VIST - Vista Continues To Offer Margin Of Safety And Is A Buy

2023-12-13 21:19:05 ET

Summary

• VIST is one of the largest producers and largest exporter of Argentinian shale oil from the Vaca Muerta basin.
• The company has seen huge price appreciation in recent years, but I believe it still offers a margin of safety compared to its earnings potential.
• The main reason for this is that the company has a very low breakeven cost, of only $27 per barrel, assuming variable SG&A and maintenance CAPEX.

Vista Energy ( VIST ) is one of the largest producers and the largest exporter of shale oil in Argentina's Vaca Muerta basin.

I wrote about the company in October 2021 (the second article on the company in Seeking Alpha, when the stock traded at $6.5 compared to $30 today) and in January 2023 , both times recommending its purchase.

Those articles have more detailed descriptions of the company. Succinctly, I recommended the name because of its low cost of extraction, low leverage, focus on oil and not natural gas, and low valuation.

Since then, the company has continued executing the same strategy. It has decreased drilling and lifting costs and has divested assets to focus even more on shale oil.

Today, the company's price reflects its valuation a little better than before, and therefore, the margin of safety that the security offers is lower. However, I believe the stock still trades well below what the company is worth, especially considering the investment plans of the company.

Self-financed growth

Since I wrote the first article about VIST, oil prices have risen, decreased, and gone sideways. 2021 was a great bull year, while 2022 was volatile and 2023 a little more stable.

That did not matter to VIST. The company has consistently increased production and can now pump 50 thousand barrels daily. Further, the company has reduced costs: nonroyalty costs have decreased by 50% since 2018. This has been achieved by running the experience curve down. The more the company drills, the more it can improve its efficiencies.

This has generated an explosion in EBIT that is correlated with higher oil prices but also corresponds to the execution of the company's plan. VIST managed to post ROCE above 25%.

Further, VIST has increased its production capacity via the cash flows it generates from its assets without increasing leverage.

This allows the company to be in a relatively comfortable position today. It could repay all its debts with one year of operating cash flows if it wanted to disinvest, even considering maintenance CAPEX.

Plans for the future

This year, the company sold assets focused on conventional exploration in the Vaca Muerta basin. Without these, the company has almost no operating assets outside Vaca Muerta unconventional.

VIST wants to continue focusing on shale oil. The company's plans include increasing production capacity to 70 thousand barrels per day by the end of 2024 and potentially 100 thousand barrels by 2026.

Following a consistent strategy, the company does not plan to take debt to finance these investments. It expects to spend $780 million in CAPEX annually, fully financed via operating cash flows. It does not expect to pay down debt or dividends, but rather, if everything works correctly and with an oil price of $65, accumulate an additional $1 billion in cash.

There will be one big challenge in VIST's road and that is transport capacity. The company could expand faster than today but is constrained by the main oil pipeline from Vaca Muerta to the export and treatment market of Bahia Blanca. The pipeline is controlled by Oldelval, which has announced expansion plans, but these depend on receiving financing and a relatively unstable regulatory framework. I would expect the new government to be open to private investment that could increment exports, but this is still a risk.

A simple model

The company's low-cost structure and low leverage are its main assets. In a commodity industry, the low-cost, low leveraged producer is at much lower risk because it can stay on the black during market downturns. Potentially, the company could acquire assets from more leveraged players.

In this case, VIST has posted extraction costs of $16 per barrel. This includes operating expenses of $5, drilling (or D&A) of $9, and midstream of $1, approximately. On top of that, we have to add $5 of royalties per barrel. Up to this point, we have had variable expenses. SG&A has shown to be relatively stable at 10% of revenues, but to be more conservative, and expecting expanding production, we can consider it variable (less leverage) at $6 per barrel.

This yields a breakeven cost per barrel of $27. It means that even paying for maintenance CAPEX (included in drilling costs via D&A), the company needs a complete crash of oil prices to go into operating red. At $27, it can replace its wells and keep production steady without losing money. This is the company's 'moat'. Royalties could decrease if the new government decides to eliminate the export taxes currently in place (8% of FOB value).

As always with Argentinian stocks, interest expense mixes true interest with capital adjustments via inflation. Also, interest rates in USD have been extremely low in Argentina because of capital restrictions. VIST has been able to finance at less than 5% this year, and I'm pretty sure it is not a lower-risk borrower than the Federal Reserve.

My approach to work around this is to convert all the debt to pesos using the official rate and apply a conservative interest rate. For example, 10% on the above charted $700 million in debts yields $70 million in interest expenses going forward, assuming no further debt issuing and rolling over the existing debt at 10% (today, the effective rate is much lower).

Finally, the Argentinian income tax rate of 35%.

Now, it's time to work with prices.

There is a 10-15% price gap between exports and local prices. This is unimportant for our purposes for two reasons: first, we can consider the effective price per barrel as a mix between the export and the national price; second, the new government is almost guaranteed to eliminate this difference by authorizing free price setting in the domestic oil market. This convergence alone could increase VIST's revenues by 5/10% (considering 50% of sales are in the domestic market).

Also, we have to assume a discount to Brent prices. This has generally been around 10% for exports, so we can assume 15% as a mix between the national and export prices (again, although I believe this discrepancy will disappear).

Now, we are ready to project net income for a series of potential prices. The account is simple. VIST prices are 85% of Brent prices. From this, we remove $27 in variable costs per barrel. We multiply the operating income per barrel by the 70 thousand barrels expected daily (25.5 million per year). Then, we remove $70 million in interest expenses. From the remaining, we remove 35% of income taxes.

This model is not complex and does not pretend to be so. The idea is to show how, with some conservative measures (SG&A as a variable cost, higher interest rate, and 35% lower oil prices), the company is still trading at value prices.

Conclusions

VIST currently trades at a market cap of $2.5 billion.

Given its current cost and financing structure, this is a 12x multiple of what the company could potentially earn, with the Brent oil barrel at $50. Considering the more recent $70 per barrel, it becomes 5x.

To me this means the company offers a lot of margin of safety. Oil prices should fall to pre-pandemic levels for the company to trade at what could be considered an acceptable 8% earnings yield. The company remains undervalued if oil prices are sustained at current levels or rise higher.

Further, its management has shown the capacity to grow the company without leveraging while at the same time improving costs. This is a sign of quality. Finally, some improvements in Argentina's regulations (removing 8% export taxes and unifying domestic and international prices) could further improve VIST's earnings under all scenarios.

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