AES Corporation (NYSE:AES)
Q4 2007 Earnings Call
March 17, 2008 10:00 am ET
Paul Hanrahan - President and Chief Executive Officer
Victoria Harker - Executive Vice President and Chief Financial Officer
Andrés Gluski - Executive Vice President and Chief Operating Officer
Elizabeth Parrella - Merrill Lynch
Lasan Johong - RBC Capital Markets
Gregg Orrill - Lehman Brothers
Brian J. Russo - Ladenburg Thalmann
Unknown Analyst – Deutsche Bank
Good morning. My name is Elsa, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the AES Fourth Quarter and Full Year 2007 financial results conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. If you’d like to pose a question during this time, please press * then the number 1 on your telephone keypad. If you would like to withdraw your question, press the # key. Thank you. It is now my pleasure to turn the call over to your host, Mr. Ahmed Pasha, Vice President of Investor Relations. Sir, you may begin today’s conference.
Thank you. Good morning and welcome to AES Corporation’s Fourth Quarter and Year-End Earnings Call. Joining me today are our principal speakers Paul Hanrahan, President and Chief Executive Officer, Victoria Harker, Executive Vice President and Chief Financial Officer, and Andrés Gluski - Executive Vice President and Chief Operating Officer. Paul is joining us by phone due to travel. Victoria will provide an overview of our results and discussion of our outlook for 2008, followed by Paul, who will provide an update on our business development and our long-term forecast. Presentation that accompanies our financial review together with earnings press release and our 2007 10-K which were filed this morning is available on our website at www.aes.com.
Let me remind you that our comments will include forward-looking statements within the meanings of the Private Securities Litigation Reform Act of 1995. Any statements made here about future operating results or other future events are forward-looking statements under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from such forward-looking statements. Our discussion of factors that could cause actual events or events to vary is contained in our filings and in the investor section of our website. Now I would like to turn the call over to Victoria.
Thanks Ahmed, and good morning everyone. As you've seen from our press release by now, 2007 was a very good year for AES, one in which we achieved record revenues, solid profits, and strong cash flow generation from our businesses. 2007 revenues were up 17% compared to 2006 and eclipsed the $13-billion mark for the first time ever. Consolidated operating cash flow and free cash flow were particularly strong at $2.4 billion and $1.5 billion respectively, resoundingly beating our expectations. We generated adjusted earnings per share of $1.02, which includes a 7-cent one-time tax charge related to a change in Mexican tax law which was referenced in our March 2, 2008, 8-K filing. We were also pleased with gross margin for the year, which totaled more than $3.4 billion despite severe gas curtailments and low hydrology in the Southern Cone. Our businesses in Chile and Argentina were particularly hard hit facing increased fuel costs and reduced volumes available throughout the second half of the year. We were able to dampen their overall financial impact to AES through improved operations in our existing North American and European businesses along with contributions from several new businesses which came online in 2007.
In addition to the performance of existing operations, we also had a very good year with respect to the completion of a number of important transactions. As you know, we went to market in October 2007 with a planned debt offering of $500 million which was immediately up-sized to $2 billion to meet tremendous demand. This transaction added flexibility to our capital structure allowing us to use $1.4 billion to refinance secure debit with unsecured debt at lower interest rate, extended maturities, and locking in more favorable terms and conditions. We also sold a 10% interest in Gener, our generation business in Chile, later than same month due to strong market demand with net sale proceeds of approximately $300 million.
In addition, we recently announced the sale of a portion of our Kazakhstan business. The Kazakhstan sale is expected to close shortly and will yield approximately $1 billion in immediate cash proceeds to AES as well as up to $380 million in earnings over a 3-year period as a result of the negotiated management fee and performance bonuses.
All of these transactions are illustrative of the real progress we are making with respect to managing portfolio risk and increasing the flexibility in our capital structure, better positioning us to pursue and execute the strategic initiatives inherent in her 5-year plan.
While Paul will be providing a more comprehensive update on the business development activities later in the call, I’d like to now focus on some key financial and operational accomplishments made during the past year. These include finalization of the acquisition, financing, and integration of the TEG and TEP facilities in Mexico. We were also recently announced as the winners of bids in South Africa. In addition, we also made progress to secure approximately $650-million financing to close our 660-MW Masinloc project acquisition in the Philippines. We expect this acquisition to be completed in the early part of the second quarter in 2008.
Beyond this, we added more than 400 MW of wind capacity to our operating portfolio and initiated construction on the 170-mW third phase of Buffalo Gas, which when complete in 2008 will make Buffalo Gas one of the largest operating wind farms in the United States. Our rapid growth in wind generation in 2007 helped us jump into the top 5 in the US and the top 14 worldwide wind generator according EER. All of these projects underscore the continuing strength of our pipeline contribution to our long-term projections.
For now though, I’d like to turn our attention to the Fourth Quarter results. The Fourth Quarter of 2007 was particularly strong for us, generating adjusted earnings per share of $0.19, including the 7-cent nonrecurring charge related to the change in Mexican tax low. The positive results were primarily due to improved operations at our North American and European generation businesses. In the quarter, we also benefited from the onset of the summer season in the Southern Cone region of Latin America which has brought a measure of relief from the diminished hydrology and gas supply issues experienced during the third quarter. Overall, we continue to feel very positive about the proactive steps being taken by the Chilean regulator to address gas shortages, including raising the price of energy or node price by 45% this past year and providing incentives for new more cost-effective thermal generation projects to be added to the system. This is a great market opportunity for us to leverage that will Paul will discuss further later in the call.
As new non-natural gas fire plants come online in the Chilean system, we would expect residual impact from the natural gas restrictions from Argentina to be diminished. During the fourth quarter, revenue grew $739 million or 25% to $3.7 billion. Of this, $258 million or 7% was related to favorable foreign currency rates, principally the appreciation of the Brazilian Riyal and the Euro. Much of the remaining improvement is associated with higher prices and volumes across all 4 of the company’s regions. It also reflects the financial benefit of the addition of TEG and TEP, the two plants in Mexico acquired in the first quarter of 2007. When compared to fourth quarter 2006, gross margin increased by $20 million to $809 million, benefiting from higher prices in North America and Europe, as well as favorable foreign currency translations and the contributions from TEG and TEP. These gains were offset in part by higher fixed costs of Electropaulo, one of our distribution companies and Brazil, and Sonel, our integrated utility in Cameroon, coupled with the previously anticipated tariff reset at Electropaulo in July 2007.
G&A costs for the quarter decreased by $5 million to $118 million. Interest expense net of interest income increased by $27 million to $358 million, primarily due to the addition of $600 million in senior debit raised as part of the $2-billion senior unsecured debt financing in October 2007 which I referenced earlier. Other expense net of other income decreased by $108 million to $142 million. The higher expense in 2006 by comparison was due primarily to losses associated with early extinguishment of debt at several of our Latin American businesses. Investment increased $124 million quarter over quarter due to the Gener secondary share sale in October, while asset impairment expense increased to $358 million largely due to $352-million impairment over Uruguaiana, a Brazilian subsidiary, and a $14-million impairment related to a prepayment advance to AgCert. Both of these impairments were also previously reported in our 8-K filing dated March 3, 2008.
Our effective tax rate for the quarter was -226% as compared to 75% in 2006. This rate in the fourth quarter was primarily due to the impairment of Uruguaiana and a change in the Mexican tax law, both of which significantly impacted our effective rate on a one-time basis in the quarter. Weighted average shares outstanding were 676 million for the quarter versus 670 million in fourth quarter 2006. Our trust preferred securities were not dilutive to either quarter. The increase in shares was due primarily to the dilutive effect of stock options and restricted stock in fourth quarter 2007.
In the online presentation, you will find a summary of additional details of drivers of earnings from both a quarter over quarter and year over year standpoint.
Adjusted earnings per share were $0.19 for fourth quarter 2007, compared to $(0.02) for fourth quarter 2006. Our 2006 results included $0.11 loss primarily driven by higher development and overhead costs related remediation work, restatement charges in Brazil, and restructuring at our subsidiaries in Latin America. As discussed earlier, financial improvements in several key businesses account for a significant part of the positive momentum, contributing $0.07 in quarter over quarter improvement. This improvement is largely related to higher pricing and volume at Eastern Energy, higher capacity payments at Kilroot, and higher pricing and volume in Kazakhstan as well as contribution from the new businesses such as TEG and TEP in Mexico. We reported diluted earnings from continuing operations per share of $0.00 per share in the quarter compared to $0.02 in the fourth quarter of 2006.
Now, let focus for a moment at full year results. Not surprisingly, many of the same factors that led to a successful fourth quarter such as improved North American and European generation performance in addition to new businesses and favorable currency translations also paid a key role during the second half of 2007, helping to offset the negative impact of the gas supply curtailments experienced earlier in the year. Overall, we consider 2007 to have been a strong year, with revenue having reached a record high of $13.6 billion representing an increase of 17% over 2006. While gross margin did remain relatively flat on a percentage basis, improved operations in North America and Europe and contributions from recent acquisitions lifted gross margin to a robust $3.4 billion, despite the gas supply curtailments and lower hydrology which dampened operating performances in many of our businesses in Southern Cone. In addition, reduced energy losses and cost reduction programs at Electropaulo are helping ameliorate the effects of the 2007 tariff reduction there.
G&A costs for the full year increased by $17.8 million when compared to last year to $379 million, primarily due to higher spending associated with the higher levels of business development activities as well as financial restatements, Sarbanes-Oxley remediation projects, and the ongoing implementation costs of SAP worldwide. Interest expense net of interest income decreased by $47 million to $1.3 billion in 2007. The decrease is driven primarily by favorable currency translation of the Brazilian Riyal and higher cash and short-term investment balances at certain of our subsidiaries.
With all of the press associated with the current financial turmoil, we should probably point out a few important facts now about AES’s investments in financial assets and our capital structure where investors may have some questions. AES makes significant investment in hard assets around the world, and that’s the nature of our business; however, we do not invest in financial assets except in those cases where we have temporary pools of liquidity awaiting investment in our core business activities. Those of the cash, cash equivalents, and short-term investments are subject to specific covenants in our recourse and nonrecourse credit agreements which restrict such investments to conservative, liquid instruments. As a result, we have steered clear of auction rate securities, mortgage-backed securities, and other related instruments. AES does access many different markets and utilizes many specialized at financial products in its funding strategy around the world. A key part of the funding strategy is the use of nonrecourse financing, particularly called project finance. We have found that even during periods of corporate credit pressure, there is still a strong supply of such financing opportunities for well-structured projects. The anticipated near-term funding and related financing of Macinloc in the Philippines is an example of the strength of the project finance market at this time.
Returning to our financial results, our other income increased by $242 million to $358 million. The increase was primarily due to $135 million contract settlement gain at one of our subsidiaries in New York and a $93-million tax recovery at two of our Latin American subsidiaries. Other expense decreased by $197 million to $255 million. In 2007, there was a loss on retirement of senior notes to parent as well as higher losses on sales or disposals of assets at two of our Brazilian subsidiaries. Gain on the sale of investments increased by $36 million to $134 million. This gain in 2007 is primarily due to the sale of 10% of our ownership interest in Gener.
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This gain in 2007 is primarily due to the sale of 10% of our ownership interest in Gener. It’s important to know that there was no loss in subsidiary investment in 2007, but the loss on subsidiary investment of $535 million in 2006 was associated with the Brazilian restructuring. Asset impairment expense increased $391 million year over year due primarily to a $352 million charge taken at our Uruguayan subsidiary in Brazil resulting from low volumes of natural gas expected to be available from Argentina. For the full year, we recorded foreign currency transaction gains of $24 million. Our effective tax rate for the year was 42% compared to 36% in 2006. The increase in the 2007 effective tax rate was due primarily to the one-time impact of the Uruguayan asset impairment and a change in Mexican tax law in the fourth quarter. Excluding the impact of these two items, the full year effective tax rate would have been 32%. Weighted average diluted shares outstanding were $678 million for the full year as compared to the $672 million for 2006. Our Trust Preferred Securities were not dilutive to the full year 2007 results. The year over year increase reflects an increase in basic shares arising from the exercise of stock options.
In terms of earnings, adjusted EPS was $1.02 for 2007 including the 7 cents of charges for the change in Mexican tax law and 93 cents for 2006. As discussed earlier we benefited from significant operational improvements in North America and European generation businesses as well as contributions from the newly acquired businesses and favorable foreign currency translations. These improvements generated 20 cents EPS helping to offset the 9-cent impact caused by the hydrology and gas curtailments in Southern Cone as well as the 8-cent higher G&A in business development spending. We also reported diluted earnings from continuing operations per share of 73 cents compared to 27 cents in 2006.
Overall, cash flow continued to be quite strong, both for the quarter and the year. It is worth noting that even with the sale of EDC in the second quarter 2007, net cash flow from operations for the quarter increased by $12 million to $488 million. Excluding EDC, the year over year increase would have been $30 million. For the full year, net cash flow from operations was approximately $2.4 billion, up 6 million year over year. Excluding any contribution from EDC during the year, net cash from operations would have increased by $119 million or 6% compared to 2006. Depreciation and amortization expense was $249 million for the quarter and $942 million for the year. Maintenance CapEx was $199 million for the quarter. Of this amount approximately $64 million is attributable to environmental projects primarily at Kilroot, New York, and IPL. Of these, Kilroot’s contract has a pass-through cost mechanism while the other projects are expected to generate a positive economic return for the company. For the full year, maintenance CapEx was $878 million with approximately $235 million of that amount invested in environmental projects. This was slightly below our 2007 guidance of $900 million to $1 billion range. Gross capital expenditures were $705 million for the quarter and approximately $2.5 billion for the full year. This includes $506 million of expenditures related to gross investments, $393 million of which is associated with projects in construction including Maritza and Panama. Free cash flow for the fourth quarter increased by $105 million to $289 million driven mainly by the decrease in maintenance CapEx. For the full year, free cash flow remained relatively flat at $1.5 billion. This amount exceeded our 2007 guidance of $1.2 to $1.4 billion due to the higher-than-anticipated cash flow from operations and lower-than-expected maintenance CapEx. Excluding the impacts of EDC, the improvement in free cash flow would have been $82 million or 6% greater than 2006. Distributions from our subsidiaries which reflect cash flow generated by subsidiaries prior to paying parent interest expense and G&A were $343 million bringing full year distributions to $1.1 billion, which is in line with our 2007 guidance. Parent liquidity increased to a robust $2.2 billion at year end due to EDC and Gener’s share sale proceeds as well as the corporate debt issuance in the fourth quarter. This will provide us with a strong springboard for the pipeline of new projects we are now pursuing in 2008.
In the interest of time, I’ll skip over the segment analysis today, but you’ll find these in detail in the Investor Relations online presentation. However, before proceeding on to our outlook for 2008, I’d like to briefly touch on the positive $3 million non-cash operating income adjustment for the period 2004 to 2007, which is re-stated in our 10-K. As you know, we previously identified and reported several material weaknesses related to our system of internal controls over financial reporting. Many of these have now been remediated leaving only two remaining for testing in 2008. As part of the 2007 year end closing process in connection with our efforts to remediate a material weakness for contract derivative accounting, we reviewed several hundred contracts. Through this extensive review, we identified only one contract which required a material adjustment, an agreement between our Deepwater business and its off-taker TXU between 2004 and 2007 which had been previously reviewed with the appropriate accounting treatment identified. Upon further consideration, this agreement’s contract penalty provision could have been interpreted as a derivative in hindsight. We now believe that it should have been treated as a derivative under FAS 133. This change resulted in a cumulative, non-cash adjustment of positive $3 million to operating income for the period between 2004 and 2007 which on its own in the aggregative was material on a percentage basis to both 2005 and 2006 operating income given other financial re-structurings in those years. While no one is pleased with having to re-state prior periods, its size clearly indicated the results of our significant investment in time and resources over the past 3 years to improve our financial systems, processes, and controls. We expect to remediate the final material weaknesses this year, and I’m very encouraged by the hard work and dedication of the finance team worldwide to address these issues while producing the current results in both an accurate and timely fashion.
Now, I’d like to discuss our outlook for 2008. Coming off a strong 2007, we feel very good about our financial trajectory in 2008 as we continue to pursue projects in our core business and undertake investments in new markets. We expect 2008 diluted earnings per share from continuing operations of $2.43 including a net gain of $1.29 or approximately $900 million from the sale of our Northern Kazakhstan businesses which we expect to close in the first half of this year. We projected adjusted earnings per share of $1.14 for 2008. This is in line with our May 2007 guidance range of $1.12 to $1.20 for 2008. It’s important to note that our 2008 guidance includes 2 cents of dilution from our Trust Preferred Securities due to anticipated higher GAAP income resulting from the sale of the Kazakhstan assets. In addition, our revised guidance also reflects approximately 4 cents of additional interest cost associated with $600 million of incremental senior parent level debt raised during the fourth quarter, 2 cents related to acceleration of our global implementation of SAP and 2 cents of non-cash impacting expense resulting from the change to the Pakistan lease accounting referenced earlier in 2007. Our guidance also assumes that both the sale of the Kazakhstan assets and the pending acquisition of the Masinloc project in the Philippines are expected to close during the first half of this year.
For 2008, gross margin is expected to be between $3.6 and $3.7 billion, an increase of $200 to $300 million above 2007 level. Net cash from operating activities is targeted at $2.3 to $2.4 billion. We project free cash flow between $1.4 and $1.6 billion after maintenance CapEx of $800 to $900 million which includes $100 to $200 million of environmental capital expenditures. Subsidiary distributions are expected to be $1.0 to $1.1 billion. In a few minutes, Paul will link our 2008 projects to EPS projections for the next 5 years, our development pipeline and compare this to our previous guidance issued in May 2007, and also early in the year, based on the positive business trends we’ve seen thus far in the year, we believe the 2008 forecast to be achievable as we leverage existing core power businesses as well as new opportunities in climate solutions, wind, and solar.
I’ll now turn the call over to Paul Hanrahan for his insights into the current trends as well as a look at our 5-year projections.
Well, thank you Victoria and good morning everyone. Let me just start by saying that many good things are happening at AES. We met our 2007 commitments including operating cash flow and free cash flow which were two financial metrics by focus on particularly. We’re also creating a number of good options for investment in our development pipeline in our core power business, our renewables business, and our climate solutions business which is what we call our greenhouse gas offset business. With respect to financing our investments, we’ve accessed the dead markets when conditions have been good. We’ve used portfolio management as a source of funds and to optimize the cost of financing by focusing on sources that we believe have the lowest cost to us. Let me start with an overview of some of our potential investment opportunities. There continues to be a significant demand for power in many of the regions in which we currently operate or are poised to enter. Many of these countries already face significant needs for power. In some cases, there is supply shortage; for example, in India, South Africa, Turkey, and Vietnam, or there are dramatic needs for new capacity in the near future; for example, in the Philippines.
In India for example, you’ve got a 9% GDP growth rate in recent years. The Government of India estimates that there needs to be infrastructure investment at $350 billion over the next 5 to 7 years, and power demand is expected to grow by over 7% per year. The current projected needs are 80,000 MW in the next 5 years through 2012, and this represents approximately 60% of the current installed capacity of 135,000 MW. The Government of India has recognized that meeting demand for electricity is a potential bottleneck for growth of the economy. As a result they have put key incentives in place which include the allocation of coal mine reserves to potential power plant developers and they’ve made policy decisions including tax breaks and priority purchases of renewable power which have helped draw investments into that sector.
In Chile, another country where we have been putting a lot of effort, we’ve seen annual GDP of 4% per year and annual demand growth in electricity is expected to grow at 6% per year, and additionally there is a need for security supply reasons to replace the existing natural-gas-fired capacity. The recent gas cut-offs from Argentina and the subsequent actions by the regulator which included the increasing of note prices by 45% in 2007, which Victoria referenced, have confirmed our view that there is near-term opportunity to add new capacity, particularly non-gas-fired capacity. Historically, the high marginal energy cost in the SIC which is the central grid in Chile and the SING which is the northern grid have been key indicators of the shortage of efficient generation capacity. In the central grid, the average marginal cost during 2007 was US $170 per MW hour compared to US $46 per MW hour in 2006, and this again reaffirms our view that there is a genuine need for new and diversified capacity in Chile.
Looking at South Africa, a market which we hope to enter in 2008, the GDP is increasing at 5% per year and the demand for power is increasing at 7% per year. Currently, South Africa has a negative reserve margin which means that it’s currently experiencing rolling blackouts. South Africa needs to add 1200 MW each year and AES is the first international IPT developing Greenfield projects in the country. Due to the impending shortage of generation in South Africa and other surrounding countries, they’re also planning generation projects to serve the South African market and AES is participating in some of those.
Let me just spend a few minutes on the development momentum and progress in our business lines. We really have a deep pipeline of growth projects. Our core power pipeline is over 30,000 MW of which 16,000 MW is in medium to advanced stage development. The geographic breakdown of these projects is in Asia 39%, Europe, CIS, and Africa 25%, Latin America 16%, and North America 20%. We also have a renewable power pipeline of 9000 MW which includes over 5000 MW of wind with the remainder being hydro and other renewables. In our climate solutions pipeline, by the end of December our pipeline of projects in development have the capacity to produce, or more importantly, to issue 19 million offsets annually, up from 12 million at the end of the third quarter of 2007.
I now would like to provide some additional details about some of the projects that we’re pursuing. First, in our core power business, I’ll start with Asia. In the Philippines our acquisition of the 660 MW Masinloc coal-fired project is expected to close in April this year. A non-recourse financing of approximately $650 million has already been secured. In India, we’ve a couple of projects that are in advanced stages. First is the expansion of our OPGC project called OPGC-2. This is a 1200 MW coal-based power plant project with an integrated coal mine located in the state of Orissa where we already have one coal-fired project operating. This is really a good example of what we referred to as platform expansions as it’s adjacent to our existing 420 MW minemouth coal-fired power plant. Since this new plant already has land, water, and other ready support infrastructure, this gives the project inherent permitting and cost advantages. Discussions are in advanced stages with the Government of Orissa, our partner in both projects, to finalize the expansion project. With our development team’s efforts and the State Government’s support, two coal blocks with the total reserves of 530 million tons have been allocated for the project, and this was really a major development milestone for the project. We currently expect closing to occur in early 2009 with the commercial operation date in 2012.
The second project in India is called the Chhattisgarh Project. This is a 1000 to 1200 MW coal-based power plant project with an integrated coal mine located in the State of Chhattisgarh. This project is a negotiated coal-based power project being developed by AES in a high demand and capacity short western grid region. Under the agreement signed with the state government, the government has agreed to provide the allocation of a coal mine. In November of last year, the Ministry of Coal allocated to the project a coal block with total estimated reserves of 150 million tons. The water allocation for the project has also been approved, and the company has made significant development progress in terms of identification of the project site, applications for land acquisition, transmission studies, etc. Currently, our project team is actively working to secure all the required permits and our financial closure is expected to occur by the third quarter of 2009 with the commercial operation date in early 2013.
Next, let me talk about Vietnam. There we have a project that we’ve been developing over the past few years and is based on an agreement with the Government of Vietnam to develop a 1200 MW coal-fired power plant. There the environmental impact assessment is already improved, and the power purchase agreement is expected to signed during the second half of 2008 with financial close expected to occur in the first half of 2009. That would expect the commercial operation date to occur sometime in the second half of 2012.
Moving on to Europe and Africa and Turkey where we formed a joint venture to develop small and medium-sized hydro projects with our partner in Turkey. In addition to our pipeline of hydro projects, we also have the potential to close a 196 net MW open cycle combustion turbine in the entire region of Turkey. This really is a good example of how we can source potentially to track the projects with local partners once we become established in new markets, and this could represent the first thermal project for AES in Turkey.
Next, I’d like to talk about South Africa. There we have an 1100 MW combined capacity for two greenfield projects in South Africa, and these are two projects where AES has been selected as a developer of badly needed capacity in the country. As these are the first IPP projects in the country, we are facing some non-inconsequential challenges. These primarily relate to the fact that the country desperately needs the capacity and the financings must close quickly to meet the requisite deadlines imposed by the government. At the same time, addressing the typical project finance issues with a new program for IPPs adds a layer of complexity that can add time. Nevertheless, we’re committed to this market and to helping the government add capacity to their system as quickly as possible.
Moving over to Latin America, in Chile, we have 700 MW of projects in advanced development in addition to those that are already under construction. One of these is a greenfield project; it’s a 470 MW coal-fired plant. This has the environmental impact assessment approved, the engineering procurement and construction contract signed, and the power purchase agreement is in the final stages of negotiation. The financing is in place, and the port agreement has been finalized for this project. Construction could start in 2008 with a commercial operation date being achieved by the end of 2011. Another project in development in advanced stages is Chile is a 242 MW coal-fired plant. The environmental impact assessment is in the final stages of approval, the EPC is signed, and a PPA has been signed with Anglo-American and the financing is in negotiation as we speak. Construction here is expected to start in 2009 and having a commercial operation date by the end of 2011.
Let me now talk about our renewable energy business line; first wind. Wind continues to be a good growth opportunity for us. As of the end of 2007, we had 1000 MW in operation, approximately 200 MW in construction and over 5000 MW in various stages of development, and about half of our pipeline is in the United States. Our access to quality sites and relationships with major turbine manufacturers has provided us with an advantage to grow our wind portfolio in an equipment constrained environment. I’d also like to mention a new area of interest for us and this would be in the solar photovoltaic project sector. We had an internal team that has been tasked to identify, to develop, to invest, and to operate photovoltaic solar generation projects around the world to address the growing global demand for renewable energy sources. We think solar is a natural extension of our existing business much as wind generation has been, and we see tremendous opportunity for growth in this market. I personally think that solar photovoltaic business could be where the wind business was say 5 to 10 years ago. Solar represents a good fit for us. It has a good fit with our core contract generation business. These have long-term contracts, typically 20 plus years. They are in stable countries with creditworthy off-takers and they could be project financed. Solar photovoltaics is a multi-billion dollar industry growing at an average rate of 30% a year and continued rapid growth is expected, declining manufacturing costs particularly in the thin-film technology, and carbon reduction targets becoming more important. Today, attractive returns can be achieved in European markets, in Spain, Italy, Greece, and France where they’ve already put in place a structure to incentivize solar projects. It’s our belief that as costs decline more countries will find solar PV investments to be economic and AES is well positioned to expand into other markets with our presence in many countries with high solar potential and our existing expertise in project development, financing, and operations. Today, most of the projects we’ve been pursing have been small, but with the ability to aggregate and with an expanding market, this will be an area of increasing interest for us.
Let me now talk about our climate solutions business. We continue to see significant growth opportunities for AES in our climate solutions, greenhouse gas offset business. In 2007 the global market for carbon offsets improved overall, but we also experienced some significant challenges. With respect to favorable developments, the market prices for certified emission reductions or CERs and other offsets continues to strengthen with CERs starting out in 2007 at 14 Euros per CER and ending the year at 17 Euros per CER. Also, carbon regulatory developments with respect to reducing carbon continues to support an increasing demand for offsets both internationally and in the United States. Further, the pace of CER issuance increased from the previous year with a total of 76 million CERs issued by year end as did volumes of offsets traded estimated at 950 million. We made meaningful progress to expand our development efforts in Malaysia, Ukraine, Russia, and Brazil. Our development pipeline as of year end 2007 represented perspective projects totalling approximately 19 million tons per year, up from 12 million tons per year at the end of the third quarter of last year. With over 9 million tons per year under AES control meaning these have been aggregated which are subject to our final diligence in approvals.
We also reached some important milestones in our construction and operations activities. We achieved commissioning on the first two AES AgriVerde methane recovery projects in Malaysia, and in addition, we started construction on another 7 projects in the agricultural sector.
On the regulatory front, we achieved many firsts since our last earnings call. Our hydro project in Brazil has achieved registration. Our first projects in Malaysia also achieved registration and received our first letters of endorsement under the joint implementation mechanism in Russia and Ukraine. We currently have 9 projects in validation with another 40 to enter validation in the first quarter and second quarter of this year. These are important milestones for us as we continue to improve this new business line for AES.
Let me turn to financing now. Given the potentially large amounts of investment that might result if we have a reasonable success rate with the various opportunities that I just covered, I’d like to give some perspective in how we might finance these. First, we continue to be able to access the limited re-course project finance market on a global basis. Our recent experience has demonstrated the depth and strength of the project finance market. For example, we accessed this market for projects in Mexico for $450 million which closed in the fourth quarter of 2007. For Masinloc in the Philippines which requires a financing of $650 million, the financing is already secured and funding is expected in early April of 2008. We also completed 112 million financing for our Turkey hydro projects and these were the first two project financings in the country’s hydro energy sector. These financings in all cases have been at least as attractive as we had assumed at the time of our initial bids with respect to amounts, tenure, and price. We think these transactions demonstrate not only AES’s ability to work closely with our customers to close value-added deals but also the financing community’s confidence in our operating expertise to improve projects with previous operating problems. I think it’s also worth highlighting that we also see opportunities to selectively sell part or all of our position in certain assets to raise capital we need for growth. For example, we sold 10% of our stake in Gener at a price that we felt was attractive generating approximately $300 million in proceeds to AES. Additionally, we announced to sell 100% of our stake in our businesses for over $1.4 billion. These particular transactions, for example, free up capital to invest in growth projects without needing to leave particular markets where we see strategic value in retaining a position in the countries. You’ll likely see an increased willingness on our part to sell assets to finance our growth in cases where, one, the businesses have strategic value; two, our ability to add value is decreasing; and three, the value that others are willing to pay exceeds our whole value. We’re also optimizing our capital structure when the market allows us to do so, on an attractive basis. For example, we issued $2 billion of senior unsecured notes in the third quarter of last year using approximately 1.4 billion of the proceeds to pay down approximately 60% of senior secured notes outstanding and 95% of the senior unsecured notes due in 2008.
Let’s talk about some of the challenging dynamics we face however. For one, the time between investment and returns for Greenfield projects results in a near-term drag on earnings in cash. Although Greenfield projects offer much higher returns, the developments cost and no return during the construction phase dampens our near-term earnings power. We are projecting to expense roughly $125 million in development costs every year. By the end of 2011, 2650 MW or $2 billion of equity is projected to be invested in projects under construction. Another factor is that corporate issuers have seen increased volatility in the US capital markets which could continue for the foreseeable future. As a result, we believe it makes sense to postpone optional debt retirements that we might have otherwise made in order to maintain a strong cash position so we’re better able to take advantage of near-term growth opportunities. This decision creates some headwinds with respect to our earnings outlook as a result of higher interest expense, but it preserves flexibility in what may well be a market where extra capital could be an advantage. And also the climate solutions ramp-up is taking longer than planned. The principal challenges the market is facing are the limited capacity of the UN to process increasing volumes of carbon-oxide projects and the longer certification process to relevant UN agencies opposing the creating of offsets. Having said that, I believe, this is a good business for us as there is clearly a growing need and we see a lot of potential growth in this area. And finally, volatility with respect to fuels. Rising fuel prices, particularly coal along with the delays in the ability to see prices pass through did have an impact on our portfolio, and the continued lack of gas availability in the Southern Cone also impacted our ability to maximize the value of several of our plans in Chile, Argentina, and Brazil.
Now what I would like to do is talk about the long-term guidance. Looking forward on how we think our current portfolio businesses in operation, construction, and development will translate into future financial performance, let me just refer you back to last May when we gave you our 5-year guidance with a projection that we would deliver somewhere between $1.75 to $2.15 earnings per share in 2011 delivering 13% to 18% growth over a 5-year period. As we’ve gone through our annual process to update our projections for the future, we now project that we’ll be growing our earnings at 14% to 17% per year for the next 5 years through 2012. Our target EPS for 2012 is $1.95 to $2.25. This would reflect a 5-year growth rate of 14% to 17% per year. By 2012, we also project our consolidated free cash flow to be between 2.5 and 3.3 billion. Let me give you how that compares to our previous guidance. As you could see in the earnings call presentation which we provided, we are now projecting $1.72 to $1.95 EPS in 2011 yielding 13% to 16% per year growth from 2006 through 2011. This updated guidance range is 5 cents to 20 cents lower than our May 2007 guidance, and the base case that would be roughly 12 cents. Last year our base case EPS forecast for 2011 was $1.95 as compared to our updated guidance of $1.83 in 2011. The key drivers of this 12-cent change in our base case include the following factors. The current base case assumes 3000 MW and our core power business will be online by 2011 versus the previous guidance of 4000 MW online by that same time. Under our new guidance, the remaining 1000 MW will be online during 2012. Longer development lead times with our coal project in Vietnam and our hydro project in Panama have contributed to these change assumptions. Also, based on the best information we have today, we are estimating that there is a 3-cent per share expense relating to the regional greenhouse gas initiative or REGI compliance cost in the United States. In addition, we’ve lowered our estimates for CERs greenhouse gas offsets that would be issuable given what we’ve learnt regarding the offset issuance process. We’ve lowered our estimate of the run rate at the end of 2011 by 2 million tons per year, so now we’re at 24 million tons per year as opposed to 26 million tons per year which we had estimated previously. We’re also seeing the ongoing EPS impacts associated with the lease accounting for Pakistan businesses as well as the lease filed in New York.
Now, let me highlight some of the key assumptions behind our guidance in 2012. Our base case which is the mean of the low end and high end of the EPS range was $2.10 EPS in 2012 is based on the following assumptions. In core power we’re projecting to have an additional 6500 MW of core power projects with 4100 MW of that online by year end 2012 and 2400 MW under construction at the end of 2012. This is in addition to any projects that AES has under construction today, which is approximately 2000 MW which includes our Maritza project in Bulgaria for 670 MW, 4 projects in Chile for 670 MW, in Panama a project for 233 MW, Jordon for 370 MW, and Turkey for 63 MW. It’s also worth knowing that the bulk of the 6500 MW is expected to be in Greenfield projects. Looking at renewable energy, we expect to have 2600 additional MW of wind generation by 2012. Since we announced our long-term guidance last year, we achieved approximately 600 MW of our commitment from the following projects – Buffalo Gap 2, 233 MW; Buffalo Gap 3, 170 MW; those are 2 projects in Texas; an acquisition of 186 MW in the Mid-West, and we also recently closed another acquisition in California of 67 MW. In climate solutions, the issuance rate is expected to be at 34 million metric tons in greenhouse gas offsets CERs annually by the end of the year 2012. And in 2012 our projected free cash flow nearly doubles in 4 years. It grows from 1.5 billion in 2008 to 2.9 billion in 2012.
So, in conclusion I’m pleased with the progress we made in 2007 and believe that we are continuing to build a deep pipeline of projects that can help us achieve our growth goals. By 2012, we’ll increase our core power generation by approximately 15% over our current capacity of 45,000 MW. We will be a leading player in renewable energy. We’ll add 2600 MW of wind capacity reaching a total installed capacity of 3200 MW. We also think we’ll be a significant player in the developing solar power market. In addition, we’ll continue to be an active player in the greenhouse gas offset business producing over 30 million tons of greenhouse gas offsets per year.
I’d like to thank all of you for your attention this morning, and operator, at this point, why don’t we turn the call over to any questions that people would have.
Thank you. The floor is now open for questions. If you do have a question, please press * followed by 1 on your telephone keypad at this time. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. Once again, that is * followed by 1 for any questions at this time. One moment while we poll for questions.
Our first question is coming from Elizabeth Parrella with Merrill Lynch. Please go ahead.
Elizabeth Parrella – Merrill Lynch
Thank you. Just to clarify, wanted to follow up something you said Paul. With respect to your base case growth assumptions, the 2000 MW that is currently under construction on core power type projects doesn’t count toward the 6500 MW, that’s correct – what counts is in terms of what you announced recently – is the Philippines acquisition and potentially South Africa if that actually goes to closing?
Elizabeth Parrella – Merrill Lynch
Okay, and with respect to the billion dollars that’ll be coming in from Kazakhstan – it sounds like what you’re indicating is you are going to take a conservative view on holding on to cash. It sounds like it is not likely or that we shouldn’t really be assuming that you go out and try to call the remaining senior secure debt that’s callable this spring.
Probably not. I think what we’re going do though is we are just going to continually evaluate the projects we have in front of us and the near-term investment needs, and how much liquidity we want to keep on hand to meet those needs. I think if we see a great opportunity, it could make sense to call some or all of those, but I wouldn’t put that in as our base case, but we’re always going to maintain that flexibility to do that if it looks like it’s the best use of funds at the time.
Elizabeth Parrella – Merrill Lynch
Okay, alright. I think that would be it for now. Thank you.
Thank you. Our next question is coming from Lasan Johong with RBC Capital Markets. Please go ahead.
Lasan Johong - RBC Capital Markets
Good morning. Just following up on Elizabeth’s question. You have over $2 billion in cash at year end ’07. You’ve got another billion at least coming in from Kazakhstan, and you’ve got probably something close to a billion and change, I believe, foreign free cash flow minimum. That’s quite a chunk of change to have on your balance sheet. What exactly would you be spending it on over the next several years, if you didn’t pay down debt? It doesn’t seem like you could effectively or efficiently use all that cash.
Lasan, this is Victoria. Just to clarify, the $2 billion is not all cash. It’s a billion in cash and a billion in credit facilities we have available to us.
Lasan Johong - RBC Capital Markets
Okay, but it’s still a lot of money.
Yes (laughs…), but in general we are currently looking at a pipeline that will effectively use large portions of that depending on what types of acquisitions, both in terms of greenfield opportunities as well as the new lines of business that we’re going into with wind and its capital requirements as well.
Lasan Johong - RBC Capital Markets
So, am I to assume that all the cash that you plan to generate should be earmarked for growth projects and not for any kind of debt repayments going forward?
I think as Paul said we obviously will continue to assess our options, particularly as we move into 2008. Given market volatility at this point, we want to make sure that we’ve got available cash and financing opportunities before we consider more optional debt paydown.
Lasan Johong - RBC Capital Markets
Then, can we assume that new equity issues are unlikely going forward for at least a couple of years?
I think we’ll have to continue to monitor the market and see what the opportunities look like. I’m not sure we want to close out any options right now.
Lasan Johong - RBC Capital Markets
Okay, and then in the Southern Cone, the gas shortage is starting to get really ugly over there. What kind of impact are you assessing for that in the 2008 guidance?
This is Andrés Gluski. We are assuming a continuation of the gas shortages in the Southern Cone, which basically affect Chile, to a lesser extent Argentina, and the Uruguaiana which have been impaired. We are assuming a continuation. However, the hydrology conditions are better at this moment than they were last year.
Lasan Johong - RBC Capital Markets
Okay, so the impact I think last year was 8 cents, so you expect that to be something less than that this year?
Again, basically we are saying that the situation would be similar to last year. Hydrology is better, and we’ve had the first two months of the year.
Lasan Johong - RBC Capital Markets
Organic growth rate – in the past, AES talked about organic growth rate being about 5% to 6% compound annual. Is that still true? Should we shift our focus slightly differently?
I would say and up to that amount. I think we are currently seeing closer to 4%.
Lasan Johong - RBC Capital Markets
Okay, thanks very much.
Thank you. Our next question is coming from Gregg Orrill of Lehman Brothers. Please go ahead.
Gregg Orrill - Lehman Brothers
Thanks a lot. I had two questions. The first one was on the status of the Brasiliana restructuring, sort of the right of first refusal on the purchase there, and then secondary on the ‘09 guidance. You provided a sectoral analysis there. The updated year was below your prior range, and I just talked around a few things including REGI and rising A&G costs, etc. I was wondering if you could just try to provide the same analysis for ’09?
Let’s talk about the Brasiliana auction. As you know, our partner BNDES is going through the process of bidding, having bids for its stake in Brasiliana. Currently, the process has been postponed. The indication from BNDES is that it would take place sometime in June. Situation remains the same—we have the first right of refusal. We are keeping our options open. We have local lines of credit in place, and we are also exploring possibilities with partners to exercise our first right of refusal.
In terms of the ’09 question that you had, a number of these factors Paul already referenced, but I’ll just give you the view of the lineup in terms of what we are seeing on the drivers. The cost of delay in the projects which are obviously impacting from a timing perspective more than anything else, given it pushes out past ’12 results as well, is about 5 cents. We also had as Paul referenced the lower sales in climate solutions in ’09—that was another 5 cents, and then the Pacgen lease, a New York lease buyouts were another 2 cents, and the REGI cost compliances Paul also referenced was about 3 cents which is an ongoing 3 cents per year from a cost mitigation standpoint, so those are the significant drivers of EPS relative to ’09.
Gregg Orrill - Lehman Brothers
Our next question is coming from B Brian J. Russo with Ladenburg Thalmann. Please go ahead.
Brian J. Russo - Ladenburg Thalmann
Good morning. Most of my questions have been asked and answered. Just wondering what is the income tax rate assumed in the 2008 and beyond guidance.
It’s effectively about the same range from the low to mid 30s.
Thank you. Our last question is coming from [__________] of Deutsche Bank. Please go ahead.
Unknown Analyst – Deutsche Bank
Good morning. The wind business appears to be growing pretty meaningfully in scale and in pipeline. It looks like your new target as you mentioned is not 2600 MW, and Paul I believe you also talked about 5000 MW in the pipeline, some of which of might overlap with the 2600, but do you have any interest in spinning or IPO’ing that business to highlight the value and fund future growth once the market stabilizes?
It’s a good question. I believe the previous question was what do you do with all that money. A big chunk of it is going into wind. What we’re finding in wind is that we are having to put the money down to buy the turbines well advance of starting construction, so it’s using up a fair amount of capital. So I think in the sense of portfolio management, looking to find other ways to finance that, that would not be 100% on us on us, would be an attractive way to do it, but only if we could see there is lower cost of capital out there to help us do that, or we can bring in somebody with some additional skills that could accomplish some other objectives, but something like an IPO and spinning it off to other parties who might be willing to provide capital and essentially a form of promote would be attractive to us, not so much to highlight the value but rather as a way to finance the investments to make sure we’ve got adequate capital, because I don’t want to put too much into buying the equipment because it’s not the most efficient way to do it. Over time, we could finance that out through tax equity in the US or other debt financings, but in the interim we are sort of stuck with a lot capital being put into that business.
Unknown Analyst – Deutsche Bank
Okay, that’s helpful. On a separate topic. It sounds like for now you are not looking out taking out the $750 million of senior secured notes; you are going to continually evaluate that on an ongoing basis. My question is that that tranche of debt is what really stands in the way from a covenant perspective between you all being able to do some type of a stock buyback—you know I understand that your growth pipeline is very robust, but I’m trying to understand your interest in taking some of the excess cash from the sale and some of the free cash flow that’s generated and looking at buybacks instead of some of the greenfield investments. With the stock at $16 and change, effectively where it was in the beginning of 2006 over two years ago, I’m trying to understand why your stock isn’t also a very compelling investment opportunity with some of your cash flow.
That’s the tricky part. That really is the problem we’re facing in terms of thinking where do we put the cash, because the stock represents a great buyback opportunity, we think, but we also have other opportunities, and do we have enough to finance all of that, and that’s the tradeoff we are trying to make. We are thinking about it; we are constantly looking at it. If it weren’t for the fact we have to go and pay off those notes, it would be an easier decision, but having to put that much capital to paying down debt – clearly it starts to use up a lot of capital – and do we really want to really slow down our growth rate in order to achieve that? That’s the tradeoff we are trying to evaluate, so I don’t have all the answer to it, but it’s something we’re continually trying to balance, and as we see good growth opportunities, and what we don’t want to have to do is go out and buy back stock and then have to go out and reissue equity as a way to continue to grow the company, so that’s a tradeoff we’re looking at.
Unknown Analyst – Deutsche Bank
Okay. As far as additional asset sales are concerned, you touched on that a little bit Paul. Are these assets that you are looking at sort of like Kazakhstan where the multiple in the private market or to another party is substantially greater than the multiple that your stock is trading at? Those are the types of things that you’ve identified in your portfolio that you might be interested in monetizing?
Well, we think about it more along the lines of looking at the cash flows coming from the business—the DCF value. What’s the value of the business to us, and what would somebody else be willing to pay, and I think particularly where we have gotten operations to a point where we can’t really do a whole lot more to increase the value of the asset or where we look at the market and say holding this asset doesn’t particularly give us any insights or advantages to expanding our growth pipeline. Those are the kinds of things we look at trading out of. Not so much looking at the multiples as much as it is the whole value has had. If somebody is willing to pay something that might be 20% higher than that, and no strategic value, those are the ones that will be easier for us to trade out of, but where there is some significant value in holding them, for example in Chile, we don’t want to leave the Chilean market because there are a lot of good growth opportunities there. We might trade out of bits and pieces of it over time, but we still want to maintain a controlled position there. Kazakhstan, we still like the market, but there was an opportunity to maintain our position in the market without having to hold all those assets. That’s another way we looked at trading out of a couple of those assets in order to get some capital and keep growing the company.
Unknown Analyst – Deutsche Bank
Okay. Thank you very much.
Okay. At this time, I’d like to turn the floor back over to Ahmed Pasha for any final remarks.
Thank you, and I want to say thank you very much everyone for participating today. If you have any followup questions, please do not hesitate to contact either Michael Cranna or myself in Investor Relations. Any media enquiries should be directed to Robin Pence. Thanks very much, and have a nice day!
Thank you. That concludes our teleconference. You may disconnect your lines at this time and have a wonderful day!
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