CEPU - Vistra Corp.: A Green Transformation With Significant Upside Potential

2023-12-17 07:04:21 ET

Summary

• Vistra, an integrated retail and electric power generation business, is a strong buy due to its impressive growth, cheap shares, and stable cash flows.
• The company scored well on stock screeners, with high ratings for valuation and growth.
• Vistra has seen improvements in revenue and profitability, and is undergoing a significant acquisition that is expected to drive long-term success.

Anybody who follows my work closely knows that I am a huge fan of pretty much anything related to the energy sector. This is really because I believe that, as a consequence of the global population continuing to grow and as the economy grows, energy consumption will have to continue to increase as well. I view this as a safe place to invest in for the long haul and the stability that some aspects of the energy space offers can result in attractive cash flows for investors over time. One firm that has recently come across my radar that falls in this space is Vistra Corp. ( VST ). At first glance, some of the fundamental data regarding the company of looks questionable. Profits have been a particularly weak spot for the business in recent years. However, growth has been impressive and the company is in the process of completing a rather significant acquisition that should set it up for long term success. Add on top of this how cheap shares are relative to cash flows, and I cannot help but to rate it a ‘strong buy’.

Big changes are happening here

I have never been of the opinion that investors should look at a stock screener and make an investment decision based solely on what the screener in question says is the most attractive opportunity. If investing were that easy, everybody could get strong returns. But I do believe that stock screeners can go a long way toward narrowing down some of the best opportunities that are out there. From that point on, it's all up to you. One firm that came across my radar because of the Quant Screener that Seeking Alpha has is Vistra Corp, an integrated retail and electric power generation business that focuses largely on the U.S. market.

The company scored a rather impressive 4.78 out of a possible 5 from a Quant Ratings perspective. That's quite a bit better than the 3.66 rating it gets from analysts on Seeking Alpha in the aggregate. Ratings from Wall Street give it a rather lofty 4.40 score. Helping the company is the fact that it scores an A- on valuation and a solid A when it comes to growth. As you can see in the image above, it scores highly on all the other default settings of the screener as well. In fact, of the top 50 highest rated companies picked out by the screener, it comes in at a rather impressive 23.

As I mentioned already, the company is an integrated retail and electric power generation business. Across the 20 states (and DC) in which it operates, it serves about 3.5 million customers. In 2022, its generation fleet boasted 37,000 MW of generation capacity, with its portfolio consisting of assets that are based not only on natural gas, but also on nuclear, coal, and solar. The firm also has battery energy storage facilities. Although coal is a four-letter word that is taboo in the energy markets, it is important to note that management has been working hard to move away from it. Since 2010, the company has retired over 14,500 MW of coal and gas power plants, allowing it to significantly reduce its greenhouse gas emissions. Management has prioritized a move in the direction of cleaner energy. As you will see shortly, the firm is undergoing a rather significant change at this time. But it would be helpful to first touch on its fundamental performance up to this point.

In some respects, Vistra Corp is a really attractive prospect. Take revenue. From 2020 through 2022, the business has seen its sales rise from $11.44 billion to $13.73 billion. Rising energy costs have been a key driver of this expansion. However, on the bottom line, the company has seen some real pain. It went from generating net profits of $636 million in 2020 to generating a net loss of $1.38 billion in 2022. Operating cash flows have been all over the map. Though the picture does change a little bit for the better if we adjust those figures for working capital changes. The only profitability metric to show consistent year over year changes of a positive nature has been EBITDA. It has managed to grow from $1.09 billion to $2.99 billion over the past three years.

As you can see in the chart above, the 2023 fiscal year has been a big improvement for the company. The increase in revenue for the first nine months of 2023 to $11.70 billion from the $9.86 billion generated one year earlier was driven by improved performance at the company's facilities, as well as by rising demand because of hot weather, particularly in Texas. These improvements pushed the company from a net loss of $1.09 billion last year to a profit of $1.57 billion this year. Operating cash flow shot up from $92 million to $4.57 billion, while the adjusted figure for it rose a more modest but still impressive amount from $2.32 billion to $2.98 billion. And lastly, EBITDA for the company managed to grow from $2.26 billion to $3.17 billion.

Back in March of this year, the management team at Vistra Corp announced that they had reached an agreement to acquire another energy company known as Energy Harbor. This is a nuclear and retail business that brings with it 6.4 GW of nuclear generation and around 5 million retail customers. But this is not a simple acquisition. Rather, Vistra Corp is separating some of its own assets, namely its own nuclear assets, as well as its retail and renewables operations, and certain storage projects, and putting them under the umbrella of a new subsidiary called Vistra Vision. It is then adding Energy Harbor to those assets, with the seller of Energy Harbor receiving 15% ownership in Vistra Vision. Unfortunately, Vistra Corp must also pay $3.63 billion on top of this in order to make the deal go through. That involves $600 million from the company's balance sheet, as well as $3.03 billion of debt.

As of this writing, the deal has not yet been consummated. And that's where things get a bit tricky. When Vistra Corp announced updated financial guidance for the third quarter of its 2023 fiscal year, as well as initial guidance for 2024, the likes of which can be seen in the images below, management did not factor into the equation anything associated with this transaction. That means we only have part of the story of the fundamental picture moving forward. But of course, this is fairly simple to rectify.

Due to hedges and synergies that can grow to be up to $125 million, Energy Harbor is expected to generate around $700 million worth of EBITDA for 2024 and $800 million in 2025. In the long run, as hedges roll off, this number should grow to $900 million per annum. For the purpose of being conservative, I have decided to use the $700 million figure in my own calculations. Naturally, EBITDA does not need anything stripped from it. But operating cash flow does. For the $3.03 billion in debt, I have assumed an 8% annual interest rate. This is based on the December 11th press release that Vistra Corp issued in which the company discussed that it was issuing senior notes in order to refinance some other debt. The highest interest rate on those was 7.75%.

If this all comes to fruition as planned, EBITDA for this year, factoring in the acquisition as though it occurred at the start of the year, should be $4.725 billion. Adjusted operating cash flow, which strips out $150 million of preferred distributions since those are also required cash outflows, should be around $4.54 billion. As you can see in the chart above, I did the same kind of calculations using data from 2022 and forecasts for 2024.

Using these results, I then was able to value the company as shown in the chart above. The stock is trading quite cheap on an absolute basis, especially if we use the results expected for 2023. As you can see in the table below, I also valued the company against five similar firms. On a price to operating cash flow basis, three of the five companies were cheaper than it. But this drops to only two of the five if we use the EV to EBITDA approach.

It's also worth noting that Seeking Alpha’s rating system also has its own assessment of similar firms as well. As you can see in the images below, Vistra Corp has been granted a higher quality than any of the five firms except for one of them. In my view, when coupled with how cheap the stock is on both an absolute basis and relative to similar firms, I would say that this makes the enterprise truly appealing.

Takeaway

At this time, Vistra Corp is undergoing a rather significant change in its business. In the near term, as well as in the long run, I wouldn't be surprised to see continued significant upside. Shares are already up 69.1% year to date, but that doesn't mean that the stock can't continue to rise. With how cheap shares are and the premium that they deserve relative to similar firms, I would make the argument that a ‘strong buy’ rating is most certainly appropriate at this time.

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