2023-10-04 06:30:07 ET
Summary
- Vistra faces ongoing regulatory difficulties.
- The net total of the company's GAAP Net Income/Losses over the past 6.5 years since coming out of bankruptcy is a loss.
- Management's actions over the past 6.5 years have resulted in a significant weakening of the balance sheet.
Investment Thesis:
Background -I last wrote about Vistra Corp. ( VST ) in a July 2021 article, " Vistra Corp. : Potential High Returns Tempered By Risk", with a Buy rating. Seeking Alpha Premium shows Price at publication $19.28, Change (in share price since publication) plus 65.98%, and Total return plus 77.77%.
Highly regulated "free market" - Regulated utilities are a strange economic beast. These are generally natural monopolies or oligopolies, designed by regulatory authorities to perform in a "free market" manner. The theory is wholesale prices for generators are determined by auctions, and participants will be incentivized by higher prices to act to meet supply/demand imbalances. A number of difficulties arise here. Fixing a supply/demand imbalance will invariably require additional long-term capital outlay which will result in the incentivizing higher prices reverting to more normal levels in the short term. Higher prices at times of supply/demand imbalances is a strong incentive for generators either not to act to fix supply/demand imbalances, or to create demand/supply imbalances by either deliberate action or by inaction. So having created a "free market" by regulation, regulatory authorities must create another whole raft of regulations to avoid 'bad behavior', resulting in an ever increasing highly regulated "free market". The problem for participants in this highly regulated "free market" is regulatory authorities tend to be self-protective and adopt a "heads I win, tails you lose" approach. These include regulations placing supply obligations on participants, regardless of the cost to the participant.
Vistra's winter storm Uri experience - The storm may have triggered events, but the storm itself was not the main issue for Vistra. Gas wells and pumps for distribution were not categorized by the authorities as essential services. So electrical power was cut and gas flow essential for gas fired electricity generation was also cut. Vistra acted to help get gas restored, but this took time, while buying gas wherever they could at a very high price (free market forces). Vistra estimates the entire 2021 Adjusted EBITDA impact from the storm was less than the negative impact from gas deliverability issues and the incredibly high costs to procure gas. Vistra's firm gas contracts that were not honored by third parties led to the company procuring replacement gas at incredibly high costs, while the lack of physical gas and insufficient pressures on the pipelines impacted the company's ability to generate power at full capacity. As a result of these challenges, Vistra had to procure power in the ERCOT market at prices at or near the price cap to meet its supply obligations. Absent these issues with gas deliverability and increased gas costs, Vistra estimates that the 2021 Adjusted EBITDA impact of Uri would have been a slight positive. All of this was brought on by regulatory failures, but Vistra bore the cost.
Vistra's Move From Fossil Fuel to Clean Energy Generation - Vistra is moving to increase its proportion of clean energy generation with the acquisition of Energy Harbor's nuclear power generation plants. Vistra has partitioned its operations into "Vistra Vision" and "Vistra Tradition". Vistra Vision contains the clean energy generation assets and Vistra Tradition the fossil fuel generation side of the business. From the Vistra FY-2022 10-K filing ,
2022, Vistra brought online 418 MW of zero-carbon generation and storage in Texas, while also retiring approximately 2,900 MW of fossil generation in Ohio and Illinois. We also made significant progress on other projects, including an additional 350 MW of battery storage at our Moss Landing facility, which is expected to come online in mid-2023.
In 2023, Vistra announced the proposed acquisition of Energy Harbor's three nuclear power plants, furthering its move towards clean energy generation. NRC, FERC and HSR (DOJ) approval requests are required and have been filed. Vistra announced on Sep. 29, 2023 it has received approval from the Nuclear Regulatory Commission ("NRC") to transfer the operating licenses of Energy Harbor's three nuclear plants. Vistra is still awaiting a decision from the Federal Energy Regulatory Commission ("FERC") on its request for approval of the transaction. In the meantime, on 23 August 2023, the Department of Justice ("DOJ"), made a s ubmission to FERC (Dkt ED23-74-000) raising concerns including,
Vistra and Energy Harbor currently compete in auctions run by PJM Interconnection, a regional transmission organization that manages the electricity grid for more than 65 million consumers.1 In PJM’s auctions, market prices are determined by the prices offered by competing generators, including Vistra and Energy Harbor. The proposed acquisition would combine different generating units with different cost structures under the control of Vistra. This combination may enable Vistra to profitably withhold electricity from some of its generating units to raise market prices. After the transaction, Vistra would supply the same customers with electricity from nuclear plants, whose generating units usually offer low prices in the auctions, and natural gas plants, whose generating units usually offer higher prices. To increase the wholesale price it receives on the low-cost nuclear plants it acquires from Energy Harbor, it is possible that Vistra could withhold output from its higher-cost natural gas generating units. By combining these generating units, the transaction may therefore increase Vistra’s incentive or ability to raise electricity prices profitably.
While I understand the concerns expressed by the DOJ this is potentially a huge issue for Vistra and any other energy utility moving away from fossil fuel to clean energy. As mentioned above, Vistra retired approximately 2,900 MW of fossil fuel generation in Ohio and Illinois in 2022. If acted upon, could the DOJ suggestions result in a proposed retirement of a fossil fuel plant being seen in the same light as, "profitably withhold electricity from some of its generating units". There is a huge amount of solar and wind power generation scheduled to come on line over the next few years, and that will have a huge impact on the market, and the capacity and price generators will submit at auctions. These ever changing market dynamics will likely bring on more regulation with possible unintended adverse consequences for generators such as Vistra.
Stock Rating:
In my July 2021 article linked above I concluded, "Subject to regulatory changes to avoid or reduce adverse outcomes from further catastrophic events such as Uri, the present beaten down share price offers the potential for high returns for buying now and holding through the end of 2023." Significant regulatory risks remain, the share price is now 66% higher, and the balance sheet metrics are now significantly weaker than at July 2021. Based on SA Premium analysts EPS estimates a wide range of returns are possible, from positive double digit returns to negative returns. The wide range of analysts' EPS estimates indicates considerable uncertainty, and greater uncertainty equates to greater risk. Taking all the foregoing into account I believe a downgrade to a Strong Sell rating for Vistra is now appropriate. A detailed balance sheet analysis appears below, which adds support to the downgrade to a Strong Sell rating.
Checking Vistra's "Equity Bucket"
Table 1.1 Vistra Balance Sheet - Summary Format
Over the 6.5 years from the end of 2016 through the end of Q2-2023, Vistra has increased Net Assets Used In Operations by $6,688 million despite a reduction of $3,238 million in common stock Shareholders' equity. The funding to support this total $9,926 million application of funds came from an increase of $7,926 million in debt net of cash and a capital raise of $2,000 million by way of preferred stock issue. Net debt as a percentage of net debt plus equity increased from 37.1% at end of 2016, as the company emerged from bankruptcy, to 77.9% at end of Q2-2023, due to borrowings to increase investment in the business, pay dividends and repurchase shares. Outstanding shares decreased by 58.0 million from 427.6 million to 369.6 million, due to share repurchases offset in part by share issues for employee compensation. The $3,238 million decrease in shareholders' equity over the last 6.5 years is analyzed in Table 1.2 below.
Table 1.2 Vistra Balance Sheet - Equity Section
Explanatory comments on Table 1.2 for the period end FY-2016 to end Q2-2023
- Vistra does not report Net Income on a non-GAAP basis, but does report EBITDA on a non-GAAP basis. This has two main effects on reporting disclosure in 8-K filings of quarterly operations. The first is, EBITDA is calculated from adding back Depreciation and amortization and Interest expense to Net Income (Loss) before Income tax expense. As Depreciation and amortization and Interest expense total to ~$2 billion or more per year, even if Net Income before tax is a considerable loss, a positive EBITDA will almost always be reported. The second disclosure effect is, the company does not provide shareholders information on the underlying earnings and EPS after excluding items of an unusual or non-recurring nature. So, there is no picture provided of how the company would perform going forward, absence unusual and non-recurring items. Also, analysts' consensus EPS estimates are less useful if the basis on which they are prepared is unclear and the company does not report EPS results on a basis that can be compared to analysts' EPS estimates.
- We do not have non-GAAP figures, but GAAP based reported net income over the 6.5-year period since emerging from bankruptcy totals to a loss of $316 million, equivalent to diluted net loss per share of $0.61.
- Other comprehensive income is positive at $34 million (EPS effect $0.03).
- Amount taken up in equity to account for 18.4 million shares issued to staff over the 6.5 years is $451 million. This compares to an estimated market value of $394 million at the time of issue of these shares.
- Shares issued in relation to the 2018 Dynegy merger increased common stock shareholders' funds by $2,273 million and issued shares by 113.2 million.
- Costs related to the preference shares issues reduced common stock shareholders' funds by $25 million.
- The company has not accumulated any net income since emerging from bankruptcy, so share repurchases of $4,401 million cannot be claimed to be a form of distribution to common stock shareholders out of earnings. These repurchases represent a reduction of common stock shareholders' capital, funded by borrowings and proceeds of Preference share issues.
- Similar to share repurchases, dividends of $1,254 million have not been paid out of earnings. Dividends have been paid out of capital and funded by borrowings.
- In summary, Vistra came out of bankruptcy and at beginning of 2017 had $6,597 million in common stock shareholders' funds, which funds had declined to $3,359 million by end of June 2023. Table 1.3 below details how this decline has occurred.
Table 1.3
The Board and Management of Vistra appear to be pursuing a course that is greatly increasing the risks for common stock shareholders. After coming out of bankruptcy in 2016, Net assets used in operations of $10,492 million was funded 62.9% ($6,597 million) by Common Stock shareholders equity and 37.1% by ($3,895 million) debt net of cash. By June 30, 2023, net assets used in operations increased to $17,180 million of which $11,821 million (77.9%) was committed to supporting net debt, $2,000 million (11.6%) committed to Preference shareholders, and $3,359 million (19.6%) in which common stock shareholders have an equity claim. So common stock shareholders equity in the net assets of the business has declined from 62.9% to just 19.6% over the space of the past 6.5 years. The danger this creates for common stock shareholders is another event like winter storm Uri could reduce the value of the Net assets used in operations and effectively wipe out their equity share, leaving them exposed to bankruptcy action. The fact there have been no net earnings over the past 6.5 years does not give comfort the company can quickly earn its way out of this position. The company appears committed to continuing with share repurchases and dividend payments, so even if there are positive earnings in the quarters ahead, they are unlikely to result in an increase in common stock shareholder equity.
Summary and Conclusions
The business Vistra is in obviously has its risks, evidenced by past bankruptcy and events such as winter storm Uri wiping out hard earned profits. As described further above the business also faces regulatory risks. In addition to earnings risks, Management's actions over the past 6.5 years have significantly increased balance sheet risk for common stock shareholders. It is believed the promise of possibly solid earnings in future quarters is insufficient to offset the risks entailed in an investment in stock of Vistra at this point in time, and for that reason the stock is downgraded to a Strong Sell.
For further details see:
Vistra: Regulatory Nightmares Compounded By A Weak Balance Sheet (Rating Downgrade)