Vistra Energy (VSTE, Financial) is the ex-TXU emerged from bankruptcy late 2016.
TXU was the top utility in Texas. It was bought out by a collection of private equity firms in a $45 billion buyout in 2007, the largest leveraged buyout deal in history. The private equity firms participating in the buyout are among the most regarded, Kohlberg Kravis Roberts, Texas Pacific Group and Goldman Sachs Capital Partners.
The company subsequently changed its name to Energy Future Holdings Corp. Energy Future Holdings had a spectacular fall in April 2014 when the company declared Chapter 11 bankruptcy as natural gas prices plummeted, and the company’s operations could not serve the heavy debt load. On Oct. 3, 2016, Energy Future Holdings emerged from bankruptcy and changed its name to Vistra Energy and sold its transmission and distribution assets. Vistra Energy stock currently is traded on a pink sheet with limited liquidity for large shareholders.
Vistra Energy is the largest merchant power generator and largest electricity retailer in Texas. It generates and sells power into the wholesale market through its subsidiary Luminant and buys power from wholesale market then resells to the end users through its subsidiary TXU Energy. The amount of power TXU Energy sells is about the same as the amount of power Luminant generates.
Luminant has the largest generation fleets in Texas with capacity of 17 GW, or about 20% of share in Texas. The fuel source is diversified with 2.3 GW in nuclear and the rest about equally split between atural gas and coal/lignite. In 2017, Lumina is expected to generate $640 million EBITDA.
Source: company presentation
TXU Energy is the largest retail electric provider in Texas with 1.7 million total customers and 25% of market share. In 2017, TXU Energy is expected to generate $790 million EBITDA.
Source: company presentation
The current CEO, Curt Morgan, is a 35 year power industry veteran who has held leadership responsibilities in nearly every major U.S. power market, including being president and CEO of both EquiPower Resources Corp. and FirstLight Power Resources, Inc. He recently served as a director of Summit Midstream General Partner at Summit Midstream Partners. He has also held leadership positions at NRG Energy, Mirant Corporation, Reliant Energy and BP Amoco.
Currently Vistra have several large private equity firms as a result of the buyout and subsequent bankruptcy.
Financial profile
Merchant power generation is a tough business in that the profitability depends on commodity prices (both power price and fuel). The power price is determined by the marginal cost of the least efficient producers with the highest fuel cost. In most days the power price is determined by the price of natural gas. Fuel cost depends on the prices and mix of different fuel sources. The independent power producers (IPPs) sell the power forward to reduce volatility, but there is no perfect solution as hedges are costly and require a lot of capital. Fundamentally the IPP business is not a good business.
An IPP business with a large retail operation like Vistra Energy is much more stable. The power price to end users is much less volatile than in the wholesale market. This results in a more stable cash flow than pure IPPs.
Source: company presentation
However, the overall earnings of Vistra Energy are still exposed to power price in a significant way. The last 10-year period is probably one of the worst in the company’s long history with natural gas prices dropped from over $10/mmbtu to $2/mmbtu. At the same time, renewables with government subsidies took market share from traditional generation technologies. Vistra’s prebankruptcy predecessor, the competitive electric segment of EFH, saw its EBITDA dropped from $2.8 billion in 2013 to $1.5 billion in 2015. Keep in mind this was a $4 billion EBITDA business in 2010. On the positive side, we think that we are probably through the worst of commodity price declines.
Vistra Energy emerged from bankruptcy with a much stronger balance sheet compared to its peers. The current net debt/EBITDA is 2.1x.
Source: company presentation
Why attractive
Texas' power market has a large size, strong growth and low reserve margin. Texas is the seventh-largest power market in the U.S. The population growth was 8.8% between 2010 and 2016, more than double the U.S. population growth of 3.9%. Texas power demand grew 1.5% per year from 2005 to 2015, compared to -0.6% to 0.8% in other U.S. markets. Reserve margin (which indicates the power supply demand balance) of Texas appears to be the lowest among major U.S. power markets.
Vistra has diversified assets with good cash flows
Due to low natural gas prices, the power price is depressed. It is a hard time for IPPs. Natural gas plants and coal plants have seen margin squeezed and utilization lowered. But Vistra has a large portion of nuclear and lignite capacity that are at the bottom of the cost curve. This gives it a big cushion in profitability. Free cash flow in 2017 is projected to be around $800 million for a free cash flow yield of 11%. Based on $800 million free cash flow, if Vistra Energy pays out 30% as a dividend, then the company would have 3.4% dividend yield and still have $500 million a year paying down the $3.8 billion gross debt or $2.9 billion net quite quickly.
Source: company presentation
Vistra is positively levered to natural gas price
Increase in the natural gas price will improve the profitability of nuclear and lignite generation and also the load factor of coal generation.
Vistra is cheaper compared to peers, who have higher leverage and much less stable earnings.
See valuation for details.
Catalysts
Trading on main stock exchanges will be positive as the stock draws liquidity.
Vistra is a $7 billion market cap company and will only be pink sheet-listed temporarily. When the stock moves to main stock exchanges, the liquidity will improve significantly and also allow institutional investors to buy. It may also be included in major indices and therefore attract demand from index funds and ETFs.
Starting to pay common dividends will be positive to the stock price.
Vistra does not have a common dividend yet. But it paid a $1 billion special dividend or $2.3 per share last December. Given the strong cash flow, there is no reason to doubt that Vistra would install a common dividend when the time is right. That should be positive for shares.
Risks
Natural gas price could continue to plunge. We think the likelihood is small. The signs have been pointing to the upside.
Renewables technologies such as wind and solar, which are subsidized, could continue to take market share from traditional generation technologies. But demand is also growing nicely in Texas. Subsidies to renewable could get worse under the Trump administration. We think the threat of disruption is not immediate.
Regulation risks are not as high as for regulated utilities but still significant. For example, the government's policy toward renewable energy would have significant impact.
Valuation
Vistra has a more stable earnings profile than its peers and lower leverage.
Source: company filings, presentations
But Vistra is priced cheaper due to the facts: 1) It just emerged from bankruptcy, and 2) it is traded on pink sheet. We believe these problems would be over within a year or two. The valuation should catch up with the peers.
Source: company filings, presentations
We think Vistra deserves 9x 2017 EV/EBITDA, slightly higher than its peers’ average of 8.9x. Our target price is $23 per share for 37% upside. If the energy price goes up, there is more upside. There is a risk that the utilities sector could be sold off as the interest rate goes up. But Vistra is not a regulated utility. The downside of sector selling off should be more than offset by the upside from higher energy prices as a result of higher inflation and growth. In fact, NRG, Dynergy, and Calpine all underperformed the Standard & Poor's 500 utility index significantly over the last two to three years due to the collapse of energy prices.
Source: gurufocus.com
If an investor worries about utilities stocks selling off or market risk, one could hedge his long position in Vistra by shorting NRG Energy (NRG, Financial). But the risk is NRG is more leveraged to power price and also have higher financial leverage.
Disclosure: We do not have a position in Vistra Energy.
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