When I last wrote on international utility operator AES (AES), a Seeking Alpha reader commented that the company reminded him of a person who consistently tests at a genius level IQ, but never actually amounts to anything in life. As a long-term holder of AES, that comment cuts a little close to home, as there always seems to be to some external excuse for what in retrospect has become a tradition of under-performance. Although there is still potential for this company to do better, you can go broke betting on potential in lieu of performance.
Another Disappointing Quarter
The results that AES delivered earlier this August were hardly the stuff of legend. Not only did the company miss, and miss by a sizable amount, management also guided down toward the low end of the full year range.
Consolidated revenue fell 5% from last year, with a sizable reported decline in the Latin American utility business (down 25%) offsetting a big increase in revenue from North American utilities. Gross margin was likewise weak. Overall gross margin dropped 30% as profits from Latin American generation dropped about 20% and a year-ago gross profit from Latin American utilities reversed to a loss. North American and Asian performance were better, but not nearly enough to offset Latin America.
Problems Here, Problems There
AES's second quarter underperformance was driven by a collection of issues in Latin America. Not only did the company bear the brunt of an adverse tariff move for Eletropaulo, but the company also absorbed adverse currency moves and a combination of weaker prices and higher outages in Chile. Relative to Enersis (ENI), another Latin American utility with a sizable presence in Chile, AES did alright, but the comparisons to CEMIG (CIG) and COPEL (ELP) aren't quite as favorable.
The company's U.S. operations are also seeing some pressure. In the near term, AES is coping with cheaper gas-fired generation, and there are still uncertainties regarding the deregulation process in Ohio. While AES bought DPL to offset some of the instability of overseas operations and take advantage of what should be a better power market in the coming years, other utilities like American Electric Power (AEP), Duke Energy (DUK), and FirstEnergy (FE) have found Ohio to be tricky from time to time.
Is There Still A Value Case To Make?
It seems like AES is a utility with a perpetually bright future just around the corner … but the corner never quite seems to come. That cynicism aside, I can still appreciate the bull case for hanging on to these shares.
For starters, the currency issues strike me as a "market giveth, market taketh away" sort of phenomenon that doesn't really worry me for the long term. What's more, while I do worry about the governments of countries like Brazil and Chile opting to side with the voting populace when it comes to tariffs and prices, these countries have generally gotten more rational over the past decade and seem to appreciate that utilities have to see a profit if they're going to build the generating capacity these countries need to keep growing.
On the domestic side, who knows? Sure, deregulation and eventual higher natural gas prices (compare the current price of Henry Hub natural gas in the U.S. to what Japan is willing to pay for LNG imports) ought to improve AES's money-making potential in the U.S., but investors have been waiting for variations on that industry-wide story to work for quite a while.
The Bottom Line
The ongoing murkiness and uninspiring guidance make it difficult to trust AES as a long-term holding, and the share price weakness despite over $250 million in buybacks is not encouraging. While AES has been quite weak relative to CEMIG in terms of stock market performance, AES is basically in the same boat as COPEL and Enersis. What's interesting to me, though, is that AES gets seemingly no valuation benefit for its cleaner balance sheet and more diversified operating base (including growth opportunities in India and Turkey).
The best I can say about my experience as an AES shareholder is that it hasn't hurt me much to wait and see if this story can develop into a winner. Right now, the stock seems undervalued on the basis of a 4% revenue growth estimate and a mid single-digit free cash flow margin, though it has been many years since AES has consistently produced that sort of free cash flow.
Fair value may sit in the mid-to-high teens, but I'm not recommending that others follow me into this name. I do think the company is worth more than today's price, but there are other, better, plays on Latin America and I can't very well suggest people buy a stock that I may sell in the next few weeks or months to free up capital for a more interesting idea. To be clear, I don't hate AES (and I wouldn't short it), but I'm getting tired of waiting and sometimes you just have to be willing to move on to new ideas.
Disclosure: I am long AES.