The AES Corporation (NYSE:AES) Q2 2016 Earnings Conference Call August 5, 2016 9:00 AM ET
Ahmed Pasha - Vice President of Investor Relations
Andrés Gluski - President and Chief Executive Officer
Thomas O'Flynn - Chief Financial Officer
Bernerd Da Santos - Chief Operating Officer
Ali Agha - SunTrust
Julien Dumoulin-Smith - UBS
Stephen Byrd - Morgan Stanley
Lasan Johong - Auvila Research Consulting
Brian Russo - Ladenburg Thalmann
Brian Chin - Bank of America ML
Charles Fishman - Morningstar
Good morning and welcome to the AES Second Quarter 2016 Financial Review Conference Call. All participants will be in listen-only mode [Operator Instructions]. Please note that this event is being recorded.
I would now like to turn the conference over to Vice President of Investor Relations, Ahmed Pasha. Please go ahead.
Thank you, William. Good morning and welcome to our AES's second quarter 2016 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors.
Joining me this morning are Andrés Gluski, our President and Chief Executive Officer; Tom O'Flynn, our Chief Financial Officer; and other senior members of our management team.
With that, I will now turn the call over to Andrés. Andrés.
Thanks you, Ahmed. Good morning, everyone and thank you for joining our second quarter 2016 financial review call. Today, I will discuss our year-to-date performance, provide an updates on market conditions and our progress on our strategic and financial objectives. Tom will then discuss our second quarter results and capital allocation in more detail. Before turning to results, I would like to highlight the most significant milestones that we achieved so far on our key objectives for 2016.
To continue de-risking our portfolio, we announce our close asset sales with proceeds of more than $500 million well above our target range of $200 million to $300 million. We brought online one-third of our capacity under construction, or 2.4 gigawatts on-time and on-budget. We prepaid $300 million in current debt exceeding our full-year target of $200 million, to accelerate our credit improvement. We are on-track to achieve our three-year $150 million cost reduction and revenue enhancement goals.
In Bulgaria, we receive payment of all outstanding receivables and continue to collect timely payment of invoices. And we continue to make progress to resolve DP&Ls pending rate case and our encouraged with recent regulatory developments in Ohio. I will discuss these achievements in more detail in the moment, but first, I would like to summarize our financial results on Slide 4.
Year-to-date, we generated proportional free cash flow of $670 million, representing 57% of our full-year guidance and reflecting the collection of outstanding receivables in Bulgaria during the second quarter. Our year-to-date adjusted EPS was $0.32 representing 32% of our full-year guidance, consistent with our comments on our last call. These results keeps us on-track to achieve our full-year financial guidance, which Tom will cover in detail.
Now I'll provide an update on macroeconomic conditions in our markets on Slide 5. First in Brazil, although we have seen a modest improvement in energy demand since our last call, we are still projecting negative growth for the year. In U.S. demand is essentially flat, but in most of our other markets, we continue to see robust growth in energy demand in the range of 4% to 10%.
Second while we have seen significant volatility in foreign exchange and commodity prices over the last couple of years, we are generally seeing market stabilize, as a result foreign exchange and commodity forward curves are largely in line with our expectation as of our last call. The one exception is that as a result of Brexit the British pound has depreciated by roughly 10%. However, we are largely here in the near-term and more importantly our exposure to the pound, is only about 3% of our pretax contribution.
Turning to Slide 6 on our portfolio optimization activities. In Brazil, we are seeing significant consolidation of the regulated utility sector at attractive valuations. We capitalize on this trend with the announced sale of our 100% ownership interest Sul, our most material utility business in Brazil from an investment point of view for approximately $470 million in equity proceeds to AES.
We are currently seeking regulatory approval for the transaction and expect to close before the end of the year. Including, the proceeds from the sale of Sul, we have announced our closed a total of $540 million in asset sales this year. Since September 2011, we have announced our closed asset sales with $3.8 billion in proceeds. The corner stone of our strategy in Brazil is [indiscernible] by perusing contracted wind and solar generation. Now that we are seeing the opportunity for reasonable inflation adjusted returns. These investments for help diversified [indiscernible] generation mix, while also allowing us to take advantage of the 300 million to 500 million in untapped debt capacity at [indiscernible].
Turning now to our platform expansion opportunities on Slide 7. Our ongoing construction program is the most significant driver of our growth over the next few years. We are focusing on our investment efforts on platform expansion projects with long-term U.S. dollar denominated contracts. One such opportunity is using our DR and future panama assets, to play a leading role and expanding the use of L&G throughout Central America and the Caribbean.
Regarding our construction projects, I’m happy to report thus far this year we have commissioned 2.4 gig watts on-time and on-budget. The majority of this capacity is that Indianapolis Power and Light, our regulated utilities Indiana, where we will be earning predictable regulated returns on these investments. Later this year, we expect to complete our 5502 mega watt [7.20] plant in Chile, also on-time and on-budget.
We have another 3.9 gig watts of new capacity currently under construction and expect it to come online through 2019. To deliver sustainable growth beyond 2019 we continue to advance our development pipeline. To that end, we recently received approval for the 1.4 gig watts Southland repowering project from the California Utility Commission and we are on-track to receive final environmental permit, early in 2017 and expect to break ground at summer.
Turning now to Slide 8. Our 3.9 gigawatt currently under construction represent total capital expenditures of $7.8 billion. However, through a combination of non-recourse financing and equity partners, AESs equity commitment is limited to 1.3 billion of this all but 215 has been funded. Roughly 74% of our investments are in the Americas and of this a majority is in the U.S. and Chile. We expect average return on equity from these projects of approximately 15%.
The majority of our construction projects are conventional power plants such as the 670 megawatt Eagle Valley combined cycle gas fired plant at IPL. Additionally, as we have discussed in the past, we are also building the 530 megawatt Alto Maipo, one of the river hydro project in Chile. This project is our most complex, as we are excavating 67 kilometers of underground tunnels. One-third of which are already complete. The project is roughly six months behind its original schedule and we expect to complete the project in 2019.
Turning to Slide 9, and Colon project in Panama. We have made significant progress since our last call. As a reminder, the $1 billion Colon project will contribute to our growth beyond 2018 and includes, a 380 megawatt combined cycle gas plant and a 180,000 cubic meter LNG regasification and storage facility. The power plant is contracted under a ten year U.S. dollar denominated power purchase agreement, and our partner Grupo Motta, one of the largest financial and commercial groups in the country.
We recently achieved two important milestones at Colon. Closing the financing of 535 billion with the consortium of banks and initiating construction. The Colon project seeks to replicate the success of our Andres LNG facility in the Dominican Republic. Andres provides gas to our adjacent power plant to another power plant via a gas pipeline and to numerous downstream customers in the transportation and industrial sector.
Last month, Andres also delivered its first international shipment of LNG to Barbados. This is a great example of our facility’s ability to serve as a reasonable gas hub by breaking large bulk shipments to serve smaller markets. There are many commercial and operational synergies between our LNG terminals in the Dominican Republic and Panama and with both facilities in operation, we will become the largest provider of the LNG regasification and storages services in Central America and the Caribbean.
Turning to Slide 10. We remain optimistic on the future of battery base energy storage, because we believe it will play a critical role in an increasingly renewable based generation mix. As you may know with our proprietary advancing system, we are the world leader in battery based energy storage with a 136 megawatts in operation across four countries, 13 megawatts under construction and 228 megawatts in advanced development including a 100 megawatts under our long-term contract.
We integrate [indiscernible] view in the energy storage space through two primary business models. First by developing and operating AES own project, such as the 20 megawatt Harding Street battery array we recently commissioned at IPL. As I just mentioned we currently have a 166 megawatts in operation or construction and another 220 megawatts in advance stage development.
Second by marketing and selling our Advancion Energy storage solution to other utilities commercial and industrial customers directly or through our sales channels partners, these sales require no investment capital and help advance to capture economies of scale. Thus far this year, we have sold 40 megawatt of Advancion systems third-parties, representing approximately $70 million in growth revenue.
Our second quarter results do not include these sales, but margins are on our initial sales will be modest, as we amortize start up cost. Although battery based energy storage is still it’s early adoption cycle and we have not included any matured amount in our projection. We believe Advancion, presents an interesting opportunity for upside.
Turning to Slide 11, as a result of all the actions we are taking, we expect at least 10% annual growth in proportional free cash flow through 2018, which will support our 10% annual growth in dividend, continue deleveraging of the plant and subsidiary and investment in attractive platform expansions.
As you can see on Slide 12, we also see robust growth in the earnings to 2018. From 2016 to 2018, we expect an attractive growth rate of 12% to 16% in our adjusted EPS. Approximately 5% of this annual growth is driven by cost reductions and revenue enhancements. Another 8% to 10% of expected growth is driven by the construction projects coming online in 2017 and 2018. With that, I will turn the call over to Tom to discuss our second quarter results, capital allocation, and full-year guidance in more details.
Thanks Andrés. Good morning, everyone. Today, I'll review our results including adjusted EPS, proportional free cash flow, and adjusted pre-tax contribution or PTC by strategic business unit or SBU, and I'll cover our 2016 capital allocation, as well as our guidance and expectations.
Turning to Slide 14, second quarter adjusted EPS of $0.17 was $0.09 lower than 2015. This decline is in line expectations communicated on our last call. Specifically, our second quarter results reflect $0.03 lower contributions from SBU, including anticipated drivers, such as timing of schedule maintenance in ANDES and MCAC.
A reduction of $0.03, because last year’s results included the favorable impact of the reversal of a liability at Eletropaulo. And the $0.03 impact from the evaluation in foreign currencies as expected particularly in ANDES in Europe. Before moving on, I want to touch on a couple of large impairment charges we had this quarter that are not included in adjusted EPS.
First we impaired 235 million of assets at DPL, primarily at Kelin station, this impairment impacts our quarterly diluted EPS, and was larger driven by the results of the recent PJM capacity auction and our expectation of higher future environmental compliance cost under the EPA Effluent Limitation Guidelines in coal combustion with [indiscernible]. Second as you have seen in our 10-Q, as a results of the sale, we have included Sul in discontinued operation and an imperilment was recognized during the second quarter.
The remaining loss on sale will be recorded at the closing of the transaction. After taking into account previously recorded cumulative transaction adjustment. The net impact on as is equity will be a reduction of our 100 million. Given this business is in discontinued operations, these non-cash items do not affect either diluted or adjusted EPS. As a result of placing Sul, into Disc Ops, it’s earnings and losses are removed from our 2016 and 2015 results. Consequently, our first quarter results have been restated to $0.15 after moving the $0.02 negative impact for Sul, which brings our year-to-date adjusted EPS for $0.32.
Now to Slide 15 and our overall results for the quarter. We generated 417 million of proportional free cash flow an increase of three 355 million from last year a significant of working capital improvements primarily at Maritza in Bulgaria offset lower margins. We also earned a 160 million in adjusted PTC during the quarter, a decrease of 100 million.
Now, I’ll cover our SBUs in more detail over the next six slides, beginning on Slide 16. In the U.S., our results reflect relatively flat margins, as lower wholesale prices and lower contributions from regulated customers; at DPL were largely offset by higher contributions at IPL. Including the benefit from the recent rate case and environmental upgrades they came online through this quarter. Also adjusted PTC was up modestly reflecting lower interest expense at DPL and IPL. Proportional free cash flow also reflects favorable working capital changes at IPL.
At ANDES, our results reflect the slightly higher margins due to higher spot and contract sales as well as lower maintenance at [indiscernible] in Chile. Partially offset by planned outages in Argentina as well as the devaluation of the Colombian and Argentine pesos. Proportional free cash flow also benefitted from higher collections in Argentina and at [indiscernible]. In Brazil our result reflect lower margins due to the benefit of a liability reversal at Eletropaulo in 2015. The exploration of Tietê PPA at the end of 2015 and the 12% devaluation of the Brazilian real. Proportional free cash flow also reflects higher collections at Eletropaulo and Sul.
In Mexico, Central America and the Caribbean, our results reflect lower margins due to lower availability including a planned outage ion the Dominican Republic, where we were performing interconnection work in the preparation for the expansion of existing DPP gas fire facility. As you may recall for converting the simpler cycle DPP plant to combine cycle. Improving its capacity by 50% to 358 megawatts.
Construction on this project is progressing well. We have already completed 80% of the upgrade and it is expected to come online in the first half of 2017. Our quarterly results were also impacted by lower third party gas sales in the Dominican Republic. In Europe, our results reflect lower margins due to 45% devaluation of the Kazakhstan Tenge. Proportional free cash flow also reflects the settlement of our 350 million outstanding receivable at Maritza in Bulgaria this quarter.
It’s worth mentioning that we've seen greatly improved collections in the roughly three months since that settlement and payments occurring. As a direct results of recent energy sector reforms our off taker, NEK is now cash flow positive versus substantially negative in 2015. This improved financial condition also drove strong interest in the recent bond issuance by NEKs parent where they are able to raise more than €0.5 billion and attractive rates. Finally, in Asia, our results reflect steady margins and lower working capital requirements, at Mong Duong in Vietnam.
Now Slide 22, I’ll provide an update on a regulatory filing at DP&L and Ohio. Under DP&L current ESP which cover the period from 2014 to 2016. DP&L has been collecting a service stability writer of little over 9 million per month. As you may know the Supreme Court of Ohio reverse the Utility Commission's approval of current ESP in late June. The court has since remanded the case to the commission, which now has jurisdiction.
Last week the DP&L filed to withdraw its current ESP and requested that the commission revert to the rates in effect prior to 2014, which would result in an in material financial impact of company. Matters now pending before the commission and we expect a ruling within a matter of weeks. At same time, we continue to progress on our filing for a new ESP. Which we expect to be effectively to begin in 2017. We expect an outcome that will supports the financial viability and credit profile of the business.
Now to Slide 23, and the progress we are making to improve our credit profile. We recently completed the refinancing of 500 million of our 2019 notes, extending the tender with 10 tenure notes. Additionally, since our last call, we have prepared a 180 million in parent debt. Bringing our total pay down year to date to 300 million, exceeding our 2016 debt reduction target by 50%. Since 2011 we reduced parent debt by 1.7 billion or 27% and reduced interest by on that 125 basis points, resulting in an annualize interest savings of 180 million. As you can see at the top of the slide, we now have no debt maturities maturing at the parent until 2019 when only 240 million is due.
In addition to the refinancing excluded to parent, we have also taken advantage of favorable market conditions and refinanced 1.4 billion in non-recourse debt primarily in Latin America. Through these proactive actions, we have been able to extend our maturities lower interest cost and reduced our exposure to floating rate interest. As you can see at the bottom of the slide, these proactive steps has helped us to reduce our parent leverage ratio from almost 6.5 times to slightly over 5 times debt to parent free cash ratio plus interest. These actions reflect our continued efforts to derisk our portfolio and improve our credit metrics. We believe this will help us reduced our cost of debt and enhance our equity valuation.
Now to our parent allocation on Slide 24. Sources on the left hand side, reflect 1.5 billion of total available discretion in cash, which includes 575 million of parent free cash flow. We continue to focus on maximizing cash to core and as a recent example, once with Macori administration looked at currency controls is in Argentina, we took a modest dividend of the first time since 2011.
We remain confident in our 2016 parent free cash flow range of 525 million to 625 million, which is the foundation for our discretionary cash available for dividend growth and value creation. Sources also include 540 million of proceeds from asset sales including approximately 470 million sales of Sul. As we expect to sell the close late in the year, the likely not deploy much as capital in 2016. We have however accelerated a portion of the expected proceeds by pre-paying a 180 million of parent debt in July that I just discussed.
No to uses on the right hand side of the slide, consistent with our capital allocation plan that we showed during our last call. With 10% growth in our dividend and completed share repurchases we returned about one third of our allocated cash to shareholders this year. Going forward, we continue to see our dividend as the primary means to distribute cash to shareholders. As just discussed we already prepaid 300 million in near term maturities.
We also allocated 360 million for investments in our subsidiaries and majority of which is for new projects driving our growth to 18 and beyond. After considering this investments in our subsidiaries, debt repayment and electronic dividend we are left with roughly 450 million of discretionary cash, which we will invest consistent with our capital allocation framework.
Finally, turning to Slide 25. We are reaffirming our 2016 guidance and 2017, 2018 expectations for all metrics with the foreign exchange and commodity fortress as of June 30. We continue to generate strong proportional free cash flow with our first half results reflecting the settlement of all outstanding receivables at Maritza.
Our first half, adjusted EPS was in line with what we have indicated on our last call. As our results were impacted by higher tax rate planned outrages and softness in U.S. power prices. The majority of our earnings are expected to be generated in the second half of the year and we should benefit from a few factors putting lower schedule maintenance, a lower effective tax rate, the realization of cost savings initiative and a couple of other items we are working on.
With that, I'll now turn it back over to Andrés.
Thanks Tom. Before we take our question, let me summarize today's call. First we are executing on our priorities for 2016. Exiting certain businesses at attractive valuation completing 2.4 gigswatts of projects on-time and on-budget improving our credit profile and collecting on our outstanding receivables in Bulgaria.
Second we continue to invest our growing cash flow to reduce debt and in select gross projects as well as offer our investors a significant and growing dividends. Third, we remain confident in our ability to deliver strong free cash flow growth through 2018, which is driven by our projects under construction and our cost savings and revenue enhancement initiatives.
Finally, we believe we are well positioned to deliver sustainable growth beyond 2018 due to our strong business platforms in attractive and growing markets and our leadership position in deploying new technologies.
With that, I would like to open up the call for questions.
[Operator Instructions] The first question is from Ali Agha with SunTrust. Please go ahead.
Thank you good morning. First question, can give us the sense of what gives you the confidence that the Ohio issue is particularly that's a correlation to the non-by passable are going to be resolved favorably and what are sort of the key milestones we should be looking at to figure out how this is playing out?
We continue to have normal discussions consistent with the process in Ohio. We are obviously aware of developments with the other major utilities in the phase especially [Indiscernible] and they have got little bit different perspectives, but we think those are both constructive directions. We do continue to think that those strong support in the state for in state generations giving the fall of vertex diligent too far removed. The in state jobs in state revenue from taxes and those kind of things. So we think there is strong support for that and I apologize to say we are encourage by discussions as we said we re-filed our rates for the remainder of 2016 to go basically back to the pre 2014 structure and we think that there is constructive and consistent with the sentiments.
And secondly as insulated to that Tom, so what is on that in to both your 2016, 2017, 2018 and outlook for this non by passable and I’m assuming your attiring that continuing. And what if that doesn’t happened, how should we think about the sensitivities with your earnings, whether it’s for this year or for the growth in 2017, 2018 if that goes away?
I think what we would say is, I think we have been consistent here, number one our most recent filing would not have material impact, assume we go back to the 2013 rate structure, we would not have material impact on our financials for the reminder of 20`6. Going forward, as we discussions this different approaches here, but we generally baked into our guidance is less than what we are currently getting, which is about a 110 million a year or 9 million a month, but it’s still material amount. We haven’t put a fine point on that but certainly it would be meaningful impact if there are a large fall but at this point we believe we will get something in that range.
Remember also Ali, we’ve not taken a dividend out of DPL, for some time and there is no parent free cash flow from DPL at least till 2018 in our forecast.
Okay, understood. Separately Andrés when you look at your portfolio today, can you just highlight for us, what regions or assets in general would you consider to be non-core to this portfolio as you continue going down the road of streamlining your platform?
Okay, we have, I think on very well in terms of focusing this company, in terms of getting out of those regions were we didn’t see those markets was so attractive and realizing attractive valuation from those sales. So what we are focused on in terms of growth, it’s going to be those places we can get, long term ideally dollars denominated contracts and were we can bring something besides just money. So these are additions where there are synergies or economics have scale.
So we don’t like talking about exactly those places that we are going to get out of until we do it. And you know we have very much stuck to that rule over the years. But I would say those countries, where we don’t see those opportunities. Where we see that, today quite frankly they are either too volatile or we don’t see opportunities for growth. So what I would like to say, we will continue to grow those businesses, especially those that are cash accretive and our real focus is on creating a company where we have a strong sustainable growth in our dividend and that’s what we are focused on.
So I’m not going to get into it specifically, but I think if you do it by the process to elimination which is those places where we don’t see growth, where we don’t see long-term contracts and we really don’t have any really sort of particularly advantages position we will get out of. Now we won’t talk about them, until it’s actually done, because obviously those can affect our operations.
Last question, Tom just remind us, why don’t you, you’re not allocated specially cash in terms of your priority of the use of that cash and you just remind us what your priority would be on ranking your priorities?
Yes, I think will across all the [indiscernible] side I think we will look at incremental growth and I think we have said that we would expect about 300 million to 400 million of contributions into our businesses from core on a normal year. This year we are kind of right in middle of that point. Of course continuing to grow the dividend on a regular basis, we will continue to look to deleverage and may take some of this opportunity to accelerate the deleveraging in our balance sheet. And of course stock repurchases is still something we have authority for, we have done a lot. So as we said, I think our primary focus in terms of cash to shareholders would be by the dividend.
The next question is from Julien Dumoulin Smith with UBS. Please go ahead.
So, perhaps a few more specific questions on the [Indiscernible] process here just being very clear. How to think about the ESP-1 rate structure for 2013. What I understand it's mostly a regulated structure with fuel pass through how should be think about power prices and just competitive retailers under that rate structure. I know it's a bit detailed, but I'm just to be curious so it is are you still positively exposed to stock prices increasing net-net. I'm just trying to understand how that the supplier recovery gets done and then secondly can you talks you the ESP-3 filing that you have pending are you been to need the re-filing of that or are you been amended to reflect some of the changes that might be necessary out of the Ohio Supreme Court.
Yes, Julien let me try to tackle that. In terms of number one the market risk and reward that we have is under our restructure and one that we had it or one that we are not going to revert back to is really the gen, is really at our generation that - basis of risking rewards of the market. In terms of structure of going back to, its different kind of financially at the end of day, it's about the same for us, but there was a group of people that have they not chopped then they would go to a defined rate structure. And that kind of slices it up a little bit different way, but the utility is not exposed to that it's a little bit different way to slice up the same amounts.
In terms of going forward, we believe that what we had filed earlier in January and February, we can work under that umbrella, if you will. So we don’t need to pull that back and re-file. Remember we had a couple of different alternatives and so we feel that that umbrella gives us the flexibility to shape a solution in different ways.
Got it and just to be clear. The ESP-1 the 2013 rate structure will remain indefinitely until you got a rate outcome under the ESP-3 structure. So kind of agnostic perhaps too strong award there, but throughout the process whenever you eventually get an outcome in ESP-3 just to be clear.
Yes, it would remain outstanding until those a supplement for it. And both of them are supportive of our financial structure.
Go it, excellent. And then jus the quick one and following up on the last question as well. Brazil Eletropaulo, can you comment just on what your thought process is there, obviously there has been some media comments there. How do you think about Brazil both on the [indiscernible] and the Eletropaulo by prospectively in the [indiscernible] region and how would you execute the your going into?
Okay, first given that Eletropaulo is a publicly listed company, we don’t comment on it. I think what we have said is that, we made a significant strategic move by existing Sul. If you look at today’s market price the equity value we had at Sul is more than [indiscernible] the value that we have in the Eletropaulo, so we have made a significant shift. Second, we have been very disciplined in Brazil, specially at [indiscernible]. We always for many years had this leverage capacity and the ability to buy new assets to grow. But we didn’t really see the valuations. We really didn’t see valuations that we are attracted for us.
With the correction in prices in Brazil, we are starting to see opportunity that would make it more attractive to leverage up [indiscernible] and buy something in Brazil. Now what would we buy? Well as we said in the past, we are really looking at our sort of risks, and we wouldn’t want more hydro risk in Brazil, so ideally it would be something like sola or wind or perhaps even thermal that would not be correlated to hydrology in Brazil to make our cash flow from [indiscernible] more steady. So again, Eletropaulo being a publicly listed company, it would be process pertinent to that market, but we are going to comment on it.
Sorry and then the last quick one, any update on the assets the you impaired in DPL, just curious if that has any reflection on the future viability of them in terms of retirement or whether they clearly [indiscernible].
No that was just at Kelin and that was just because it had a higher carrying value it was reflecting the result of the latest capacity auction.
They are all cleared Julian, all our [indiscernible] is cleared.
The next question is from Steven Byrd with Morgan Stanley. Please go ahead.
Hi good morning. Just wanted to check in with you on the storage business, there is increasingly talk about the business and you all obviously are very early into this business, when you think about growth potentials, we are seeing reports that costs are coming down for the actually equipment. Do you see that there are sort of inflections point at which it does become a fairly large driver of spending or is it a more gradual thing, where there is ultimately a step change, buts it’s rather just a gradual increase as you go down the curve. In other words, do you see relatively significant changes within, a year or two or three in terms of where the cost is going that going to allow the businesses to scale up a lot or do you thinks it’s probably more gradual pace?
What we are seeing in the business, is continued reduction in cost. So if we look at the cost of batteries they have come down 80% in the last five year and we are projecting an additional 50% in the next five. So that would driven them down significantly and really this is not technological breakthrough, it is as much as just really massification of the production process. So the more people that bring online giga factories and drive down battery prices, the batter it will be for people such as ourselves.
Now, given that how do you see this market, well this market is growing one of the main let's say things that are slowing it down it regulatory, since these batteries operate differently than just regulatory say [peeking] plans where other people providing ancillary services, because for example it goes positive and it goes negative. But having said that we are seeing this market that was a couple of 100 megawatts last year this it's growing some of the forecast by 2020 could be 10 gigawatts globally.
The forecast the lower as forecast you will see it's probably around 6 gigawatts that's still a tremendous rate of growth. Now that there are many applications, there is little bit of the hammer and so you can use it for many different things from load shifting ancillary services capacity release transmission constraint.
So that's how we see this market, now I see it kind of growing quickly some markets quicker than others the U.S. is clearly leading great the UK is having an important auction now, we see interesting markets in India with their expansion of renewable. So basically as I said in my speech as you have more renewable on the grid interruptible renewable the greater the need for these batteries, and there are different forms to alleviate that.
So we are pursuing it by two means one is on our own platform, we are participating in some of these auctions when they are big enough we do bring in partners like we do on all large projects, but we are also pursuing through some direct sales, but also through sales channel partners global sales. And we have already have had some success with $70 million so far this year. We expect that to grow over the remainder of the year and into next and of course that has overtime will have an interesting margin. But right now one of the things it does it helps to drive down cost, because this is all about scale. So if are one of the largest suppliers to the market I think you will have across advantage.
That's very helpful color, Andrés. And you had mentioned in your prepared remarks about essentially amortizing some of these initial cost. Could you remind us just sort of how rapidly you think you would be able to kind of [indiscernible] through those cost so that we can start to see significant margins on incremental sales.
Look it's going to depend on - this is volume. So basically think of startup cost and things like that are fixed cost, the more you have the more quickly we are not really prepared to sort of give guidance on the third-party sale, but I really don’t see this certainly not this year and probably next is not being a meaningful contributor.
Thank you. I'm sorry?
And the finally this is not in our guidance for that reason, but this could become quite interesting outside that time horizon.
That's great. Thank you very much.
Our next question is from Lasan Johong from Auvila Research Consulting. Please go ahead.
Good morning thank you. Tom, I have a quick question on the 15% rate of return should we expect the hurdle rate to go up as interest rates go up and your cost of capital go up with it?
Yes, I think the short answer is generally interest rates are being coming down and our cost of capital I think has been coming down so I think that's a good number certainly on the projects we are doing. To the extent that I think Andrés mentioned much of our focus will be on long-term U.S. contracted business some of that may warrant some compression of that modestly, but I don’t think we see them going up.
My point eventually the interest rate are going to go up at some point, right whether it’s a year or two years from now. When that happens, are we going to see is that 15% hurdle rate go up?
Yes the one thing I would say is we certainly look at our cost of capital IRRs on a real time basis, real time for global interest rates, local interest rates, local risk. So certainly if there is a meaningful change in macro conditions, be it interest rate risk or other things inflation what have you. We would certainly factor that into that into our capital allocation framework.
Lasan I think, one way to look at this is, we want to earn a 200 basis points plus over our sort of weighted cost capital on this projects. So it’s going to depend on their locations. So for example, you are really, we will have a lower ROI for those projects that are rate based on our regular utilities Than we do on some of the other projects which are one different locations. But the one thing we are moving towards, I would say, de-risking the company.
And so that I think it’s an important component and I so it’s dollar denominate long term contract, in the good zip code and that’s a great country. Those will have a lower return than some of the other locations. But I do think that when you look at our projects, what is important is there is a lot of synergies between them. So if we look at for example the Panama project, it will have significant synergies if we increase the amount of tolling we do from that facility, you know our power plant will take roughly about 30% of the capacity to tank in the terminal.
So we are really looking for a third-party sales, like we do in the Dominican Republic. So once you have the two hubs operating the return from the project will not only be from the project itself, will also be from the existing businesses. So that’s how we are looking at it. and just to say, so I don’t think that if interest rates go up, it depends, how much they go up, but we are also shifting our business to less risky businesses and the returns of the project is also returns to the bits to existing businesses, which perhaps were not included in that ROE.
No let me flip the question around. How much more businesses you usually get if you drop the hurdle rate to 12% or 10% even?
I think if we drop the hurdle rate, again we don’t have a universal hurdle rate. The lower the cost of [Technical Difficulty] projects in some other markets [Technical Difficulty] we don’t use the universal hurdle rate.
Okay. Thank you very much for your help.
Our next question is from Brian Russo with Ladenburg Thalmann. Please go ahead.
Hi good morning. Just curious are there any issues or risk to the Sul approval process, I believe that these acquires, shareholder approval, just may be some comment on the milestones there to get approved?
Yes the milestone and they have a shareholders’ approval. We believe that they are very confident of getting it. Then there would be an approval of [indiscernible] which is the regulator. And that’s why we are targeting this close for the fourth quarter of this year, but given all that’s happening in Brazil, we don’t expect any issue. And furthermore, it’s a acquisition that makes a lot of sense, which is consolidating the distribution company into state of real grounded to Sul. So there is lot of logic, a lot of cost savings from bringing these together. So we think the fundamentals for the transaction for the acquirer are very strong.
Okay, thanks. And then just on the TPO, Ohio process. I'm just curious what was the thought process to file to revert back to the pre 2014 rate structure. I mean did you have discussions with staff or what made you choose that route versus any of the other alternatives.
Yes, I mean we did have some consultation, I better not go into the specifics, but following the Supreme Court we wanted to look for something that had the same provision of stability and supporting the overall financial viability of the company, but staying away from let's say the specifics of the Supreme Court. But also appreciating that there was strong motivation for the reason that I mentioned earlier to keep the utility stable and keep our generation viable.
Got it. Thank you.
Our next question comes is from Brian Chin with Bank of America ML. Please go ahead.
Hi good morning. I have got a question on the effluent requirement and the coal combustion residual requirements. How much extra CapEx is that going to necessitate?
Yes, we haven’t disclose that specifically. I believe DPL has the three-year forward CapEx table that is in their K. We are still reviewing it, but we did have some preliminary number let's say that were baked into our impairment analysis and it was really the combination of those numbers. They really be out - I believe it’s a 20 to 21 times zone as well as we did have to take note of the recent capacity auction that was down much from 160 to about 100 and that we think a 100s low, we did have to factor that most recent data point into our long-term forecast.
Okay, so just to be clear that CapEx spending would be done in 2021 or there is a deadline for the plants to meet the requirements by 2021?
Brain this is Ahmed. This is [Indiscernible] 2022 and as Tom mentioned I mean we did have a number in our forecast, but based on the revised forecast the projections are slightly higher, but real impact for this impairment is the capacity prices, which came in lower than what we were expecting. So that was the bigger driver than the CapEx.
Got you. And then just going back to your prepared comments on Sul. You mentioned that you had re-classed Sul into discontinued operation and there was a $0.02 sort of swing on year-to-date to adjusted EPS. I'm just assuming that you haven’t change guidance, because $0.02 is relatively minor or immaterial versus the guidance range is that right?
That's fair and to be honest when we talked last time we did say - when we had a slower first quarter we did say there were some things that we are working on and this is at least one of the thing in the bucket.
Got you. Great, thank you very much that’s all I got.
Our next question is from Charles Fishman with Morningstar. Please go ahead.
Thank you. Andrés [indiscernible] discuss the slide. Slide 12, on the third bar. In the 8% to 10% new construction that I get and you have laid that out very well. The 5% from existing business, I wonder if Andrés you or Tom could may be give a little more color on that. is that like just a full-year of IPL for instance, improving Brazil or what plays into the 5% over the two years?
That is our cost savings and revenue enhancement initiative, which is well under way. We have a three year $150 million cost saving new enhancement initiatives in three chunks of 50-50 and 50. This is an annual run rate, prior to this in the previous four years we did a $200 million cost savings and revenue initiative. So we have a lot of experience at this. Perhaps Bernerd our Chief Operating Office can make a few comments on what that consist of.
Bernerd Da Santos
Yes thanks Andrés, I think we are very pleased that we are on-track with the $50 million that was what we commit for the first year in 2016 and we also have a - we thought the initiative that we have underway well tracking on into [indiscernible] and the $250 million for 2017 and 2018. And just as to reminder a those are the initiatives that we were disclosing our synergies and economics has scales that is one with the pocket that we are working in sourcing.
And the service centers that we have in lower cost location and what they can [indiscernible] between the labor cost that we have and deficiencies of standardization that we have in those places and the standardization [indiscernible] improvement that we are doing in our fleet. [indiscernible] sharing or replication of the lead practice of our thermal plants. A best performance thermal plants across the rest of the fleet. So with that, we actually have identified largely he $150 million that need to be delivered and we are very confident to deliver those.
Okay so lot of 5% is these cost savings, pretty well, we can count on that sound pretty - you can bank that. That’s good. Okay, that was all I had. Thank you very much.
Okay. Thank you.
This concludes our question and answer session. I would now like to turn the conference back over to Ahmed Pasha for any closing remarks.
Thank you everybody for joining us in today’s call. As always the IR team will be available to answer any question you may have. Thank you and have a nice day.
The conference has now concluded. Thank you attending today’s presentation. You may now disconnect.
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