Description

Vistra Corp (NYSE:VST) Long Thesis:

Thesis:

·         VST is cheap, trading at less than 5 times free cash flow despite long-term revenue stability.

·         Deleveraging goal will be met by year end at 2.5x net debt / EBITDA. Investment grade rating in 2021 will lower cost of capital and improve valuation.

·         Insiders have been buying stock and the company recently announced an aggressive share repurchase plan over the next two years.

·         Acceleration in solar investment at attractive returns should improve narrative going forward.

Business Summary/History:

Vistra is the largest competitive electricity production and retail distribution company in the US, primarily concentrated in the Texas market. VST owns power generating assets (primarily natural gas) that sell energy on a wholesale basis, and distributes and bills retail customers for electricity, but does not own transmission assets. The original VST assets began operating under the TXU name in 1999 and were taken private in the largest LBO in history for $44 billion on 10/10/2007. As the marginal producer of electricity are combined cycle natural gas power plants, electricity prices tend to follow natural gas prices (which are both correlated with weather). The levered bet on natural gas that private equity made through TXU ultimately fell apart with the fracking boom and the company entered bankruptcy on 4/29/2014. Of the three original TXU businesses (generation, transmission, and retail sales/distribution), the company’s generation and retail distribution segments emerged from bankruptcy as Vistra in October 2016.

The charts below show the historic correlation between oil and gas that ended once the fracking boom began:

After emerging from bankruptcy, VST has made one large power generating acquisition in Dynergy on 4/9/2018 and two smaller retail acquisitions in Crius Energy on 7/15/2019 and Ambit Energy on 11/1/2019. Since then VST has focused on reducing debt to achieve their target leverage ratio of less than 2.5x net debt to EBITDA.

Valuation:

On almost any metric, VST is exceptionally undervalued. VST currently trades at 4.5x midpoint 2020 FCF (assuming $500 million of growth investments) and 5.2x 2020 midpoint EBITDA. VST is also trading near its lowest multiple to earnings since coming out of bankruptcy.

Calpine, a competitive power generation company, was taken private in 2018. Their merger proxy has additional data on past comparable valuations:

These past transaction valuations implied a fair value of 7-8x EBITDA. We believe VST’s assets are comparable to this set and the company is far less leveraged than Calpine. A 7-8x EBITDA multiple for VST would imply a stock price of $32-39, which is 77-116% higher than VST’s current stock price.

Looking at what VST expected to earn when they first emerged from bankruptcy and what valuation was assigned on that initial view is instructive when compared to the company’s current valuation:

VST came out of bankruptcy with leverage of 2.7x net debt / EBITDA and expected to generate FCF of $1.95 per share and EBITDA of $1,425 million in 2017. Using these numbers, the bankruptcy plan valuation was $11.1 billion meaning the company expected to trade at about 8x EBITDA and 9.7x fcf.

VST will end 2020 with less than 2.5x net debt / EBITDA, will generate FCF of $4.00 per share (after growth investments) and trades at less than 5x FCF and 5.2x midpoint EBITDA guide.

Insider Buying:

Insiders have recently been purchasing shares around the current price. After a flurry of purchases in March when VST shares crashed below $14 during the height of the market sell-off, insiders have begun purchasing shares again at prices above $18. On September 8^th Vistra’s CEO, Curtis Morgan, purchased 41,176 shares for an average of $18.185 per share increasing his ownership in VST by 10%. On the same day, Vistra’s chairman, Scott Helm, purchased 20,000 shares for an average of $18.188 per share. 

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. Interestingly, Energy Capital Partners was one of the investors that took Calpine private. Most recently CEO Curtis Morgan bought $749K and Scott Helms bought $364K of stock on September 8th. 

Catalysts:

We believe the strongest near-term catalyst for VST shares will be the return to aggressive stock repurchases in 2021 and 2022. While focused on deleveraging, VST discontinued their stock buyback program in Q4 2019. VST now expects to reach their target leverage ratio by the end of the year, and at their analyst day on September 29^th, the company announced a capital plan for 2021 and 2022 that included up to $1,500 million in share repurchases, which would equate to almost 20% of VST’s market cap at current prices.

Historically, VST shares has been highly correlated with the price of natural gas, but during the peak of VST’s last repurchase activity, the stock was able to outperform in a period of weak natural gas prices:

VST’s multiple has suffered from ESG flows due to their concentration in fossil fuel generation. Even with the high levels of capital expected to be returned to shareholders, the company’s capital plan includes growth investments that may alleviate some of this pressure as VST revealed plans to take their renewable generating capacity from 0.5% to 18% by 2030 and reduce coal capacity from 29% to 10%. Most importantly these renewable investments are still expected to generate healthy returns of 18% on equity.

As investors gain confidence in management’s capital strategy over the next 12 months, we believe VST shares will rerate to at least 6.5x 2021 EBITDA which would translate to a price of $25.54, more than 40% above the current price, with additional upside to 7-8x EBITDA in a potential take-private transaction. VST is also seeking to achieve an investment grade rating on their debt in 2021, which should contribute to a rerating in the company’s stock. Even before a credit upgrade, VST’s long term unsecured debt currently has a yield to worst of 3% which stands in contrast to the stock’s current FCF yield over 20%.

Risks:

·         Renewable generation competition: A large amount of wind generating capacity has been constructed in Texas recently. Renewable power has a zero-marginal cost of production which lowers median power prices. However, as wind becomes a larger percentage of total power production it leads to more volatile energy prices in the summer as higher temperatures do not necessarily correlate with higher wind. This leads to higher peak prices on hot days with lower wind. More volatile electricity prices may actually benefit natural gas power producers like Vistra.

·         Commodity prices: Forward electricity price curves tend to follow natural gas prices.

·         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.

·         ESG / Political risk: Changes in national energy policy could disfavor utilities with higher fossil fuel generating capacity like VST, though we believe the current valuation compensates investors adequately for these risks.

Catalyst

We believe the strongest near-term catalyst for VST shares will be the return to aggressive stock repurchases in 2021 and 2022. While focused on deleveraging, VST discontinued their stock buyback program in Q4 2019. VST now expects to reach their target leverage ratio by the end of the year, and at their analyst day on September 29^th, the company announced a capital plan for 2021 and 2022 that included up to $1,500 million in share repurchases, which would equate to almost 20% of VST’s market cap at current prices.