Global utility company AES (AES) is still waiting to see some of the tangible benefits of its multiyear restructuring. AES has gotten a lot more realistic about its international growth plans, added the stability of a regulated utility, and sharpened its focus on generating (and distributing) cash flow instead of a growth-at-any-cost philosophy. Nevertheless, the shares have not exactly soared on this transition to the new AES.
Core Improvements In Q1
AES reported 14% revenue growth for the first quarter, with a one-point deterioration in gross margin. Operating income rose 11%, and the company surpassed the average analyst guess.
Reported results beat the First Call average by eight cents. Stripping out a six-cent gain from an arbitration case in Spain still leaves a better-than-expected quarter. Relative to last year, AES added five cents from higher volumes in Latin America, two cents from cost control, and six cents from new business in Bulgaria and Panama. On the flip side, lower charges in Chile took out four cents, while outages in Northern Ireland and Panama were a two-cent headwind.
A Clearer Path To Value
As I have mentioned before, there was a long stretch of time where the operating plan at AES rather resembled the infamous Underpants Gnomes of South Park fame - the business plan was basically a three-step process of "buy/build assets with borrowed money … something good happens … profit!".
Now the company is a much more cogent collection of growth-oriented assets. The company has decided to let the likes of Huaneng Power (HNP) and Datang Power (DIPGY.PK) have the Chinese market, while it focuses on Latin America, North America, and select emerging markets like Vietnam and India.
Somewhat frustratingly, though, it actually still trades at a discount to the likes of Huaneng and less-diversified Latin American utilities like Copel (ELP) and Cemig (CIG). That comes despite the fact that management has outlined a goal of 8-10% annual returns for shareholders, complete with ongoing debt reduction, share buybacks, and a dividend to come later this year.
The Bottom Line
There's still ample room for things to go wrong with AES. Rate hikes are seldom ever popular with the general public, and emerging market governments have shown no compunctions in the past about sitting on rates despite rising costs and then express outrage and wonderment when service quality declines. Likewise, I suspect some investors remain worried that AES management will upend this disciplined capital plan in lieu of chasing some new generating project in Timbuktu or Shangri-la.
I think this skepticism is understandable but excessive. At this point, AES trades at a discount to just about any utility, including lower-growth stories like American Electric Power (AEP) and ConEd (ED). Even independent power producer Calpine (CPN) gets more respect these days.
Although AES still has substantial debt, a lot of it is non-recourse to the company. Moreover, the company has been hitting its targets with respect to cash flow and liquidity improvements. All in all, then, I think today's multiples are simply too low and AES is a significantly undervalued power company. Consider other diversified utility names like CLP Holdings (CLPHY.PK) if you like, but AES looks like an exceptionally cheap name in power right now.
Disclosure: I am long AES.