Vistra ($VST) — Initiation (5/28/21)

Vistra Corp is an independent power producer (i.e. utility) operating in 20 states. They operate a “generation fleet totaling approximately 38,700 MW of generation capacity with a portfolio of natural gas, nuclear, coal, solar and battery energy storage facilities.”1

There’s an opportunity to pick up shares on the cheap following the severe Texas winter storm Uri earlier this year. Vistra was left with large losses from the rare weather with shares still in the dumps. Shares are flat since emerging from bankruptcy and beginning trading in late 2016.

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Rightfully so, the storm will wind up taking a ~$1.6bn cash flow hit on the business in 2021! You can read more about the “why” of the losses below.2

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Here’s the revised 2021 guidance with the Uri impact:

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Incredible that an extreme event like this can wipe out nearly an entire year’s worth of earnings / cash flow. Vistra is fortunate to be in a financial position to withstand this.

Let’s get into the financial picture…

There are 482m shares outstanding and a $16 stock price = $7.7bn market cap. Net debt should be $10.5bn at yearend (based on guidance) for an $18.2bn enterprise value.

Though the business model is simple (Vistra operates power plants to supply power to residential and business customers), the markets they operate in are complex and have some risks… The big risk on their markets are their deregulated nature; these are competitive markets and therefore less “utility”-like. I’m going to set those aside for now and cover why Vistra is an interesting setup:

1) Attractive valuation when looking through the extreme winter weather in 2021. Prior to the storm, Vistra was expecting ~$3.3bn in EBITDA and ~$2bn in FCF. At $8b market cap / $18bn enterprise value, that’d be 4x FCF and 5.5x EV/EBITDA. Management is trying to telegraph that this is a rare occurrence which shouldn’t be extrapolated into future years…

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2) Cash flow has been and should remain strong. Vistra emerged from bankruptcy and came in public in 2016, then acquired Dynegy in an all-stock deal in 2018 — this led to the sharp jump in cash flow from 2018 to 2019.

Excluding the 1Q21 outflows from Uri — Vistra generated nearly $9bn in operating cash flow and $6bn in free cash flow from 2017-2020… compared to the current $7.7bn market cap…

Most of this FCF went to repaying debt — $3.6bn. Dividends came into the picture in 2019 but still amount to less than $300m per year. The remainder started to go toward buybacks until COVID happened in 2020. Vistra was starting to spend $700m per year in 2018-2019. This would be close to 10% of shares at today’s price.

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3) Massive share repurchase plan was announced prior to the Texas storm. In September 2020, Vistra authorized a $1.5bn share repurchase plan. They were only able to execute $125m during January and February 2021.

Slide highlight from Sep2020 investor presentation

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The statement is a tad misleading as they include repaying debt as a capital return to a “financial stakeholder.” But it still has the same affect — management believes they have ~$1.5bn (under normal conditions) in firepower to use toward discretionary capital allocation purposes. The dividend consumes $300m per year or less and until 2021 came along, they were nearing their targeted leverage ratio which would have left more available for buybacks.

My guess is that they’ll still include some level of buybacks in 2022 but the majority will go to repaying debt up until that targeted leverage ratio.

4) Merger with Dynegy in 2018 lowered exposure to coal generation and Texas market specifically. The Dynegy deal was a great move by Vistra… Dynegy was on the heels of a large acquisition themselves and were highly levered at the time of the deal (but still generating excellent cash flow) — Dynegy came into the deal carrying 6x leverage.

Vistra issued 115m shares at ~$19 to acquire Dynegy for ~$2.2bn (before debt) and picked up more than $600m in annual FCF — less than 4x multiple of FCF paid for the business. Since then, they’ve repurchased more than 60m of the issued shares.

Dynegy + Vistra assets

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5) Insiders have been scooping up shares in the $15-17 per share range. Insiders — including both management and the board — have spent a combined ~$4.3m buying stock since March of this year. Remember when management was trying to tell us that the winter storm effects shouldn’t be extrapolated?

Insider buying

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6) Guidance does not include any potential upside from legal. Vistra is obviously working to offset some of the losses from the storm in claiming that markets failed to function properly. I’m not going to place any probability on this or estimate any dollar value to it. Just noting that if it panned out, it would be outside the estimates provided by management.

Credit Suisse estimated potentially $150m from ERCOT pricing “glitch” and another $150m from gas suppliers.

7) Peer NRG Energy Inc ($NRG) is trading at ~7x EBITDA while Vistra trades at 5.7x based on 2022 estimates — i.e. looking past winter storm Uri.

NRG is experiencing a fraction of the losses Vistra incurred thanks to Uri — ~$1bn vs. $2.5bn (gross impact) — so it might not be a fair fight. They have similarities and differences but generally they are both exposed to the same markets an have similar leverage profiles.

At 7x $3.2bn in EBITDA = $22.4bn EV less $10.5bn in net debt gets a $11.9bn equity value. With 482m shares outstanding, this works out to a $25 share price… 50% upside before considering additional debt paydown, share repurchases, etc.

8) Working the renewable story. Vistra is making investments to reduce coal exposure and increase renewable exposure on earnings… Not a perfect comparison but NextEra Energy ($NEE), the largest renewable utility in the US, trades at 15x EBITDA and 27x earnings.

Over time, as Vistra retires coal generation in favor of renewables, the story (and thus the multiple) should be more palatable to investors.

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Final thought…

It would be surprising to see Vistra repurchase any shares in 2021 with the heavy cash outflows during Q1. They’ll likely spend the remainder of 2021 and part of 2022 rebuilding the balance sheet back to 3x leverage or better. After that, I see them resuming a $1bn per year pace of dividends + buybacks.

Uri was a setback which is also creating an opportunity to own this business at a very reasonable price. As investors gain confidence that 2022 will be a “return to normal,” we should see a share price back to the mid-20s. Within 24 months I think you’ll see a share price in the $30s as they execute the plan.

I like simple ideas… This reminds of me H&R Block ($HRB) which spent most of 2020 in the $13-14 per share range after a tax deadline extension ruined an entire year’s earnings. The stock rallied back to the mid-20s in part from a COVID rebound but also as the market gained confidence that the “lost year” wasn’t to be extrapolated. Vistra has plenty of similarities to that situation.