AES Corporation — Q3 2014 Form 10-Q Summary
Business context and reporting period
The AES Corporation is a diversified power generation and utility company operating through six strategic business units: United States, Andes, Brazil, MCAC, EMEA and Asia. This unaudited Form 10-Q covers the three and nine months ended September 30, 2014, with comparisons to the corresponding 2013 periods.
Effective July 1, 2014, AES adopted ASU 2014-08, which narrowed the criteria for discontinued operations. Prior periods were reclassified under the previous guidance; the U.K. Wind disposal remains in continuing operations under the new standard.
Financial performance and key metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Revenue | $4.441 billion | $3.996 billion | $13.014 billion | $12.091 billion |
| Operating margin | $767 million | $927 million | $2.380 billion | $2.577 billion |
| Operating margin percentage | 17.3% | 23.2% | 18.3% | 21.3% |
| Income from continuing operations | $508 million | $339 million | $878 million | $903 million |
| Net income attributable to AES | $488 million | $71 million | $563 million | $320 million |
| Diluted EPS from continuing operations | $0.67 | $0.23 | $0.81 | $0.61 |
| Adjusted EPS | $0.37 | $0.39 | $0.89 | $1.01 |
| Cash flow from operations | $763 million | $855 million | $1.216 billion | $2.040 billion |
Q3 revenue increased 11%, but operating margin fell 17%, primarily because of weaker results in Brazil and Asia. Nine-month revenue increased 8%, while operating margin declined 8%. Adjusted EPS, which excludes dispositions, impairments, unrealized derivative and foreign-currency effects, and debt-extinguishment costs, declined 5% in Q3 and 12% for the nine months.
- Segment trends: Q3 operating margin increased in the U.S. by $16 million, Andes by $78 million, MCAC by $33 million and EMEA by $9 million, but declined in Brazil by $262 million and Asia by $26 million. Nine-month operating margin increased in Andes, MCAC and EMEA, but declined in Brazil by $187 million and Asia by $72 million.
- Cash flow: Nine-month operating cash flow decreased $824 million, largely from higher receivables, regulatory assets, taxes and working-capital requirements, especially in Brazil, MCAC and EMEA. Reported free cash flow was $706 million for the nine months versus $1.445 billion in 2013; proportional free cash flow was $604 million versus $923 million.
- Capital spending: Nine-month capital expenditures were $1.749 billion, including $789 million of growth capital, $600 million of maintenance and environmental capital, and $360 million of financed capital expenditures reflected in financing activities.
- Balance sheet and liquidity: September 30 cash and cash equivalents were $1.670 billion, short-term investments were $686 million, and restricted cash and debt-service reserves totaled approximately $967 million. Parent Company liquidity was $1.028 billion, consisting of $229 million of parent and qualified holding-company cash and $799 million of available credit-facility borrowings.
- Debt: Non-recourse debt was $15.719 billion and recourse debt was $5.347 billion at September 30. Approximately $2.3 billion of non-recourse debt was current, including $0.9 billion classified as current because of covenant defaults at Maritza and Kavarna in Bulgaria. These were not payment defaults and were not considered at risk of triggering a parent-level cross-default at period-end.
- Shareholder returns: AES declared a $0.05 quarterly dividend and repurchased 7.4 million shares for $108 million during Q3. The remaining authorization under the repurchase program was $192 million at September 30.
Material changes versus the prior comparable period
- Net income attributable to AES rose to $488 million in Q3 from $71 million, and to $563 million for nine months from $320 million. The increase was driven primarily by asset-disposition gains, lower prior-year impairments and reduced discontinued-operation losses.
- Q3 included a pretax gain of approximately $283 million from the sale of a 45% interest in Masinloc and a $78 million gain from the sale of U.K. Wind projects. The Masinloc transaction reduced AES ownership from approximately 92% to 51%, while AES retained control.
- Interest expense increased 9% in Q3 and 2% for nine months. AES recorded debt-extinguishment losses of $47 million in Q3 and $196 million for nine months, primarily from parent-level refinancing and early debt retirement.
- Foreign-currency transaction losses increased to $79 million in Q3 and $91 million for nine months, compared with gains of $32 million and losses of $16 million, respectively, in the prior-year periods.
- Goodwill impairment was $154 million for the nine months, including $136 million at DPLER and $18 million at Buffalo Gap. Asset impairment expense was $90 million, including additional impairment at Ebute and impairments at East Bend and U.K. Wind.
- Operating conditions deteriorated in Brazil because of low hydrology, lower generation and expensive spot-market purchases, particularly at Tietê. Asia was affected by lower Masinloc availability, maintenance costs, unfavorable market-price recalculation and lower contracted prices at Kelanitissa.
- Comprehensive income attributable to AES declined to $295 million in Q3 from $92 million? The filing reports $295 million in Q3 2014 versus $92 million in Q3 2013, while nine-month comprehensive income attributable to AES was $229 million versus $322 million. The nine-month decline primarily reflects foreign-currency translation and derivative losses.
Guidance, outlook, management commentary and risks
The filing does not provide a formal full-year revenue or earnings guidance range. Management’s stated priorities are to improve operating reliability and cost management, increase discretionary cash for debt repayment, growth investments, dividends and share repurchases, selectively expand or exit markets, and reduce currency, commodity and political risk.
- Hydrology and operations: Dry conditions in Brazil, Panama, Chile and Colombia reduced generation and may require additional spot-market purchases. Management noted that some forecasts indicated continued dry conditions through the remainder of 2014, with potential 2015 rationing risk in Brazil.
- Regulatory matters: DP&L faces an Ohio requirement to separate or divest generation assets by January 1, 2017, subject to appeals. Philippine regulators’ recalculation of 2013 spot-market prices reduced Masinloc revenue by approximately $15 million; permanent price-cap measures could have a material effect.
- Country and counterparty risk: Argentina faces inflation, currency devaluation, restricted foreign exchange access and sovereign-credit uncertainty. Bulgaria’s NEK had $226 million of outstanding receivables owed to Maritza, including $88 million more than 90 days overdue. AES Puerto Rico had $95 million of receivables from PREPA, including $33 million overdue at September 30, although $30 million was collected after quarter-end.
- Debt and liquidity: Parent liquidity depends on distributions from subsidiaries, asset sales and capital-market access. Subsidiary defaults can restrict distributions, require additional support, cause asset losses or potentially trigger parent-level defaults if materiality thresholds are later met.
- Contingencies: Accrued litigation liabilities were approximately $258 million. Reasonably possible material losses, where estimable and excluding accrued amounts, were estimated at $1.1 billion to $1.4 billion. Parent contingent contractual obligations totaled $1.145 billion, including guarantees, asset-sale indemnities and letters of credit.
- Environmental exposure: New Chilean carbon and emissions taxes begin affecting future periods, and IPL estimated approximately $332 million of wastewater-compliance investment, subject to regulatory recovery. DP&L and IPL also face environmental-permit and Clean Air Act matters with uncertain costs.
- Subsequent events: AES’s board approved the sale of its 49.62% Entek interest for $125 million in October 2014; closing was expected in Q1 2015 and was expected to produce additional impairment related to accumulated currency translation losses. AES also agreed to redeem Puerto Rico preferred shares for $52 million by year-end 2014.
Important facts for investors to verify
- Whether Maritza and Kavarna covenant defaults can be resolved without payment defaults, additional liquidity support, asset impairments or parent-level cross-default consequences.
- Collections and regulatory treatment of Maritza, PREPA, Argentine government and Brazilian utility receivables.
- The effect of continuing drought conditions, spot power prices and potential Brazilian rationing on Tietê, Panama and other hydroelectric operations.
- The timing, proceeds and accounting impact of the Entek sale, the Dominican Republic partnership and other announced portfolio transactions.
- Potential additional goodwill or asset impairments, particularly at DP&L, Buffalo Gap, Ebute and other businesses exposed to weak market conditions.
- The ultimate cost of litigation, tax assessments, environmental compliance and other reasonably possible contingencies, including the Eletropaulo and Tietê tax matters.
- The sustainability of operating cash flow, proportional free cash flow, dividends and share repurchases given lower year-to-date cash generation and significant capital requirements.