Waiting for global electrical utility operator AES to pay off as an investment has been a lot like waiting for Godot, though I don't remember so many disappointments in Beckett's play. Although AES has a great collection of power generation assets, it has for some time now and management has never yet managed to wring much value out of them. With new management and a new plan, perhaps long-suffering investors will see some rewards for their patience in 2012.
The New New Plan
Long-term investors in AES have heard enough new plans over the years that they should well be skeptical. In particular, AES has a long history of shuffling the deck – selling this or that project and investing hundreds of millions into the next “big thing” all in the hopes of generating some real returns from a large asset base. Heretofore, it hasn't worked out so well and investors would have frankly done better with a money-market account for the last decade.
Now there's a new CEO and a new plan and maybe this is the one that does the trick.
For starters, the company has made a significant move from being a “anywhere but here” utility to having a significant presence in North America. In acquiring DPL (Dayton Power and Light), AES now has a meaningful presence in the U.S. regulated utility market. It doesn't make them another American Electric Power (NYSE: AEP) or Con Ed (NYSE: ED) but it was a low-risk deal at a good price. Moreover, it reduces some of that Latin American exposure such that Latin America is now closer to a 50% contributor to gross margin (versus nearly two-thirds at one point).
AES is also getting more rationale about its international portfolio. Instead of chasing what look like growth markets, AES appears to be refocusing on those markets where it can actually make economic profits. That means selling out of regions like the Czech Republic and China (where regulatory issues seem to overwhelm growth prospects) and centering on operations in areas like Brazil, Chile, India, and Vietnam. To be sure, there are plenty of growth options left in the AES portfolio, but they seem more focused now than before.
After many years where debt refinancing and liquidity generation was a preeminent topic, AES also now finds itself in a situation where it has excess cash to deploy. In addition to share buybacks, AES will be initiating a dividend in 2012 – not a large one, mind you, but at least something. This isn't going to make AES another Exelon (NYSE: EXC) or Duke Energy (NYSE: DUK), but it does put AES stock on the table as an option for income investors and it may help assuage institutional investor worries that the company would always divert cash towards the next great idea in overseas utilities irrespective of probable returns on investment.
Does AES Need An Emerging Market Rebound?
For quite some time, AES's share price has tracked fairly closely to major emerging market indices, even though power demand is not quite so sensitive to economic or market conditions. On the other hand, AES doesn't pay the sort of dividend that other emerging market power plays like Enersis (NYSE: ENI), CEMIG (NYSE: CIG), or Huaneng Power (NYSE: HNP) offer, so maybe the volatility is merited.
It has done pretty well when compared to the likes of Copel (NYSE: ELP) or Korea Electric Power (NYSE: KEP). Like AES, many of these emerging market utilities have struggled to earn compelling returns on invested capital and have likewise frustrated investors who bought in thinking they could piggy-back emerging market growth with some of the stability that utilities traditionally offer.
Sussing Out AES's Value
AES has long traded below the value of its assets, and perhaps that is fair given the poor returns management has produced. For too long now the bull thesis on AES has carried a bit too much resemblance to the Underpants Gnomes of South Park fame – AES has attractive assets and there should be big profits here, but nobody seems to have been able to figure out the middle step.
With a new management that is focused on cost reductions and a cogent portfolio of assets, there's more reason for optimism than there has been in some time. Still, the valuation is not so compelling right now. If AES can generate the sort of cash flow from its assets that analysts have long believed it should, the stock is easily worth something in the high teens. Unfortunately, AES has to prove that it deserves that benefit of the doubt and that makes a more reasonable current target somewhere in the mid-to-low teens.
This is not a bad speculative play for investors who believe that good management can unlock the value here, and I happen to be one of them. That said, AES is a name that has long been heavy on promise and short on reward and investors need to go in with a bit of skepticism.
Disclosure: I am long AES.