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The AES Corporation: Capital Allocation on Track but Still Too Much Debt

November 26, 2012 | About:
The AES Corporation (AES) is a Fortune 200 global power company. AES owns a portfolio of electricity generation and distribution businesses in 27 countries on five continents, with total capacity of approximately 44,200 megawatts and distribution networks serving approximately 12 million customers. AES' 2011 revenues were $17 billion, and it manages and owns $45 billion in total assets. It has a workforce of around 27,000 people.

On Nov. 1, 2012, AES announced that it will restructure its corporate support and subsidiary business operations to affect cost savings. The reorganization will consolidate operations into market-oriented strategic business units under one chief operating officer. These changes are expected to yield an additional $45 million of recurring cost savings.

Valuation

AES is currently trading at a trailing 12 months EV/EBITDA of 10.2. AES achieved a five-year average ROE of 14.6% and a five-year book value per share CAGR of 11.6%.

Financial and Business Risks

AES is highly geared with a gross debt-to-equity ratio of 487% and a net gearing of 423%. This is not helped by an interest coverage ratio of 2.8 and a quick ratio of 1.05. However, AES has spent $717 million in pre-payments of debt since September 2011. This does not take into account $61 billion of purchase obligations in addition to $21.6 billion of debt on the balance sheet. These purchase obligations relate to purchase of electricity from third parties, fuel purchase contracts and other enforceable and legally binding agreements to purchase goods or services.

AES sells to a wide variety of customers, with no individual customer accounting for more than 10% of its 2011 revenue. However, many of its generation plants power sales contracts with one or a limited number of customers for the majority of the plant’s output and revenues over the term of the power sales contract.

For each of the fiscal quarters between 2004 and 2008, AES' management reported material weaknesses in its internal control over financial reporting. AES completed the remediation of the material weaknesses in internal control over financial reporting in 2008.

On Nov. 1, 2012, AES announced a non-cash impairment charge in the range of $1.7 to $2 billion related to goodwill recorded in connection with the acquisition of DPL, as power prices in Ohio trended downward and customers moved towards competitive retail electric services.

Business Quality and Capital Allocation

AES is a diversified power generation and distribution company, driven by faster demand growth in emerging markets combined with cash flow stability from developed markets. Commodity and currency risks are largely mitigated by contracts and regulatory structures. AES' generation portfolio, where AES owns and/or operates power plants to generate and sells power to wholesale customers, is largely sold under long-term power purchase agreements, which reduces the risk related to market prices of electricity and fuel. AES also attempts to limit risk by matching the currency of most of subsidiary debt to the revenue of the underlying business and by hedging some of its interest rate and commodity risks.

AES is also optimizing its capital allocation strategy. It is improving profitability through targeted cost reductions and debt repayment. It is also exiting non-strategic assets and markets. AES sold various businesses for $933 million and at a P/E multiple of more than 20 times its 2011 adjusted earnings, including Cartagena in Spain, Red Oak in the U.S., French Wind in France and Yangcheng & China Wind in China.

On Oct. 15, 2012, AES announced that it will pay its first quarterly cash dividend of 4 cents per share in almost 20 years payable on Nov. 15, 2012. This equates to an annualized dividend yield of 1.58%. Since September 2011, AES repurchased 34 million shares for $390 million at an average price of $11.55 per share.

Conclusion

The first quarterly cash dividend in history and the significant repurchases are steps in the right direction. However, notwithstanding $717 million of debt prepayments, AES has an unacceptable level of financial risk with its high gearing and huge purchase obligations.

Disclosure

The author does not have a position in any of the stocks mentioned.

About the author:

Mark Lin
Mark is a private value investor and runs the Cheapskate Investing website which borrows from the wisdom of value investing giants, using a systematic quantitative screening approach to filter the global stock markets for cheap cigar-butts and wide-moat compounders. He is also a regular contributor to various value investing communities.

Visit Mark Lin's Website


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