AES Corporation: The Turnaround Company

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About: The AES Corporation (AES)
by: Kurt Pollet
Summary

AES has a history of volatile earnings and high debt levels.

Since 2012, AES has exited markets where it was not competitive.

The company now operates profitably which was reflected in its strong 2018 financial results.

AES is currently paying a 3.1% dividend.

Introduction

The AES Corporation (NYSE:AES) is a power generation and utility company operating in the United States and globally,

The company has two main business units. The first is their Generation business where AES operates power plants to generate and sell power to wholesale customers such as utility companies. The second is their Utilities business where AES operates their own utilities that sell electricity to customers.

AES is a company with a history of volatile earnings and high debt levels. To improve the company’s financial performance, AES has in recent years exited markets where the company could not operate profitability.

Divesting the company’s unprofitable markets has turned AES into a profitable business which was reflected in its strong 2018 financial performance.

The stock price has surged over the last year making it a little expensive; however, the stock price could potentially surge even higher if the company continues to deliver future earnings growth. As a bonus, AES is currently paying a dividend with a 3.1% yield.

Financials

AES has reported financial results for the fourth quarter of 2018 (data from Seeking Alpha and Yahoo).

The company’s reported fourth quarter revenue was down 0.8% from the fourth quarter of 2017. AES reported a profit with diluted earnings per share of $0.15 compared to a loss of $1.04 from the fourth quarter of 2017.

On an annual basis, revenue for 2018 was up 2.0%. AES reported a profit with diluted earnings per share of $1.48 compared to a loss of $0.77 for the 2017 fiscal year. The 2018 EBIT was up 7.5% over the 2017 fiscal year.

AES paid a dividend of $0.5265 for the 2018 fiscal year which was up from the dividend of $0.39 paid for the 2017 fiscal year. The current trailing yield is 2.94% and the forward yield is 3.09%.

Since 2012, AES has paid out a total of $2.28 per share in dividends. However, since 2012, the company’s total diluted earnings per share were $1.03 meaning that AES has paid out more in dividends than its net earnings since 2012.

The return on equity is currently 25%. At first, this sounds good but since 2012, the company has reported three fiscal years with earnings losses. Out of the profitable years, the next best return on equity was 10% and the next after that was 4%.

The profit margin is currently 11%. This is significantly higher than its next best profit margin year of 4% since 2012.

AES’s current ratio is 1.1 meaning that its current assets just exceed its current liabilities. AES has had a consistent current ratio of 1.1 since 2012.

The asset ratio (total liabilities to total assets) is 81% which means that AES’s total debt is 81% of the value of everything the company owns (note that the asset value is the book value and not the liquidated value of its assets). Since 2012, its asset ratio has dropped from 90%.

The company’s book value is currently $4.84 and with a stock price of $18, AES is trading at 3.7x book value.

The analysts’ consensus forecast is for revenue to increase by 4.6% in 2019 and increase 1.7% in 2020. Earnings are forecast to drop by 10% in 2019 and increasing 8.3% in 2020. The 2020 P/E ratio is 12.5x.

Revenue And Earnings

As an investor, I personally like to examine the company’s revenue and earnings history. To make this task easier and more convenient, I like to visually present the data on a chart.

AES revenue and earnings history chart AES data by ADVFN

The above chart visually shows AES’s revenue and earnings' historical trend along with the next two years of consensus forecasts.

Examining the chart shows that AES’s revenue has declined since 2012. The chart also shows the volatility in the company’s earnings. The current reported 2018 earnings have been the best since 2009.

The forecast revenue shows modest increases heading into 2020. The forecast earnings shows a slight drop from the strong 2018 result heading into 2020, however, these forecast earnings are still significantly higher than the earnings in recent years. The future earnings will also be needed for the company to maintain its dividend payments – considering that AES has paid out more in dividends than what it earned over the last seven years.

Since 2012, the company has changed its operation by exiting markets where it could not compete. This has streamlined the company making it more focused on profitable markets. This is reflected in the decline in revenue since 2012. For the 2018 fiscal year, AES’s efforts showed up in its financials with a strong return on equity along with a decent profit.

Andrés Gluski - President and CEO stated in the company’s earnings call:

AES today is a very different company than it was in 2011, doing business in 28 countries around the world with significant commodity exposure. Since then we have focused our portfolio on roughly a dozen markets where we have a competitive advantage and we have reduced our overall exposure to foreign currencies, commodities and hydrology by 70%.

I think that management is on the right track here. Personally, I think it's pointless operating power stations and supply utilities if you can't make a profit from those operations. These losing businesses just drag down the company's overall profitability. Just recently, AES divested its Philippines business operations for $1.05 billion and in 2016, AES divested its Brazilian business operations for $486 million. Now, this is good business management - sell losing businesses and redeploy the capital such as lowering debt.

The company's improved return on equity is in part due to its newfound profitability but it's also attributable to the company lowering its rather substantial debt level of 90% in 2012 down to 81% in 2018.

Andrés Gluski further added in their earnings call:

In 2018 alone, we paid down $1 billion dollars in current debt, and we are on a path to attain investment grade ratings in 2020, supported not only by our financial metrics but also by the lower level of risk and higher quality of our portfolio.

Management is confident that their newly focused leaner business structure will lead to a continuation of the strong results achieved for the 2018 fiscal year.

In the company’s earnings call, Gustavo Pimenta - Chief Financial Officer stated:

To-date, we are also providing our outlook of 7% to 9% EPS and cash flow growth through 2022. We have extended this outlook by two years, which reflects improving confidence in our backlog and increased visibility of earnings and cash flow.

To me, this provides a certain degree of confidence that AES will continue turning this company around and potentially making it a growth company. However, I still consider AES to be a higher-risk company mostly due to its remaining debt levels which are still quite high. While the debt levels are lower now than they were in 2012 they are still high with an asset ratio around 80%.

The problem with high debt levels is that if the company suddenly needs additional funding they can't simply go to the bank and borrow. As a general rule, banks don't like lending to high debt companies and that's fair enough. After all, banks want the security that their borrowings will be repaid with interest - which is less likely with high debt companies, not to mention the bankruptcy risk.

On a positive note, AES has managed to lower its asset ratio from 90% down to 81% in recent years as a direct result of its divestment strategy. AES's debt level will likely fall further if the company continues to operate profitably as it did in 2018.

Another risk factor with AES is that it does not have a proven history of earnings growth - in fact, it's just the opposite. While the company expects earnings growth of at least 7% going forward, this is merely what management thinks will happen. At this stage, the only fact is that AES reported one good profitable year and the forward projection in earnings growth is taken from that one good year.

The point here is that at present any future earnings growth is speculation - it's what probably will happen but there is no proven history. This makes AES a turnaround play. Personally, I like the approach management has taken by divesting underperforming businesses to improve the company's profitability and lowering its debt levels.

As far as paying dividends is concerned, I personally think it would be better to pay down some more debt first, but this is management's decision. Certainly, a lot of investors would be pleased with the company paying out dividends, but I still think it would be better if management deferred paying dividends for the time being.

Stock Valuation

AES is expecting earnings growth of at least 7% heading into 2022. While AES does not have a history of growth, I do feel comfortable with management's approach to turning around the company. This will potentially lead to future growth and an appropriate method for valuing growth stocks is the PEG (P/E divided by the earnings growth rate).

With a 7% growth rate, AES’s forward PEG is 1.8 with a 2020 P/E multiple of 12.5x.

It’s commonly accepted that a stock is fairly valued when its forward PEG is 1.0 which means that AES is overvalued with a stock price of $18. Its fair value would be around $10.

Stock Price

As an active investor, I personally like to determine some likely price targets. This gives me a feel for how high the stock price could go in the short term and how soon it could get there.

AES ten year stock chart

AES chart by StockCharts.com

The stock chart reveals that AES’s stock price has broadly traded sideways for most of the last decade and this was all during a bull market. It seems investors have found a renewed interest in AES as its stock price surged during 2018 and into 2019 having almost reached $18. This surge was probably due to AES’s solid financial performance for 2018.

Should the stock keep rallying, in the short term, it could replicate the 2018 advance again in 2019. In 2018, the stock advanced from the $10 low to the $16 high. Adding this $6 advance to the 2019 low of $14 gives a target of $20. Given that AES’s strong rally seen so far this year has already reached $18, the stock could even trade well past this $20 target. For this rally to continue, it would require the stock market to continue with its rally.

Over the longer term, the stock has the potential to continue higher and will probably do so as long as its forecast earnings are met. If future earnings show poor growth, then I would expect its stock price to trade back down into its general trading range.

Given that AES’s earnings have been volatile in recent years, I think this is a riskier stock as its stock performance hinges on its future earnings growth.

Conclusion

AES is a turnaround company with a history of volatile earnings and high debt levels. Management is focused on improving the company’s financial performance having exited unprofitable markets in recent years. While this has lowered the company’s revenue stream, it has also streamlined the company turning it into a profitable business with strong returns on equity.

The stock price is a little expensive considering that the company still carries a fair amount of debt; however, the stock price could potentially surge higher if the company continues to deliver future earnings growth. As a bonus, AES also pays a 3.1% dividend.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.