According to aggregated second quarter 13F filing data, the second-largest stock buy among significant value funds last quarter was Vistra Energy Corp. (VST, Financial). Vistra made it into the top 10 thanks to activity from one large investor, Howard Marks (Trades, Portfolio).
During the quarter Marks acquired 50.3 million shares of the company at an average price of $16.80 per share, making it the largest holding in his equity portfolio accounting for 25.3% of the $3.34 billion equity portfolio managed by his firm Oaktree Capital Management.
One of the greats
Marks is one of the greatest value and distressed debt investors alive today, and his ownership of more than 50 million shares of Vistra is a huge vote of confidence in the company and its management. It also signals that he believes the firm is significantly undervalued.
So what's to like about Vistra?
Well, at first glance there's nothing that stands out. The firm has a market capitalization of $7.6 billion and an enterprise value of $11.2 billion. The company is an energy company that is focused on energy and power generation markets in Texas via two subsidiaries, Luminant and TXU Energy. Luminant generates and sells electricity and related products from its fleet of generation facilities totaling approximately 17,000 megawatts of generation in Texas while TXU Energy sells retail electricity and services to approximately 1.7 million residential and business customers in Texas.
Based on figures for the end of 2016, the company is currently trading at a price-book (P/B) value of 1.1 and a price to tangible book value of 4.2. Wall Street estimates suggest the firm will earn 59 cents for 2017 giving a forward price-earnings (P/E) ratio of 23.7.
Recovering from the lows
Vistra's back story is an interesting one. The company was formerly known as TXU and was taken private in 2007 following a leveraged buyout that left the company with more than $40 billion in debt; Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) invested $2 billion in the debt and in 2013 lost nearly half of its investment. Plunging natural-gas prices tipped the company into bankruptcy in 2014. After restructuring, the new, leaner Vistra emerged from the ashes of TXU last year, and after strengthening its balance sheet, the company looks like a cheap defensive investment. Net gearing is around 54% or two turns of estimated 2017 EBITDA. Peers such as NRG (NRG, Financial), Dynegy (DYN, Financial) and Calpine (CPN, Financial) have ratios of around six times.
As well as a strong balance sheet, the company also has a robust free cash flow, which is estimated to come in at around $745 million to $925 million for 2017, giving a free cash flow yield of around 12.2% at the high end. Wall Street estimates of how much the company could pay out in dividends in the bull case are as high as $2 per share, giving a yield of around 11.4% (a more conservative projection is $1 per share giving a yield of 5.6% and leaving room for expansion through acquisitions).
Cheap, high-quality growth
For Marks, Vistra seems to be a simple bankruptcy recovery play. The company has a strong balance sheet with room for growth as well as plenty of free cash flow, putting the company in prime position to take advantage of the depressed Texas power market. Any recovery in energy prices would be a boon for Vistra. Electricity is around $25 per megawatt/hour in Texas; the 2017 average is expected to be about $30. A $5 per megawatt/hour, or 16%, increase in Texas power prices would lift Vistra’s annual EBITDA by about $270 million.
What's more, wholesale supplier Luminant's largest customer is residential supply company TXU, which means income is sticky and Vistra can offer customers better prices through vertical integration.
As an example of what the company can do, management recently closed a $350 million deal to buy a 1,054 MW gas power plant in West Texas to boost capacity, grid flexibility and give the company exposure to deeply discounted gas supply from the Permian Basin.
Disclosure: The author owns no share mentioned.
