A Big Sell Order Produces A 7% Yielder (AES-C)

| About: The AES (AES)

Summary

Preferred stocks offer attractive yields but can carry liquidity risks.

The preferred issued by power generator AES Corp. stock fell on Friday due to one or more large sell orders overwhelming the market.

AES has been having problems in South America recently, but its reliance on non-recourse funding helps insulate the preferred dividend.

An advantage a small investor has over a money manager with billions in assets is the ability to get high yields from preferred stocks without being trapped into a position by lack of liquidity.

 The AES Corporation One such stock that has provided attractive income for 17 years is AES-C, a 6.75 percent traditional preferred issued by AES Corp. (NYSE:AES), a global owner of power companies.

The preferred has traded near its par value of $50 for the last several years, barely moving except in line with its quarterly ex-dividend date. Last week, the pattern changed. It went ex on Tuesday and recovered some of the dividend that day, but fell on Thursday, a day when the overall market rose.

The other shoe dropped on Friday. Around noon, a big holder decided to get out - an order of around 30,000 shares caused the stock to plummet $1.50 in 15 minutes - liquidity risk in action.

It recovered some after the selling pressure eased, closing at $47.62, down $0.97, on much heavier-than-average volume of 81,300 shares. That raised the yield to 7.08 percent.

Source: Google Finance

The preferred dividend has been paid on time since the stock was issued in 1999, even during the deregulation-induced crisis for independent power producers in 2002, when AES-C briefly sank below 7 for a 50 percent yield.

Even then, management insisted the preferred dividend could be met easily. I can remember thinking that if I had the guts to buy $100,000, I could be receiving $50,000 in annual dividends and move up my retirement date.

In reality, I bought much less and watched it slowly recover to par value over the next several years. At that point, I sold some shares, but have held on to a small position for more than 13 years.

Is Friday's selloff a one-off event or the start of a trend? There's no guarantee that the selling pressure is over, which is especially a problem when the exit door isn't wide enough to handle more than one skinny person going out at a time.

Let's look at the parent company. Not surprisingly given what's going on in the world, AES has been going through a rough patch, missing revenues and lowering guidance last quarter, largely due to currency and commodity problems, especially in Brazil, Colombia, and Argentina.

Still, the firm expects full-year 2015 EPS of $1.18-$1.25 and recently raised its common dividend by 10 percent.

The company also recently made a tender offer for $250 million of outstanding debt, of which only $85 million was tendered, indicating bondholders are hardly screaming for the exits.

CEO Andres Gluski said during the third quarter conference call:

Despite being affected by the macroeconomic pressures that I just discussed, our free cash flow remains strong. We are expecting average annual growth in proportional and parent free cash flow of at least 10%. Specifically, in 2016, we expect to generate roughly $1.3 billion of proportional free cash flow which translates to $0.90 per share. We also expect to generate about $625 million in parent free cash flow in 2016, which is 20% higher than our 2015 guidance."

The key to the safety of the preferred dividend is something that screens do not show.

Most of the AES debt is non-recourse, that is, belonging to affiliates and in no way the liability of the parent company.

Currently, long-term recourse debt is just a quarter of total - $5.1 billion, compared with non-recourse debt of $15.6 billion. Even a total meltdown in South America (unlikely) wouldn't sink the parent, which has a solid base with two large Midwestern power distribution companies, IPALCO (Indianapolis Power and Light) and DPL (Dayton Power and Light).

Preferred dividends are only about $35 million ($517 million outstanding times 6.375 percent), a small fraction of free cash flow. The company's website says the preferred is rated B2 (Moody's), B (S&P), B+ (Fitch).

In my opinion, AES-C is a decent investment at the current price but is vulnerable to further declines due to a falling market and headline risk, exacerbated by lack of liquidity. There is a chance it could overshoot to the downside and become a huge bargain once again.

Just don't try to buy or sell 30,000 shares at once.

Disclosure: I am/we are long AES-C.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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