THE AES CORPORATION EQUITY RESEARCH REPORT 1 Luke MacAdam [email protected] | 330.407.1140 June 26, 2015 Ticker NYSE: AES Sector Utilities Industry Electric Utilities Recommendation BUY Current Price $13.46 Target Price $19.67 Upside +46.2% Dividend Rate $0.30 Dividend Yield 2.30% Total Projected Return +48.5% Shares Outstanding 682.4 Market Cap $9.056B 52 Week High $15.65 (6/30/14) 52 Week Low $11.53 (2/10/15) FY14 Sales $17.294B FY14 Operating Profit $3.182B FY14 EBITDA $4.521B FY14 Total Debt/Equity 281.75 Beta 1.09 Trailing P/E 11.04 Trailing P/S 0.57 Trailing EPS 1.22 Trailing EV/EBITDA 7.63 Estimated PEG Ratio 1.66 The AES Corporation Company Brief AES is a global power company that owns and/or operates power plants to generate and sell power to customers, such as utilities, industrial users, and other intermediaries. It uses a range of fuels to generate electricity, including natural gas, coal, hydro, wind, energy storage, oil, diesel, petroleum coke, biomass, landfill gas, and solar. 1 Investment Thesis As AES is leaving markets where it does not see growth opportunity, CEO Gluski continues to use his previous Latin America experience to navigate future opportunities. AES continues to signal strong signs for the future in their debt repayment, increased dividend rates and share buyback program. DCF, relative, trend and sector valuations all show the current stock price as underpriced leading to a buy recommendation. Recommendation risks • With a large portion of AES’ business overseas and in emerging markets, political, economic, and currency-related risks pose a threat to AES revenues and future projects. • In a highly levered industry, interest rates are always of concern. With US interest rates set to rise after a period of unprecedented low rates, AES must ensure these rates do not slow down projected growth. • Environmental regulations around coal remain an area of concern as the EPA continues to crack down on reducing carbon emissions. 1 Yahoo! Finance Business Summary (http://finance.yahoo.com/q/pr?s=AES) $10 $11 $12 $13 $14 $15 $16 6/26/14 9/26/14 12/26/14 3/26/15 6/26/15 AES 1 Yr. Stock Ticker (close)
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THE AES CORPORATION EQUITY RESEARCH REPORT 1
Luke MacAdam [email protected] | 330.407.1140 June 26, 2015 Ticker NYSE: AES Sector Utilities Industry Electric Utilities Recommendation BUY Current Price $13.46 Target Price $19.67 Upside +46.2% Dividend Rate $0.30 Dividend Yield 2.30% Total Projected Return +48.5% Shares Outstanding 682.4 Market Cap $9.056B 52 Week High $15.65 (6/30/14) 52 Week Low $11.53 (2/10/15) FY14 Sales $17.294B FY14 Operating Profit $3.182B FY14 EBITDA $4.521B FY14 Total Debt/Equity 281.75 Beta 1.09 Trailing P/E 11.04 Trailing P/S 0.57 Trailing EPS 1.22 Trailing EV/EBITDA 7.63 Estimated PEG Ratio 1.66
The AES Corporation Company Brief AES is a global power company that owns and/or operates power plants to generate and sell power to customers, such as utilities, industrial users, and other intermediaries. It uses a range of fuels to generate electricity, including natural gas, coal, hydro, wind, energy storage, oil, diesel, petroleum coke, biomass, landfill gas, and solar.1
Investment Thesis As AES is leaving markets where it does not see growth opportunity, CEO Gluski continues to use his previous Latin America experience to navigate future opportunities. AES continues to signal strong signs for the future in their debt repayment, increased dividend rates and share buyback program. DCF, relative, trend and sector valuations all show the current stock price as underpriced leading to a buy recommendation. Recommendation risks • With a large portion of AES’ business
overseas and in emerging markets, political, economic, and currency-related risks pose a threat to AES revenues and future projects.
• In a highly levered industry, interest rates are always of concern. With US interest rates set to rise after a period of unprecedented low rates, AES must ensure these rates do not slow down projected growth.
• Environmental regulations around coal remain an area of concern as the EPA continues to crack down on reducing carbon emissions.
1 Yahoo! Finance Business Summary (http://finance.yahoo.com/q/pr?s=AES)
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Table of Contents
COMPANY OVERVIEW 3
SEGMENTS 3 BUSINESS MODEL 4 COMPETITION 4 CURRENT ISSUES 5 RECENT NEWS 5
INVESTMENT ANALYSIS 6
ECONOMIC ENVIRONMENT 6 INDUSTRY CATALYSTS 7 INDUSTRY OUTLOOK 8
APPENDIX A – AES CORP GENERATION BUSINESS (AS OF MAY 11, 2015) 15 APPENDIX B – AES CORP DISTRIBUTION BUSINESS (AS OF MAY 11, 2015) 16 APPENDIX C – INCOME STATEMENT FORECASTS 17 APPENDIX D – DISCOUNTED CASH FLOW MODEL 19
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Company Overview The AES Corporation, headquartered out of Arlington, Virginia, is a global power company that owns and operates a portfolio of electricity generation and distribution businesses that provide energy to customers in 18 countries across 4 continents. A large firm with approximately 18,500 people in their workforce, AES owns eight utility companies that make up over 100 power plants with a generating capacity of 35 gigawatts (GW). Outside of their generation and distribution businesses, AES is recognized as a world leader in the use of lithium ion batteries for energy storage. Figure 1 below shows the broad range of locations that AES sees its Pre-Tax Contributions (PTC) from as well as the types of fuel used. For a full list of countries of operation and fuel types for each region, see Appendices A & B.
Figure 1: AES Business Locations and Fuel Types Since Andrés Gluski took over as President and Chief Executive Officer of AES in
September 2011, there has been much change to the direction of the company. AES has exited 10 markets and also currently has over 7,000 MW under construction with more development projects underway. These moves have reduced overhead costs and accelerated growth in investments.
Segments AES has two major lines of business – its generation and distribution businesses. Under
the generation business line, the company owns and operates power plants to generate and sell power to customers, such as utilities, industrial users and other intermediaries. Under the utilities business line, the company owns and operates utilities to generate or purchase, distribute, transmit and sell electricity to end-user customers in the residential, commercial, industrial and governmental sectors within a defined service area. Its utilities also generate and sell electricity on the wholesale market.2 Based on AES’ 2014 10-K filing to the SEC, revenues were split nearly 50-50 between the two lines of business in 2014, with regulated revenues 2 eTrade’s AES Company Overview - http://bit.ly/1KhYhxx
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(utilities) listed with sales of $8,874 M (51.8%) and unregulated revenues (generation) listed with sales of $8,272 M (48.2%). The generation business sees slightly more of a contribution to the operating margin, with 56.5% of earnings coming from unregulated revenue. More details of where AES has its generation and distribution businesses can be found in Appendices A & B.
Business Model During the latest investor presentation in May of this year, AES laid out four concrete
areas they believe to have value for their investors.3 First, they called out the great job management has done on execution of the company strategy, especially since Gluski has taken over as CEO. Management continues to reduce risk by exiting non-core markets and recycling capital, improving profitability by a 1/3rd reduction in overhead costs and improving capital allocation with a 20% parent debt reduction & 10% share count reduction while expanding profitable platform expansions. Secondly, AES has highly visible growth through 2018 with a $1.3 billion equity investment in existing construction of which 70% is funded. AES is projecting this to increase EPS by 6%-8% in 2017-2018 while creating 10%-15% annual free cash flow growth in 2015-2018. The third part of AES’ value proposition is their attractive free cash flow valuation, with $1,175 billion proportional free cash flow in 2015, offering about a 13% free cash flow yield. Lastly, AES also has a competitive divided which they have recently upgraded to a $0.10 quarterly dividend for a 3.3% annual yield, which they expect to grow 10% annually.
As with a commodity such as power, finding a competitive advantage can be difficult, especially for a company as large as AES. AES does seem poised well for the alternative energy business as these alternatives become more economically accessible, with generation capabilities in hydro, wind and solar outside of the traditional fuel sources of gas, oil and diesel. AES also believes their early advantage in energy storage will help create an advantage over other companies, as they believe their lithium ion battery storage creates a dependable, cost competitive energy alternative.4 AES also sees a lot of growth opportunities in emerging markets and will continue to seek out these opportunities as they arise. They have a stable source of revenues into the future as their medium- and long-term contracts have an average of 7 years remaining which will help ease concerns as they take on additional risk into emerging markets. Being such a large utilities company, AES further hopes to use its economies of scale for greater purchasing power as they bid for their long-term contracts.
Competition Electricity creates a natural monopoly at the individual consumer level – normally there is only one power source connected a house and consumers do not get to choose who generates their power. At the generation and distribution level this is good news – most operate as monopolies within a certain geographical area set by regulatory agencies. Distribution does face challenges as the US begins to deregulate their power markets – for example AES’ subsidiary Dayton Power & Light (DPL) in Ohio has struggled since being acquired by AES as Ohio has deregulated their markets. Customers now have a choice where they buy their power from, which typically lowers margins and eliminates switching costs. As with many
3 AES May Investor Presentation: http://www.slideshare.net/AES_BigSky/may-investor-presentation-48157848 4 AES Energy Storage Advantages: http://www.aesenergystorage.com/advancion/advantages/
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other markets, M&A activity occurs within the utilities sector, as companies want to expand both their market share as well as differentiate the types of fuel they deliver to customers. AES faces most of the competition in contracted generation businesses prior to the execution of a power sales agreement during the development phase of a project and as contracts near expiration and they seek to extend contracts or seek new contracts with other customers. Due to the long-term nature of sales contracts, they generally face very limited competition during the operational phase.5 AES’ competitors differ by market – in the US some other major power companies include Duke Energy Corporation (DUK), American Electric Power (AEP), Exelon Corporation (EXC) and Consolidated Edison, Inc (ED). Overseas, major competitors are Power Grid Corporation of India Ltd., Edison International (EIX), National Grid PLC, and Centrica PLC. These major competitors, along with smaller companies who want to compete based on specializations unique to geographical location, will bid against AES as they hope to lock down contracts that can last anywhere between 1 to 25 years.
Current Issues While AES has exited 10 markets where they see limited growth potential over the past
four years, one area that is still a concern is Dayton Power & Light (DPL). Since acquiring DPL in 2011, the Ohio coal-fired power plants have negatively impacted AES earnings. AES continues to wait on the outcomes of AEP and FirstEnergy proposals to the state regulator to enter into modified power purchase agreements between their unregulated generation and regulated affiliates. While Ohio’s path to full deregulation of electricity generation could have a significant upside once power prices recover, AES must continue to monitor the situation to ensure future gains do not outweigh the negatives being seen currently.
As Brazil experiences a drought, AES’ hydro plants in Latin America have been negatively impacting the company, as they have to purchase high-priced power to help subsidize their plants. Morningstar reported in November of 2014 that since the rainy season began that same month, a lack of rainfall has caused low reservoir levels and the impact due to poor hydrology was estimated to reduce 2014 full-year earnings by $0.10 per share.6 Similarly, in AES’ May 2015 investor presentation, they are expecting a $0.07 per share impact from poor hydrology in Brazil. Hydro conditions are expected to improve in the future which will lift earnings in Latin America.
Recent News • AES announces ~60 million share offering, 20 million of a buyback program7: In May, AES
announced a secondary share offering of 60 million shares from a subsidiary of China Investment Corporation (CIC). AES plans to repurchase 20 million of the shares and the remaining 40 million were to be offered to the public. AES will use most of the $381 million authorized for common stock repurchases on this transaction. This will help boost the EPS of the company into the future as AES continues their share buyback program.
5 AES – The Power of Being Global: http://www.slideshare.net/scarlet-sails/aes-report 6 AES, Morningstar Equity Research Report. Analyst Charles Fishman 7 The AES Corporation. May 13, 2015. AES Announces Pricing of Secondary Offering of Approximately 60 Million Shares of Common Stock by a Subsidiary of CIC. [Press Release] Retrieved from http://www.aes.com/investors/press-releases/press-release-details/2015/AES-Announces-Pricing-of-Secondary-Offering-of-Approximately-60-Million-Shares-of-Common-Stock-by-a-Subsidiary-of-CIC/default.aspx
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• AES plant in Vietnam operational8: In May, AES announced their 1,240 MW coal-fired Mong Duong 2 plant in Vietnam, the largest private sector power project in Vietnam, achieved commercial operation six months ahead of schedule. AES has a 51% equity interest in the plant and hopes the success of the new plant opens up future opportunity in the country. The Vietnam Institute of Energy and the National Center for Socio-Economic Information and Forecast expect Vietnam’s power demand to increase by 10.5% over the next five years. Analyst Julien Dumoulin-Smith from UBS estimates the project will contribute ~0.06 in EPS on an annualized basis assuming the high-teens EPS guidance contribution.9
Investment Analysis
Economic Environment Figure 2 highlights the movements for the utilities sector and S&P 500 over the past 10 years. Since the market hit its lowest point during the 2008 financial crisis in the first quarter of 2009, the utilities sector has underperformed the market. While the S&P 500 has improved nearly 19.32% on an annual basis, utilities have only gained just over half of the market rate, at 10.25% annually. Historically utilities have performed comparable to the market from mid-2005 to mid-2013; however the past two years have seen the sector lag behind.
Figure 2: Utilities sector 10 year movement (White) compared to S&P 500 Index (Green)
Fidelity’s business cycle analysis as of June 2015 puts the US economy in a mid-cycle expansion, where we have economic, profit, sales and inventory growth. As such, Fidelity ranks utilities to underperform the market during a mid-cycle expansion, and thus the utilities industry as a whole is not expected to perform well.10 This is not to say utilities companies can’t
8 The AES Corporation. May 11, 2015. AES Achieves Commercial Operation of 1,240 MW Mong Duong 2 Plant in VIetnam. [Press Release] Retrieved from http://www.aes.com/news-views/press-releases/press-release-details/2015/AES-Achieves-Commercial-Operation-of-1240-MW-Mong-Duong-2-Plant-in-Vietnam/default.aspx 9 AES, UBS Equity Research Report. Analyst Julien Dumoulin-Smith 10 Fidelity Business Cycle Analysis: https://eresearch.fidelity.com/eresearch/markets_sectors/sectors/si_business_cycle.jhtml?tab=sibusiness
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perform well during an economic boom (both the utilities sector and energy industry are non-cyclical which means they will see profit regardless of economic gyrations as they produce products that consumers are in constant need of), however investors do tend to look at the industrial and information technology markets during a mid-cycle expansion.
Figure 3: Fidelity’s Business Cycle Analysis as of June 2015
Industry Catalysts Due to the capital-intensive nature of the industry, utilities stocks are highly sensitive to
interest rates. While the interest rates have been low since 2008, many companies within the industry have taken advantage by undertaking large capital projects, and AES is no different. On June 16 & 17, the Federal Open Market Committee (FOMC) met to discuss an interest rate increase. While the FOMC did not give a concrete timeline for the rate hike, many are expecting the rate hike to begin later in 2015. Analysts are also projecting the hike to not be as steep as once initially thought as inflation is still under the Fed’s target.11 This is a good signal to the utility industry, as growth opportunities will not be hampered by high interest rates in the near future.
As the current energy sector stands, a large portion of power comes from natural gas and coal, both of which are commodities. As with all commodities, prices are a function of
11 Sontakke, Mayur. Utilities Gain in June on the Fed’s Cautious Rate Hike Stance: http://marketrealist.com/2015/06/utilities-gain-june-feds-cautious-rate-hike-stance/
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supply and demand (e.g. an increase in demand for coal while the supply remains the same will mean a rise in price, or an increase in supply while demand remains the same will drop prices). The recent shale gas boom has led to an increase in the production and inventories of natural gas, which drove the price of natural gas down. As such, natural gas became an attractive, low cost-fuel, taking market share away from coal. Since AES’ business is nearly equally split between gas (34%) and coal (38%), they have largely mitigated any risk from low prices of either commodity.
Industry Outlook The utility industry is undergoing somewhat of a major transformation in the US that
will test current companies. When John McCue, Vice Chairman and the US Energy & Resources leader at Deloitte LLP, was asked about the industry transformation he mentioned the moving pieces around fuel prices, renewables, customer interaction, managing distributed generation, electricity storage, demand response and energy efficiency. Renewable energy such as wind and solar continue to work towards maturity as regulations around fossil fuels continue to become stricter and consumers are concerned about the environmental effects of using them at what some consider alarming rates. Besides the obvious hedging on fossil fuels, renewable energy is beginning to reduce their costs, with wind power already ranked among least expensive sources of new utility-scale generation and solar panel systems costs are declining 12%-15% per year. 12 AES continues to invest in renewable energies that currently comprise 23% of their PTC.
As renewable energy continues to advance, end consumers are advancing as well. They are requiring more advanced technologies to track their usage of electricity to help reduce usage and create individual efficiencies. Household items such as the Nest learning thermostat and smart phone-controlled lighting in the house as well as online access to account statistics are helping the consumer be more in control of their electric usage than ever before. Solar panels with battery backup may have substantial upfront costs, but consumers will begin to save money over the long-term and are increasingly looking to this as an option. AES is a leader in their lithium ion battery storage units; however their priority to the individual consumer remains unclear.
The last and most significant change underway in the US utility market is the changing of the regulatory landscape. Many states are in the process of overhauling their regulatory systems to achieve better efficiencies and increased customer choice and value. Doing so will shake up the status quo where companies essentially had a monopoly on a geographical region and introduce competition, driving down margins for the energy industry. While good for the consumer, it may weed out companies who have high operating and maintenance costs that have been able to hide with little to no competition. There is also plenty of room for success, as firms will be able to compete in areas they were restricted from doing so in the past. While AES has only 24% of its PTC from the US, it has already seen firsthand with DPL the downside of deregulation. AES will undoubtedly be on the lookout for opportunities for growth in the ever-changing US utility market.
12 2015 Power and Utilities Industry Outlook – Interview with John McCue: http://www2.deloitte.com/us/en/pages/energy-and-resources/articles/2015-power-and-utilities-industry-outlook.html
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A look at the Porter’s Five Forces Analysis in Figure 4 highlights the profitability attractiveness of the utility industry as it stands today.13 Overall the industry still seems to be an attractive one as pure competition is still far from the normal for utilities. With low threat of new entrants and low availability of alternatives to power, people will continue to be in need of utilities far into the future. The power of suppliers has historically been high as a small number of suppliers control access to natural resources that are needed such as oil, natural gas and coal. Utility companies are trying to combat the supplier power by offering alternatives which require no supplier such as solar power and wind. The concerning two forces heading into the future are the power of buyers and competitive rivalry. While competitive rivalry has always been high when going after long term power purchase agreements (PPA), the deregulation of the market will increase competition as power suppliers lose their geographical monopolies and must compete on price with other entrants. The same change also will give the individual consumers more power than ever before to shop around and seek better terms from energy providers.
Figure 4: Porter’s Five Forces Analysis on the Utility Sector
13 The Industry Handbook: The Utilities Industry: http://www.investopedia.com/features/industryhandbook/utilities.asp
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Valuation
Sector Valuation Figure 5 highlights some key multiples of the utilities sector relative to the S&P 500
index. All of the multiples are below their 10 year average, which signals that the sector is relatively cheap and will head back to their average multiples over time.
Multiples High Low Median Current P/E 1.1317 0.4993 0.9178 0.8991 P/B 0.9396 0.5849 0.7209 0.5849 P/S 1.216 0.809 0.944 0.8511 P/EBITDA 0.9409 0.4755 0.6705 0.5144
Figure 5: Utilities Sector Valuation Relative to S&P 500 Index (10 Year)
Trend Valuation Figure 6 below shows how AES has performed over the past 10 years compared to the
S&P 500 index. Up until 2011 when Gluski took over as CEO, AES trended very closely with the S&P 500, which is not surprising with a beta of 1.09. Since that point, the S&P 500 index has steadily increased while AES has had very minor improvements. If AES’ beta is truly close to 1 and the price will move with the market, it would stand to reason that the stock price will try to close the gap it has created between itself and the S&P 500.
Figure 6: AES 10-year stock price with moving average compared to S&P 500 (Source: Yahoo! Finance)
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Relative Valuation Figure 7 shows that AES’ multiples are below the comparable industry averages with the
exception of the price-to-book ratio. With price-to-earnings, price-to-sales, price-to-cash flow and EV/EBITDA all below the averages of the industry, this would hint at the stock price for AES as being undervalued.
Figure 7: Comparative Multiples including AES and its peer competitors
Discounted Cash Flow Model Using the previous five 10-K filings to the SEC, I have forecasted AES’ future income statements as well as created a discounted cash flow model to determine a projection for AES’ stock value. The full forecasted income statement can be found in Appendix C while Appendix D shows the discounted cash flow model. All estimates from the income statement in Appendix C are highlighted in yellow and analyst consensus numbers are in red text. Below are my thoughts and assumptions when creating these projections.
• Tax Rate: I derived a tax rate of 30% by averaging four of the previous five years. CY 2012 saw an abnormal tax rate of 298% that was removed from the projections. AES’ mix of business in the US and overseas does not seem to be changing dramatically, thus I would expect the tax rate to stay consistent.
• Earnings Per Share: EPS estimates for 2015-2017 were a little higher than analyst projections, however this is mostly due to AES’ shares outstanding being reduced recently with share buyback programs. With a lower number of shares available, this will increase earnings per share over the normal. If shares outstanding were at 704 million like they were when most analyst projections were made, CY 2015 & 2016 EPS projections would be right in line with consensus and 2017 would be slightly below consensus ($1.39 compared to $1.42).
• Depreciation and Amortization: The history puts this number anywhere from 6.9% of sales up to 8.1% of sales. CYs 2012 – 2014 saw this field drop from 8.1% to 7.5% to 7.3% of sales. To continue this trend and not fall below the historical minimum, the next three years were projected at 7.0%
• Capital Expenditures: CapEx has been declining over time compared to sales, from 14.2% in CY 2011 down to 11.8% in 2014. This decline is carried over into the forecasts, with 2015, 2016 and 2017 projected at 11.2%, 10.8% and 10.2% of sales, respectively. This will be in line with management guidance to begin to shift excess cash back to shareholders with increased dividends. CapEx also does converge down to the 7% depreciation and amortization in the discounted cash flow model.
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• Revenues: Projecting a growth rate of revenues of 2.25% per year puts my revenue forecasts very close to analyst projections during CY 2015 – 2017. As such, used 2.25% revenue growth though the entirety of the DCF model.
• Accounts Receivable, Inventory & Accounts Payable: Past years saw AR be anywhere from 13.2% to 15.8% of sales, Inventory 3.2% to 4.5% of sales and AP 11.6% to 14.8% of sales. With limited deviation, the average of the historical numbers was used throughout the income statement projection.
• Loss on Extinguishment of Debt, Other Non-Operating Expense: CYs 2013 and 2014 saw a larger proportion of these two items as a percent of sales than the three preceding years. This is mostly likely due to AES’ aggressive approach to paying down debts and share repurchasing programs. These programs show no signs of slowing down soon and projections are a reflection of the 2013 & 2014 averages.
• General and Administrative Expenses, Interest Expense, Interest Income, Other Expense, Other income, Goodwill Impairment Expense: All of these line items from the income statement showed patterns of decline compared to sales from CY 2010 through CY 2014. To keep with the lower end of the historical data, 2015-2017 projections were all set very close to the CY 2014 % of sales for each.
• Foreign Currency Transaction Gains (Losses): Outside of CY 2012 where this was a 1.0% drag compared to sales, all other historical years were between 0.1% and -0.2% of sales. As gains/losses on currencies are hard to predict, this was forecasted as 0%.
• Operating Margin, Gain on Disposal and Sale of Investments: No clear pattern compared to sales was found from the past five historical 10-K’s. The averages for the five previous years compared to sales were used.
• Terminal Growth Rate: While the 11.25% for the terminal growth rate is higher than Morningstar’s cost of equity at 10%, I do believe this is fair and just. Morningstar recently moved their cost of equity down from 12% to 10%, citing country risk premium due to emerging markets.14 I am less concerned about these risks as Gluski has plenty of experience in Latin American markets and the focus from AES will be where it’s needed since they have removed themselves from unwanted markets.
• Terminal FCF Growth: Based closely to Morningstar’s 5-year projected CAGR for free cash flow of 2.1%, I have given AES a terminal growth rate of 2.25%.
The final result of my DCF is a target price of $19.67, implying a 46.2% upside to AES’
current price of $13.46. Figure 8 shows a sensitivity analysis around different terminal discount rates and free cash flow growth rates, however a +/- 1% change in either or both terminal rates will still place my projections well above the current stock price. While the DCF valuation does come in above consensus estimates (which Bloomberg has around $15), I feel comfortable with the forecasts. No huge risks were undertaken in the financial projections and forecasted revenues and EPS are in line with consensus.
14 AES, Morningstar Equity Research Report. Analyst Charles Fishman
Figure 8: Sensitivity Analysis of DCF Model Results with differing terminal discount rates and FCF growth
Risks AES faces risks for the utilities industry as a whole and also some unique ones as well, listed below.
• With 76% of Pre-Tax Contributions coming from outside of the United States, AES has significant exposure to foreign currency fluctuations.
• As US interest rates are set to increase late in 2015, AES’ (who is highly levered like most utility companies) debt payments can be negatively affected. While the increase is set to be minimal, an unexpected sharp increase over current interest rates could hamper AES’ ability for projected expansion.
• As power is generated by coal, gas and oil, AES has exposure on commodity pricing. • AES has a majority of assets and development projects in emerging markets, resulting in
increased regulatory, political and economic uncertainty. Many analysts have discounted AES’ stock price due to the extra risk for emerging markets whereas my projections do not discount as heavily.
• As natural gas prices fall and electricity demand decreases in certain areas, AES can see their power prices fall with it. If not properly hedged with forward fixed price power sales, AES can see their profits decline.
• Natural causes can negatively impact power generation in hydro, wind and solar plants. • AES currently has a lot of development occurring in different markets. As with any
development, they can be subject to cost overruns and political and regulatory risk. • Environmental compliance regulations are a concern for all types of power plants. AES
should be specifically watching their coal-fired plants (38% of their business) as the US Environmental Protection Agency (EPA) has been proposing stricter carbon requirements.15 Tighter regulations could lead to significant upgrades in facilities, adding extra capital investment and operating costs that AES was not expecting.
15 American Coalition For Clean Coal Electricity. Jan 25, 2015. Status of Major EPS Regulations Affecting Coal-Fired Electricity Generation. Retrieved from http://www.americaspower.org/sites/default/files/EPA%20Regulations%20January%202015.pdf
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Conclusion Looking at valuations for AES based on the sector, its past trends and a discounted cash flow model, all signs are pointing towards the current price of the company as being undervalued. AES continues to send strong signals themselves that they are headed in the right direction by raising their forward looking dividends and entering into share buyback programs. With Gluski leading the way, AES continues to leave areas where they see limited or no growth potential while expanding into other regions that they see ample opportunity. They are well protected from commodity exposure and are prepared for the future by supplying energy with a number of different resources. With US interest rates set to increase slowly in the near future, AES should have no problem financing future projects. Ohio-based DPL has the opportunity to show positive results in the near future, as does the hydrology plants in drought-stricken Brazil. If these events occur AES will see even more positive financial results flow back into their future statements. I am issuing a BUY recommendation for The AES Corporation with a target price of $19.67, a +46.2% gain over the current $13.46 price.
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Appendix
Appendix A – AES Corp Generation Business (as of May 11, 2015)16 Business Location Type Gross
MW Equity
Interest Acquisition
Date Contract
Expiration Customer(s)
Tieté BRA Hydro 2,658 24% 1999 2015 Eletropaulo Southland - Alamitos US-CA Gas 2.075 100% 1998 2018 So. California Edison
Southland – Redondo Beach US-CA Gas 1,392 100% 1998 2018 So. California Edison Ust-Kamenogorsk KAZ Coal 1,354 100% 1997 Short-term Various
Ballylumford UK Gas 1,246 100% 2010 2023 Various Mong Duong 2 VIE Coal 1,240 51% 2015 2040 EVN
Chivor COL Hydro 1,000 71% 2000 Short-term Various Electrica Santiago CHL Gas, Diesel 750 71% 2000
Gener – SIC CHL Hydro, Coal, Diesel, Biomass 715 71% 2000 2015-2037 Various
Shullbinsk HPP KAZ Hydro 702 0% 1997 Short-term Various Maritza BGR Coal 690 100% 2011 2026 Natsionalna Elektricheska Kilroot UK Coal, Oil 662 99% 1992 SEM
TermoAndes ARG Gas, Diesel 643 71% 2000 Short-term Various Uruguaiana BRA Gas 640 46% 2000
Masinloc PHL Coal 630 51% 2006 Mid/Long Various Elsta NLD Gas 630 50% 1998 2018 Various
Guacolda CHL Coal, Pet Coke 608 35% 2000 2015-2032 Various Electrica Angamos CHL Coal 545 71% 2011 2026-2037 Various
Puerto Rico US-PR Coal 524 100% 2002 2027 PR Electric Power Aut.
Mérido III MEX Gas 505 55% 2000 2025 Comision Federal de Electridad
Southland – Huntington Beach US-CA Gas 474 100% 1998 2018 So. California Edison
OPGC IND Coal 420 49% 1998 2026 GRID Corp. Ltd. Amman East JOR Gas 380 37% 2009 2033-2034 Natl Elec. Power Co. Shady Point US-OK Coal 360 100% 1991 2018 Ok. Gas & Electric
Ust-Kamenogorsk KAZ Hydro 331 0% 1997 Short-term Various Andres DOM Gas 319 92% 2003 2018 Various
Sogrinsk CHP KAZ Coal 301 100% 1997 Short-term Various Itabo DOM Coal 295 46% 2000 2016 Various
Gener-SING CHL Coal, Pet Coke 277 71% 2000 2015-2037 Various TEG MEX Pet Coke 275 99% 2007 2027 CEMEX TEP MEX Pet Coke 275 99% 2007 2027 Peñoles
Bayano PAN Hydro 260 49% 1999 2030 Various IPP4 JOR Heavy Fuel Oil 247 60% 2014
DPP (Los Mina) DOM Gas 236 92% 1996 2016 Ede Este Buffalo Gap II US-TX Wind 233 100% 2007 2017 Direct Energy Changuinola PAN Hydro 223 100% 2011 2030 AES Panama
Hawaii US-HI Coal 206 100% 1992 2022 Hawaiian Electric Co. Warrior Run US-MD Coal 205 100% 2000 2030 First Energy
Buffalo Gap III US-TX Wind 170 100% 2008 2015 Direct Energy Kelanitissa LKA Diesel 168 90% 2003 2023 Ceylon Elec. Board St. Nikola BGR Wind 156 89% 2010 2025 Natsionalna Elektrichka
Beaver Valley US-PA Coal 132 100% 1984 Buffalo Gap I US-TX Wind 121 100% 2006 2021 Direct Energy Chiriqui – Esti PAN Hydro 120 49% 2003 2030 Various
