VST - Vistra Looks Forward With Proposed Nuclear Acquisition

2023-05-19 09:18:28 ET

Summary

• Vistra is a $9.1 billion market cap independent power producer generating and selling electricity in Texas and other areas of the country.
• Although over half of its generation is natural-gas fueled, it has announced a strategic acquisition of more nuclear power plants, which meets twin goals of baseload reliability and zero-carbon sourcing.
• Vistra’s dividend of 3.3% is less than the 10-year US Treasury yield, and it has significant debt; however, it may interest growth-seeking investors.

Updating from my most recent review of the company I am increasing the rating of independent power producer Vistra Corporation ( VST ) from "hold" to "buy," although only for capital appreciation and momentum investors, not for dividend investors.

Vistra continues to have to dig out of its 2021 Uri storm liabilities. It also faces the retirement and loss of generating capacity of eight coal plants. However, the company is offsetting this with the acquisition of four nuclear plants as part of its new Vistra Vision zero-carbon generation and retail customer business built from Vistra's existing zero-carbon assets and the acquisition of Energy Harbor, a nuclear power generator and electricity retailer in the Midwest. (The acquisition must first be approved by regulators and is not due to close until 4Q23.)

Other positive factors are retail market growth, a reduction from the very high 2022 natural gas prices, generating plant locations near surplus-again natural gas supplies particularly in west Texas, moderate interest rates on debt, and the effort to extend the useful life of its existing 2400-megawatt clean energy nuclear power plant.

Vistra pays a 3.3% dividend, less than the current 10-year US treasury rate of 3.6%. Its remaining stock repurchase authorization through year-end 2024 is $1.55 billion.

Concerns include its high leverage (including $11.9 billion of long-term debt, $7.4 billion of derivatives exposure, and $2.3 billion of asset retirement obligations) against $31.1 billion of assets.

Energy Harbor Acquisition

On March 6, 2023, Vistra announced a new venture, Vistra Vision, to be 85% owned by Vistra and 15% owned by retail electricity provider (one million customers) and nuclear plant company Energy Harbor. Upon closing, Energy Harbor will get $3 billion in cash and the above-mentioned 15% ownership interest in Vistra Vision. Vistra Vision is also assuming Energy Harbor's $430 million in net debt.

In addition to its retail business, Energy Harbor brings four nuclear-powered generation plants in three locations in Ohio and Pennsylvania with a total of 4065 megawatts of capacity.

For its stake in the venture, Vistra will also contribute 3800 MW of its own zero-carbon generation capacity (nuclear, storage, and renewables) for a total of 7800 MW as well as its retail customer base, resulting in a total retail customer base of about five million.

Nearly 6500 MW of the total 7800 MW of capacity, or 83%, will comprise five nuclear power generation plants.

This is a key piece of Vistra's forward strategy because between 2022 and 2027 it will close eight large coal-fired generation plants and one small natural gas-fired plant totaling 7500 megawatts of capacity.

The acquisition of Energy Harbor is expected to close 4Q23. Approvals are required from the Nuclear Regulatory Commission, the Federal Energy Regulatory Commission, and the Department of Justice (Hart Scott Rodino).

As demand for existing and new-build nuclear capacity in the US and abroad due to the need for zero-carbon, baseload power - uniquely nuclear - this appears to be a well-timed acquisition. Anecdotal examples of the appeal of nuclear power are in the uptick in Constellation Energy's ( CEG ) stock, the announcement of Vogtle 3 nuclear plant's startup by Southern ( SO ), and the startup of a new nuclear plant in Finland that can provide up to 15% of that country's electricity.

First Quarter 2023 Results and Guidance

In the first quarter of 2023, Vistra's GAAP net income was $698 million compared to a loss of -$284 million in 1Q22.

In the first quarter of 2023, net income from ongoing operations was $725 million and ongoing operations adjusted EBITDA was $554 million. The graph below shows a comparison of first quarter adjusted EBITDA for 2022 and 2023 by segment.

Cash provided by operating activities was $1.4 billion for the first quarter of 2023 compared to $591 million for the first quarter of 2022. This included an unrealized net gain of $1.1 billion in 1Q23 from mark-to-market valuations of commodities, compared to a loss of -$360 million in 1Q22.

As described above, the company progressed in its acquisition of Energy Harbor, a retail energy provider headquartered in Akron, Ohio. The Moss Landing 350-megawatt Phase III is due to come online in the summer.

Vistra expects good results for full-year 2023, as shown in the table. All calculations are categorized as for Ongoing Operations.

Macro and Commodity Price

Like businesses throughout the US, Vistra is exposed to inflation and any uncertainty around the debt ceiling and US budget negotiations.

Per its 1Q23 investor presentation, Vistra is 99% hedged for 2023 and 96% hedged for 2024. Thus, its sensitivity to changes in natural gas prices is relatively minor.

While gas is expected to be oversupplied in the US for the next several months, once additional LNG export plants come on starting in 2024, the demand pull toward higher-value markets may continue.

The Henry Hub, Louisiana NYMEX natural gas price for June 2023 delivery closed May 18, 2023, at $2.59/million British Thermal Units (MMBTU), reflecting storage refill and the significant use of natural gas to generate electricity as high-demand summer begins.

Total gas supplied in the US in the week ending May 17, 2023, was 105.2 billion cubic feet/day (BCF/D) with most of that (100.8 BCF/D) supplied by US dry production. The big increase in US supply due to shale production shown below gives important context.

Gas used for power generation at 32.9 BCF/D was about a third of total demand of 89.7 BCF/D.

Operations

Vistra generates and retails electricity as an independent power producer. Headquartered in Irving, Texas , with a (pre-Energy Harbor acquisition) generation capacity of about 37,000 megawatts, it serves about four million customers around the country.

Vistra operates in the Electric Reliability Council of Texas (ERCOT) intrastate wholesale grid. It also operates in the PJM interstate reliability grid, with smaller operations in the MISO, ISO-NE, NYISO (or NY/NE), and CAISO grids. The reliability grids are illustrated below.

Above:

ERCOT = dark blue

CAISO = teal

MISO = aqua

PJM = tan

ISO-NE = green

NYISO = medium brown

As shown above, the company reports in six financial segments: Retail, Texas, East, West, Sunset, and Asset Closure. The "sunset" category is operations from (primarily) coal plants due to be retired in the next four years. (Several were already retired in 2022.) These include:

*Baldwin, MISO region, 1185 MW, 2025

*Caleto Creek, ERCOT region, 650 MW, 2027

*Kincaid, PJM region, 1108 MW, 2027

*Miami Fort, PJM region, 1020 MW, 2027

*Newton, MISO/PJM region, 615 MW, 2027.

Governance

At May 1, 2023, Institutional Shareholder Services ranked Vistra's overall governance as 2, with sub-scores of audit (3), board (2), shareholder rights (4), and compensation (4). On the ISS scale, 1 represents lower governance risk and 10 represents higher governance risk.

At April 28, 2023, shorts were 2.4% of floated shares.

The company's beta is 0.98, near that of the overall market.

On March 30, 2023, the five largest institutional stockholders, some of which represent index fund investments that match the overall market, were Vanguard (12.7%), Oaktree Capital (6.2%), Blackrock (6.0%), Fidelity/FMR (5.7%), and Brookfield Corp (3.1%).

Brookfield and Oaktree, which is majority-owned by Brookfield, are alternative asset and distressed asset investors.

Financial and Stock Highlights

Market capitalization is $9.1 billion at the May 18, 2023, stock closing price of $24.44 per share. The company's enterprise value (EV) is $23.5 billion.

With a 52-week price range of $20.76-$27.39 per share, the closing price is 89% of the 52-week high. The company's one-year target price is $32.89/share, putting the closing price at 74% of that level, or an upside of 35%.

Vistra's trailing twelve months' earnings per share ((EPS)) is -$0.83. Trailing twelve months' ((TTM)) return on assets is 0.71%; TTM return on equity is negative at -3.6%.

Analysts' average estimated full-year 2023 and 2024 EPS are $2.85 and $3.04 respectively, resulting in a forward P/E ratio range of 8.0-8.6.

TTM operating cash flow is $1.33 billion and levered free cash flow is negative at -$1.41 billion.

At March 31, 2023, the company had $25.9 billion in liabilities and $31.1 billion in assets, giving Vistra an extremely high liability-to-asset ratio of 83%. Of the liabilities, commodity and other derivative liabilities are $7.44 billion, asset retirement obligations are $2.31 billion, and long-term debt is $11.93 billion.

The table below shows the timing and amounts of Vistra's long-term debt. There is virtually no change from nine months ago, in June 30, 2022.

Vistra pays a dividend of $0.82/share to yield 3.3%. Its share repurchase program has remaining authorization of $1.55 billion through year-end 2024.

Mean analyst rating is a 1.9 or "buy," leaning slightly toward "strong buy" from seven analysts. At least one analyst considers the stock overvalued.

Notes on Valuation

The ratio of enterprise value to EBITDA is 10.2, just above the preferred maximum of 10.0 or less that would suggest a bargain.

The ratio of debt to EBITDA is 5.6, considerably below 14.8 at last (October 2022) review.

Similarly, the company's book value is up to $8.45/share, above the recent $7.45/share, and still well below market value, indicating positive investor sentiment.

Positive and Negative Risks

Vistra's interest costs on its existing debt are moderate, a positive. However, any debt rolled over will likely require a higher cost.

After a tumultuous 2022, gas prices - key for Vistra in its generation profile - have moderated and gas is trending toward oversupply. Forward curve prices have ticked up a bit and may increase more in 2024 as more US LNG export plants come online.

Investors should consider their expectations of economic growth, especially for Texas. Electricity use is directly correlated to economic activity.

Alternative asset and distressed asset investors (Brookfield Asset Management and Oaktree, which is majority-owned by Brookfield) have stakes of 3.1% and 6.0% respectively in the company - and so have a say in operations.

Recommendations for Vistra

I do not recommend Vistra to dividend-hunters. The ten-year Treasury rate of 3.6% is a better, less risky option than Vistra's 3.3% dividend yield. It does have an investor-friendly share repurchase program with remaining authorization of $1.55 billion through year-end 2024.

The company's growth strategy evidenced in its push to extend the life of its existing Comanche Peak nuclear plant and its plan to acquire four more nuclear plants (and expand its customer base) provides some healthy fuel diversification and an offset to the intermittency of that other clean-energy source - renewables. Additionally, it replaces some of the baseload coal generating capacity Vistra is retiring.

The company has a 35% upside to its one-year target and serves growing electricity demand regions. Many of its gas generation plants are near prolific gas fields. However, it has significant debt (albeit rather low-cost) resulting from the Winter Storm Uri upset in 2021.

As noted, I have uprated Vistra from hold to buy for speculative investors.

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