Fitch Ratings has assigned a 'BB-'/'RR6' rating to the proposed series B fixed-rate reset cumulative redeemable green perpetual preferred stock (Series B preferred stock) to be issued by Vistra Corp.
The net proceeds from the issuance will be used for eligible green expenditures. The 'RR6' denotes poor recovery in the event of default.
Fitch rates Vistra's Long-Term Issuer Default Rating (IDR) 'BB+'. The Rating Outlook is Negative, reflecting a significant shift in management's capital allocation policy. In October, the Vistra Board authorized a $2.0 billion share buyback program over 2021-2022, just a few months after it had suspended share repurchases following winter storm Uri. The resulting increase in gross debt to EBITDA to 3.5x in 2022 reverses management's previous deleveraging path. Management is targeting more than $7.5 billion in return of capital to shareholders through year-end 2026 in the form of share repurchases and dividends.
Key Rating Drivers
Allocation of Equity Credit: The Series B preferred stock will receive 50% equity credit based upon Fitch's 'Corporate Hybrids Treatment and Notching Criteria' dated Nov. 12, 2020. The features supporting 50% equity credit include an ability to defer dividend payments for at least five years and cumulative feature of deferred dividends. The Series B preferred stock are pari passu with the 8.0% $1.0 billion cumulative redeemable perpetual Series A preferred stock (Series A preferred stock) issued in October to partly fund the announced share buyback program.
Upward Ratings Movement Unlikely: Management's updated capital allocation plan calls for a return of at least $7.5 billion of capital to shareholders through year-end 2026. While management still aspires to achieve an investment-grade rating, this goal has been pushed forward by a few years. Fitch expects gross debt to EBITDA to be approximately 3.5x in 2022, which is at the cusp of the 'BB+' and 'BB' rating levels. We would prefer to see some headroom in metrics before revising the Outlook to Stable.
Sustained gross leverage above 3.5x is likely to lead to a downgrade of the IDR, senior unsecured notes and the Series A and Series B preferred stock. The ratings of the senior secured debt at 'BBB-' may not be affected by a potential downgrade of the IDR by up to one-notch.
Resolution of Negative Outlook: The future ratings trajectory for Vistra will depend upon near-term credit metrics and greater clarity on planned investments into renewable and battery storage opportunities. Fitch will also assess Vistra's business risk profile in the context of any changes to market design that the Electric Reliability Council of Texas (ERCOT) may implement and performance of Vistra's general fleet and the broader ERCOT market as a whole in the event of future, extreme weather events.
Measures to Mitigate Future Risks: Fitch views favorably the steps management is taking to address gas deliverability and fuel handling issues, which were the key drivers of the financial loss Vistra experienced earlier this year due to winter storm Uri. These include additional weatherization of the generation fleet, including for coal fuel handling, plans to install dual fuel capabilities at the gas steam units, expanding fuel oil inventory at existing dual fuel combustion turbine sites, contracting for additional natural gas storage and maintaining greater generation length during peak periods.
Legislation passed in Texas has provided for additional risk mitigation for power generators dependent upon a reliable natural gas supply. These include legislation that mandates winterization of gas infrastructure and their registration as critical with the transmission and distribution utilities so as to prevent loss of power during load shedding. These measures alleviate Fitch's concerns around gas fuel supply availability during extreme weather events.
ESG Considerations: Vistra has an ESG Relevance Score of '5' for Exposure to Environmental Impacts due to the effects of recent severe winter weather, which has had a negative impact on Vistra's credit profile. The storm has exposed deficiencies in ERCOT's market design and ability to keep the grid functioning well in the face of an extreme weather event, which increases the risk of owning power generation and retail electricity businesses in the state. The financial hit to Vistra as a consequence of the weather event will result in a jump in near-term leverage.
Vistra is well-positioned relative to Calpine Corporation (B+/Stable) and Exelon Generation Company, LLC (ExGen; BBB/Rating Watch Negative) in terms of size, scale and geographic and fuel diversity. Vistra is the largest independent power producer in the country, with approximately 38.5GW of generation capacity compared with Calpine's 26GW and ExGen's 33GW. Vistra's generation capacity is well-diversified by fuel, compared with Calpine's natural gas-heavy and ExGen's nuclear-heavy portfolio. Vistra's portfolio is less diversified geographically, with 70% of its consolidated EBITDA coming from operations in Texas, which is similar to the Midwest-dominant portfolio of ExGen. Calpine's fleet is more geographically diversified.
Both Vistra and ExGen benefit from their ownership of large retail electricity businesses, which are typically countercyclical to wholesale generation given the length and stickiness of customer contracts. Vistra has a dominant position in the mass retail market in Texas, which has generated stable EBITDA over 2012-2019 despite power price volatility. A key benefit of acquiring Dynegy has been the significant increase in share of natural gas-fired generation, which lowered Vistra's EBITDA sensitivity to changes in natural gas prices and heat rates. Fitch estimates that Vistra's EBITDA is less sensitive to changes in natural gas prices than ExGen or Calpine.
Fitch projects Vistra's gross debt/EBITDA to increase to approximately 7.5x in 2021 due to the February storm impact and preferred stock issuance, but then decline to 3.5x in 2022, which compares favorably with Calpine's projected mid- to high-4.0x leverage by 2022. ExGen's expected leverage is higher than recent historic periods reflecting the EBITDA impacts of lower power prices and power plant closures.
Fitch's Key Assumptions Within Our Rating Case for the Issuer Include:
Hedged generation in 2021 and 2022 per management's guidance;
Power price assumption based on Fitch's base deck for natural gas prices of $3.40/million British thermal units (MMBtu) in 2021, $2.75/MMBtu in 2022 and $2.45/MMBtu in 2023 and beyond, and current market heat rates;
Retail load of approximately 90TWH-100TWH annually;
Capacity revenues per past auction results, and no material upside in future auctions;
Maintenance capex of approximately $550 million annually;
EBITDA hit from Storm Uri of $1.625 billion;
Debt paydown of $1.0 billion in second half of 2021; and
Share repurchases of $2.0 billion in 2021 - 2022 funded by issuance of Series A preferred stock and receipt of storm securitization proceeds.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Further upgrades appear unlikely over the next 12-18 months;
Rating Outlook could be stabilized if gross debt/EBITDA is below 3.5x on a sustained basis and the company demonstrates track record of stable EBITDA generation, measured approach to growth and continued emphasis on an integrated wholesale-retail platform.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Gross debt/EBITDA above 3.5x on a sustained basis;
Weaker power demand and/or higher than expected supply depressing wholesale power prices and capacity auction outcomes in its core regions;
Unfavorable changes in regulatory constructs and market;
Rapid technological advancements and cost improvements in battery and renewable technologies that accelerate the shift in generation mix away from fossil fuels;
An aggressive growth strategy that diverts a significant proportion of FCF toward merchant generation assets and/or overpriced retail acquisitions.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Adequate Liquidity: Fitch views Vistra's liquidity as adequate. As of Sept. 30, 2021, the company had approximately $2.1 billion of liquidity available consisting of $351 million of cash in hand and $1.7 billion available capacity under its $2.73 million revolving credit facility due June 2023. The company also has bilateral facility of $250 million that expires December 2021 of which $250 million of LCs were drawn as of Sept. 30, 2021. Debt maturities are modest until 2023.
Vistra has an ESG Relevance Score of '5' for Exposure to Environmental Impacts due to the effects of recent severe winter weather, which has had a negative impact on Vistra's credit profile. The storm has exposed deficiencies in ERCOT's market design and ability to keep the grid functioning well in the face of an extreme weather event, which increases the risk of owning power generation and retail electricity businesses in the state. The financial hit to Vistra as a consequence of the weather event will result in a jump in near-term leverage.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
Vistra is the largest independent power generator in the U.S. with approximately 38,500 MW of capacity. Vistra Retail is one of the largest retail providers in the country with roughly 85 TWHs of load and 4.6 million customers.