It has taken a number of years, but global electrical utility AES Corp. (AES) finally seems to have a plan in place that can drive reasonable returns for shareholders. While commodity costs and forex represent some challenges for the near term, AES has a good long-term plan in place with respect to driving out costs, focusing on high-potential growth markets, and seeing cash go back to shareholders.
Minimal Surprises In The Fourth Quarter
AES offered relatively few surprises for the fourth quarter. Revenue rose about 1% as reported, with the company's Latin American operations representing about two-thirds of the revenue base. Profitability was better, though, as GAAP gross margin, adjusted gross margin, and proportional gross margin all showed solid progress.
At the bottom line, the company did report a modest year-over-year decrease in quarterly adjusted profit. This was expected, however, and driven largely by acquisition costs tied to the DPL deal.
A Balanced Growth Outlook
Although AES did trim the midpoint of its guidance for the next year on an EPS basis, there were relatively few changes to the issues that investors care about most - cash flow, expected cash returns to shareholders, and growth/returns over the 2013-2015 timeframe.
AES is targeting high single-digit organic growth out through 2015, predicated both on ongoing cost efficiencies and the contributions of new business in areas like Bulgaria and Chile, renewable assets coming on line in 2012, and longer-range projects like a major electricity plant in Vietnam (due to go live in 2015).
A Different Sort Of Utility
The plans and structure of AES give investors an interesting choice. Certainly the growth outlook at AES is far greater than at domestic utilities like Excelon (EXC) or Duke Energy (DUK). These utilities pay much larger dividends, have a largely stable collection of assets (though Duke is in the midst of an acquisition), and a pretty stable operating environment apart from the ongoing wrangling over nuclear power in the U.S.
On the flip side, AES offers more risk diversification than pure-play emerging market utilities like Huaneng Power (HNP) or CEMIG (CIG). AES has decided that the regulatory environment in China is just not conducive to stable long-term returns (due in part to a rate regime that prioritizes access to cheap power) and has exited the market - not really an option for Huaneng. As for CEMIG, while Brazil is an important market for AES, there's that diversification benefit to having plants in 26 other countries.
Keep in mind, though, that AES has issues that other utilities do not. AES is only going to just start paying a dividend this year and the yield is going to be fairly low. At the same time, the company's asset mix is still in flux, debt is still high, and the risk is still elevated. AES pays a fair bit more for its debt than the likes of Duke Energy or Entergy (ETR) and there is heavy emerging market exposure in play.
The Bottom Line
Holding AES has taken some patience, but it looks like that patience has started to pay off. The company has a strong pipeline of growth projects (all funded) and an improving mix of stable cash-rich operations (like DPL) and more growth-oriented prospects. With the company's CDS spreads falling and free cash flow visibility improving, it looks like AES is heading in a good direction.
Cutting across so many comparables, relative valuation does not work especially well with AES. Though there is definitely some uncertainty left in the cash flow model, it nevertheless looks as though AES is on target to produce the sort of free cash flow that can support a mid-to-high teens target price. Assuming that AES sticks to this plan, investors can look forward to many years of above-average growth, an improving balance sheet, and higher dividends.
Disclosure: I am long AES.