Our summary bullet points are similar to the first note we posted on Vista Corp. (NYSE: VST) about 18 months ago (link to article). Winter storm Uri effectively delayed the completion of our original thesis. Although VST stocks performed well given their circumstances, they did not outperform the broader market as we had expected. We believe management has done well in weathering winter storm Uri and we also believe Vistra is once again well positioned to outperform over the next 12-18 months.
The broader market is facing substantial headwinds while VST has a number of positive catalysts. Consider the broader market headwinds: (1) the U.S. economy is expected to slow as households received stimulus checks a year ago and those won’t arrive in 2022, creating a negative income comparison of d year over year and therefore a negative PCE comparison (2) High inflation in basics such as food and fuel not to mention housing translates into less purchasing power elsewhere (3) The Fed raises interest rates with market prices in 7 rate hikes (4) Fed allows US government securities to mature without buying back i.e. quantitative tightening (5) War between Ukraine and Russia has contributed to the spike in commodity prices, which in turn contributes to further curb economic growth (6) New outbreaks/hotspots of Covid19 cases. The main tailwinds are the lifting of Covid19 mandates and the fact that geopolitical risks make it more likely that the Fed will raise interest rates at a gradual pace rather than the 50 basis point hikes going forward.
Compared to the major market headwinds, there are a number of headwinds for Vistra Corp. :
- Debt Reduction: Vistra reduced debt by $625 million in 4Q21 and says it is on track to reduce debt by $1.5 billion by the end of 2022.
- Potential for credit rating improvement: Based on projected EBITDA and debt, Vistra is on track to achieve investment grade status by 2024 at the latest.
- Dividend growth: Board approved DPS increase of 13% to $0.17/t/share and plans to return $300 million to shareholders via dividends in 2022
- Free Cash Flow: With a mid-2022 Adjusted EBITDA guidance of $3.06 billion, Vistara is expected to generate FCF before the ex growth cap of $2.07-2.57 billion. With a projected ex cap of $600 million, there is ample firepower for share buybacks.
- Share buyback program: Issuing $2 billion in preferred stock last year not only allowed Vistra to reduce its debt, but also allowed it to execute $764 million in share buybacks until February 22. $1.236 billion remains under the share buyback program and the company has the ability to issue an additional $500 million of preferred stock under the term of the existing preferred stock outstanding (which we assume they are doing to get closer to management’s debt reduction goals).
We believe Vistra Corp shares offer investors one of the most attractive opportunities, not only in the broader market, but also in the utilities sector. Given the broader market headwinds, the utilities sector offers stability as well as non-discretionary service for consumers. Vistra adds to the sector in that it is well positioned for an eventual credit upgrade as it plans to achieve investment grade credit quality metrics by the end of 2023. As such, we expect VST to be able to achieve an investment grade credit profile by mid-2024 at the latest.
VST is trading at a steep discount to the utilities sector and the market, as it is primarily a merchant generator. Currently, it is trading at around 6x EBITDA EV/FY 2 as well as a forward P/E in the lower double digits.
A significant catalyst is that VST generates over $2 billion a year in FCF, which is about 20% of its current market value. This type of cash flow means VST can reduce debt such that it should reach investment grade credit metrics by the end of 2023 and fall well below leverage levels for credit. investment grade by mid to late 2024. FCF yield is expected to reach low double digits this year and next and reach mid-teen yield by 2025. Once the credit investment grade achieved, we believe the valuation multiple should be re-evaluated upwards, and we suggest stocks should reach at least $27/share by 2023 and by 2023 should reach low to mid USD 30 , which is about 50% higher than where the shares are currently trading. The $1.236 billion from VST’s share buyback program is also expected to help boost VST’s stock price.
On the risk side, we discussed in (our previous article) the issues surrounding the Texas power market and the reserve margin outlook.
VST shares are also trading at a low multiple of earnings and EV/EBITDA. VST is likely to generate approximately $2 billion per year in free cash flow and achieve investment grade credit metrics by 2024 at the latest. The company’s large free cash flow relative to market capitalization suggests that VST itself could be the biggest source of additional stock purchases and, by itself, drive the stock higher. Given these factors, we believe that VST shares offer an attractive opportunity for investors.