 guidance, should lead to a rerating in VST shares. Additionally, we believe that capital returns alone are enough to generate a 20% IRR over a multi-year holding period without any multiple expansion.