2023-10-19 08:08:11 ET
Summary
- Vistra Corp. has delivered on the bullish call we made on March 31, 2022, with total return of approximately ~44% vs -1.5% return on the S&P500.
- Through modest EBITDA growth, strong FCF, and share buybacks, we believe VST has the potential to deliver ~20% CAGR through 2028.
- We expect VST free cash flow to average $1.9B-$2.1B annually over the next five years or ~11%-16% per year of VST’s projected market cap.
- Vistra should reach investment-grade status by the end of 2026, a potential catalyst for rerating to the upside.
- Risks: Energy Harbor merger integration, power prices, cost of capital, regulatory policy and valuation.
Background
To review: Vistra (VST) is the largest competitive power generator in the US with 37 gigawatts ((GW)) of capacity which is enough to supply power to 20mm homes. Vistra's generation fleet includes 2.4GW of renewable energy and storage assets online, a near-term pipeline of renewable energy and storage projects, 2.4GW of nuclear power (4th largest merchant of nuclear power in the US). Vistra also has 4 million retail customers across the US. In addition, Vistra announced plans in March to acquire Energy Harbor, which has 4GW of nuclear power and 1 million retail customers.
Source: Vistra Investor Presentation/July 2023
Energy Harbor:
- Back in March of this year, Vistra agreed to acquire Energy Harbor. The Energy Harbor acquisition combines the nuclear, retail, and renewable energy businesses of Vistra with the nuclear and retail businesses of Energy Harbor into a new subsidiary called Vistra Vision. The 4GW of nuclear generation (2nd largest fleet of merchant nuclear power in the US) owned by Energy Harbor combined with Vistra's nuclear generation assets will result in 6.4GW of nuclear power. The retail customers of Energy Harbor combined with Vistra's retail customers will result in 5 million retail customers and Vistra Vision will also have 2.4GW of renewable energy projects and a sizable pipeline of renewable energy and storage asset opportunities. The combination will advance Vistra from #14 in terms of clean net generation to #6 in the US with 54 TWh. In terms of merchant nuclear generation, Vistra would advance from #4, to #2 in the US.
Source: Vistra Investor Presentation/July 2023
- With its 2Q release, Vistra reiterated its view that the Energy Harbor transaction is expected to close during Q4. The acquisition is expected to generate a run-rate contribution to adjusted EBITDA of $900mm and 65-70% of that adjusted EBITDA to convert to FCF before growth capital. On September 29, Energy Harbor received approval from the Nuclear Regulatory Commission to transfer its operating license to Vistra. Vistra is still waiting for approval from the Federal Energy Regulatory Commission.
Source: Vistra Investor Presentation/July 2023
The Energy Harbor acquisition involves a combination of cash and a 15% ownership in Vistra Vision. $450 million in pre-capitalized financing was arranged in Q2 and which returns cash to Vistra's balance sheet. Vistra executed the remaining acquisition financing in September via $1.75B of privately placed senior notes.
Investment Thesis
Vistra has significantly outperformed over the last eighteen months, delivering a price return of ~37% (44% total return) compared to a price return of the S&P500 -4% (-1.5% total return) and -20% (-16.6% total return) from the Utilities Sector. Our call from 3/31/2022 can be found here: Vistra Stock: Still Bullish On Value, FCF, Improving Balance Sheet ( VST ) | Seeking Alpha .
We believe Vistra is well positioned to sustain its outperformance vs utilities and the broader market in the months ahead. The broader market faces substantial headwinds while VST has a number of positive catalysts.
Consider the broader market headwinds:
(1) Ongoing UAW labor strike
(2) Threat of a Federal government shutdown mid-November as the Republican caucus search for a new Speaker of the House
(3) Tightening energy markets.
(4) Resumption of student loan repayments constraining growth in consumer demand.
(5) Voracious Federal government financing needs of over $2T in 2023 and $2T in 2024.
(6) Depletion of excess savings from Covid19.
(7) Surging interest rates based on a combination of stronger than expected economy, rising US Treasury issuance to fund Fiscal commitments, stubbornly high y/y inflation (though last 3-months annualized core PCE has been encouraging).
(8) Geopolitical risks: the war between Israel and Hamas, Ukraine-Russia and the potential for a takeover of Taiwan from China and the security threat to the US from an open southern border. The offset to the numerous headwinds is that the market is set to flip to the most bullish season of the year. Over the last 20 years the DJIA has seen monthly gains average 1% in each of Oct, Nov, December with positive returns 2/3 of the time and the last three times that the S&P500 lost at least 1% in August and September, it saw big bounce in October of over 8% in each of 2022, 2015, and 2011. The other pushbacks to the headwinds are peak Fed, positive corporate commentary heading into Q3 earnings, 2024 earnings rebound, healthy consumer and corporate balance sheets.
In contrast to the broad market headwinds, consider the potential tailwinds/catalysts for Vistra Corp.:
(1) Debt reduction: Vistra's Debt/Adj EBITDA has fallen from 3.8x at the end of 2022 to 3.0 currently, is expected to exit 2023 at 3.0x, and drive Debt/Adj EBITDA to below 2.5x by the end of 2026 based on its strong FCF outlook. Based on prior disclosures during quarterly earnings calls, we assume that is sufficient for VST to achieve investment grade status and presumably a re-rate to the upside.
(2) Credit rating upgrade potential: Based on my forecast of EBITDA and the Vistra balance sheet, Vistra's debt/Adj EBITDA is expected to fall below 2.5x by YE 2026 which we assume would put it in position to have its debt upgraded to investment grade status, which in turn has the potential to open up VST to a larger pool of investors and a potential re-rate to the upside in valuation.
(3) Dividend growth: Management continues to target $300mm in annual dividend return to shareholders. Given the sizable share repurchase authorization and an assumed 10% increase in total dividends paid each year, the DPS is expected to increase by 18% in 2023, high single digits in 2024 and mid to high teens or higher thereafter if we assume a 10% increase in total payout in combination with share repurchases.
(4) Free cash flow: Following the close on the Energy Harbor assets at the end of 2023, and with 2024 midpoint Adjusted EBITDA guidance of $4.7B, we expect Vistra to generate FCF before growth cap ex but after dividends of approximately $1.9-$2.1B over each of the next five years.
(5) Share Repurchase Program: Vistra management guidance on the 2Q23 earnings call flagged the $1.35B in authorized share repurchases remaining and indicated that it is expected to complete this program by the end of 2024. We are modeling share repurchases in 2025 and 2026 to $1000mm per guidance. We are forecasting an increase in share repurchased to $1,300MM in 2027, $1,600mm in 2028, $1900mm in 2029, and $2,200mm in 2030 or a total of $10,150mm from 2024-2030 which represents over 80% of VST's current market value. Even with all the share repurchases we are forecasting VST can still reduce its Net debt/adj EBITDA to the low 2.0x's by 2028.
(6) In turn, the reduction of the shares outstanding combined with modest increases of 3% CAGR in adjusted EBITDA results in a ~20% compounded total return going based on the appreciation in the value of VST based on a conservative valuation of 6x EBITDA. More on valuation and total return prospects below.
Source: Vistra Investor Presentation/2Q 2023
- Hedge Position: Vistra is 86% hedged for the 2023-2025 time frame with 98% hedged for the balance of 2023 as of August, 95% hedged for 2024. ERCOT spark spread are hedged above $40/MWh from 2023-2028 for peak hours. For off-peak hours prices step down from above $30/MWh in 2023 to ~$30/MWh in 2024, to ~$20/MWh in 2025 and 2026. At PJM the peak hour prices are hedged at ~$40/MWh from 2024-2028 and ~$20/MWh for the off-peak hours 2024-2028.
Source: Vistra Investor Presentation/2Q 2023
Valuation
Given the increase in interest rates, the utility sector has pulled back significantly and has made it the worst performing sector this year.
Source: Factset through 10/13/2023
However, Vistra is not a typical utility that is typically tied to rate cases, system upgrades, and customer additions to generate EPS growth. Vistra, being a merchant generator with strong cash flow and strong balance sheet, adds a different value proposition in that it has been able to produce stronger EPS growth by taking advantage of market volatility to lock in advantageous power prices, as well as taking advantage of strong FCF to buy back its stock. In addition, the strong cash flow has VST well positioned to achieve investment grade credit metrics by the end of 2025 or early 2026 as we mentioned earlier.
Being a merchant generator, VST trades at 6.6x EV/FY1 EBITDA, which represents a steep discount to the utility sector and the S&P500.
Source: Factset Source: Factset Source: Factset
Target Price and Total Return Outlook - 20% CAGR looks achievable.
As we pointed out above, a significant positive catalyst is that VST is expected to generate $1.9B-$2.1B/year in FCF. This cash flow means that VST can drive debt lower such that it should achieve investment grade credit metrics by YE2026 and drop well below the debt levels for investment grade credit thereafter. Applying a conservative 6.0x EV/EBITDA VST shares would reach the mid-$40s by the end of 2025 and including dividends could deliver a return of ~50%. Over the longer term VST shares would deliver a compounded return of ~20%-21% per year and greater than 150% in five years. We believe such a return would be likely to substantially outperform both the utility sector and the S&P500.
Source: Factset, Principal Street estimates
Risks
Risks include the electricity futures market, weather anomalies, the reserve margin in electricity markets, integration of the Energy Harbor acquisition, ability to take advantage and lock in attractive pricing in the electricity market, regulatory policy, ability to take advantage and lock in attractive pricing for the cost of fuel, renewable energy growth and penetration into electricity markets, the cost of capital and its potential impact on development of renewable energy projects.
Conclusion
VST is trading at a multiple of EV/EBITDA that is below its historic average (6.6x vs historical average of 7.4x). VST is on track to generate ~$1.9-$2.1B/year in annual free cash flow for the next few years and reach investment grade credit metrics by 2026. The large free cash flow relative to market capitalization puts VST in position to continue to return large amounts of capital to shareholders through dividends and share buybacks, consistent with the company guidance of its intention to return ~$1.3B each year to shareholders. The free cash flow also puts VST in position to drive debt levels lower, making the balance sheet stronger. Considering the positive outlook, in which we believe VST shareholders could average 20% CAGR/year over the next five years, we believe that VST shares continue to offer a compelling opportunity for investors.
For further details see:
Vistra: We Believe In The Potential For Strong CAGR The Next 5 Years