Introduction
Vistra Corp. (VST, Financial) is an integrated retail electricity and power generation company based in Irving, Texas. The majority of company assets consist of gas and coal generation plants. It also owns a Nuclear generation plant in Texas.
For many years, it operated exclusively in the local Texas market, but in recent years the company engaged in a series of acquisitions, which is helping it to expand across the U.S. One of the biggest deals has been the Dynegy Corp. acquisition, which was announced on Oct. 30, 2017 and closed on April 9, 2018. The $1.74 billion acquisition made perfect sense for Vistra's growth strategy, even if it was an all-stock transaction, potentially diluting existing shareholders' value.
While both Dynegy and Vistra were headquartered in Texas, the former had the majority of its power plants in the U.S. Northeast and Illinois, offering the possibility for Vistra to diversify outside of its home state.
Decarbonization efforts
Vistra has recently announced the Vistra Zero initiative, which provides for the development of zero-carbon power generation facilities, mostly consisting of solar and battery energy storage projects. Moreover, the company announced that, in the short term, it intends to retire all of its coal generation plants in Illinois and Ohio.
For the medium and long-term, Vistra is planning to reduce its CO2 equivalent emissions by 60% by 2030 and become completely net-zero carbon free by 2050.
In order to implement the above mentioned strategy, the company has started working on six solar projects, five of which are expected online in 2021 and one in 2022. All of them are located in the ERCOT (Electric Reliability Market of Texas) market.
As we know, renewable energy sources are intermittent by nature. For example, we can't expect a solar plant to generate power overnight. Of course that could (and, for the present, will) be complemented by gas and coal generation plants, but it can also be provided by battery energy storage facilities. A battery energy storage system is used to store electric charge by using special batteries in order to balance the missing electric load that the company needs in order to provide a stable source of energy.
Vistra is already developing what is considered to be the world's largest battery energy storage project, a 400-MW/1,600-MWh plant which is located in California. Approximately 75% of power capacity will be online by the end of the year, with the rest coming by the end of August 2021.
Inorganic growth
Apart from the big Dynegy deal, Vistra has recently also completed two other minor acquisitions with the intent of diversifying geographically and increasing its scale and number of total customers, which will lead to a more stable and competitive business.
On July 15, 2019, Vistra Corp. completed the acquisition of Crius Energy for about $328 million. The acquisition was funded with cash on hand. With the deal, Vistra acquired an additional 11.6 Tw/h of load and served additional 19 states in the electricity and natural gas market for residential and small business customers.
With the acquisition of Ambit Energy, which cost $475 million plus net woking capital in an all-cash transaction and closed in the fourth quarter of 2019, Vistra added 1.1 million residential customers in 17 states. Vistra's share of the ERCOT residential market also grew from 25% to 32%. The acquisition sported an attractive enterprise-value-to-Ebitda ratio of 3.8 and is set to contribute $125 million per year to Ebitda in the long term.
Financial situation
The company doesn't look attractive at first sight from a financial perspective. It has a Gurufocus Financial Strength rating of 4 out of 10 and a Profitability rating of 5 out of 10. The debt-to-Ebitda ratio is improving after reaching a max of 5.83 at the end of 2018.
In a leverage reduction effort, Vistra has targeted a net debt-to-Ebitda ratio of 2.5 (note that cash on hand is almost negligible compared to the debt size). The company is also targeting a $1.3 billion debt reduction in 2020, most of which has already been paid.
As a consequence of the improved leverage ratios, the company has been recently upgraded to a credit rating of BB+ , and it intends to reach an investment grade rating by 2021.
Vistra has also a quite aggressive profit distribution plan for the next two years, planning up to $1.5 billion of share repurchases and a dividend increase from $0.54 to $0.58 in 2021 and to $0.76 in 2022.
Can Vistra achieve its goals?
Will Vistra be able to accomplish all its ambitious targets? It has good possibilities, in my opinion, if the solar and battery storage projects are smoothly handled and completed and start producing the planned cash flows.
There are several reasons why I got interested in Vistra. One is related to its decarbonization efforts - it is nice to see that the world is progressing towards its planned emissions reduction targets and interesting to understand which solutions are being found and realized to reach them.
Another good point for me is the fact that most of its directors and officers have recently bought stock at prices lower or similar to the current price. Moreover, Vistra represents the biggest position in Howard Marks (Trades, Portfolio)' portfolio (as of the end of the second quarter, it was equivalent to 15.35% of the firm's portfolio).
But what really triggered me to start researching this company is the relation between the projected free cash flow before growth (FCFbG) and its capitalization. For 2020, the company is projecting an adjusted FCFbG range of $2,375 to $2,575.
(Source: Q3 2020 Results Presentation, Year-To-Date FCF and FCFbG)
Vistra defines FCFbG as the free cash flow that the company would generate without taking into account its growth initiatives. For the current year, they consist of solar and battery project related landing developments, purchase of environmental credit and allowances and transition expenses.
While we can't exactly define those as one-shot expenses, they are strictly related to the project execution for the next two years, so the exercise of adding them back to free cash flow gives us a good idea of Vistra's long-term cash generation power.
If we add this to the fact that the company is selling for slightly less than a $9 billion market cap ($18.26 per share share as of the writing of this article), I think that we have a clear value proposition.
Conclusion
Vistra Corp., like many energy-focused companies, is currently engaged in a long term decarbonization effort, which is also the only way it can remain competitive and profitable in the long term.
The bulk of announced solar and battery storage projects will be online by the second half of 2022, contributing to a significant cash flow generation. Some of the coal plants will be discontinued, allowing for lower capital intensity (but more energy load balancing needs) for the future.
The company has recently pursued inorganic growth by acquiring smaller competitors in order to increase its customer base and scale, expanding in different markets and U.S. States.
Of course, the transition is not free of risks as it requires capital, experience, regulatory approvals and a favorable energy market. The risks are mitigated by Vistra's large customer base (around 5 million customers) and the stable nature of the business.
The next quarters will be critical to understand if the company can deliver on its promises.
Disclosure: The author currently does not own shares of Vistra Corp (VST, Financial), but is considering starting a small position.
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