AES Corporation: Q2 2016 Form 10-Q Summary
Business context and reporting period
The AES Corporation is a diversified global power generation and utility company operating through six strategic business units: US, Andes, Brazil, MCAC, Europe and Asia. The filing covers the unaudited quarter and six months ended June 30, 2016, with prior periods reclassified for discontinued operations and held-for-sale businesses.
Management’s priorities were platform expansion, portfolio simplification, operating-cost reduction, access to capital and disciplined capital allocation. AES had 3,921 MW under construction, representing approximately $7.8 billion of total expected capital expenditures, and expected these projects to enter service through 2019.
Key financial metrics
| Metric | Three months ended June 30 | Six months ended June 30 | ||
|---|---|---|---|---|
| 2016 | 2015 | 2016 | 2015 | |
| Revenue | $3.229 billion | $3.656 billion | $6.500 billion | $7.414 billion |
| Operating margin | $574 million | $755 million | $1.083 billion | $1.476 billion |
| Income from continuing operations | $(8) million | $274 million | $75 million | $535 million |
| Net income attributable to AES | $(482) million | $69 million | $(356) million | $211 million |
| GAAP diluted EPS from continuing operations | $(0.16) | $0.11 | $0.05 | $0.33 |
| GAAP diluted EPS including discontinued operations | $(0.73) | $0.10 | $(0.54) | $0.30 |
| Adjusted EPS | $0.17 | $0.26 | $0.32 | $0.52 |
| Cash flow from operating activities | $723 million | $153 million | $1.363 billion | $590 million |
| Proportional free cash flow | $417 million | $62 million | $670 million | $327 million |
Revenue declined 12% in both the quarter and first half, while operating margin declined 24% and 27%, respectively. Management attributed the revenue decline primarily to unfavorable foreign exchange, especially in Brazil, lower Brazilian contracted rates, the absence of Uruguaiana operations in 2016, lower pass-through costs and the DPLER sale. Operating margin was also affected by the 2015 reversal of a contingent regulatory liability at Eletropaulo, higher fixed costs and weaker demand.
Adjusted PTC, a non-GAAP pretax performance measure, was $160 million in the second quarter and $345 million in the first half, compared with $260 million and $522 million, respectively, in the prior-year periods. Adjusted EPS declined 35% in the quarter and 38% in the first half.
Cash flow, balance sheet, debt and liquidity
- Operating cash flow increased to $1.363 billion for the first six months, primarily from collections of overdue receivables at Maritza and higher collections at Brazilian utilities. The improvement was substantially influenced by working-capital timing and should not be viewed as entirely recurring.
- Capital expenditures were $1.255 billion in the first half, including $787 million for growth, $317 million for maintenance and $151 million for environmental projects.
- Cash used in investing activities was $1.326 billion. Financing activities used $43 million, including $145 million of common dividends, $79 million of share repurchases, $1.054 billion of non-recourse debt repayments and $611 million of recourse debt repayments.
- Cash and cash equivalents were $1.265 billion at June 30, 2016, compared with $1.257 billion at December 31, 2015. Short-term investments were $544 million, and restricted cash and debt-service reserves were approximately $950 million.
- Aggregate debt consisted of approximately $15.9 billion of non-recourse debt and $4.9 billion of recourse debt. No recourse debt matured within the following twelve months.
- Parent Company liquidity was $763 million at June 30, 2016, consisting of $30 million of parent and qualified holding-company cash plus $733 million of available borrowings under parent credit facilities.
- Parent Company financial covenants were reported to be in compliance. The company paid quarterly dividends of $0.11 per share and repurchased 8.7 million shares for $79 million during the first half.
In May 2016, AES issued $500 million of 6.00% senior notes due 2026 and redeemed $495 million of existing senior notes due 2019. In July 2016, after the reporting date, AES redeemed $181 million of 8% senior notes due 2017 and expected to record an approximately $16 million loss on extinguishment in the third quarter.
Material changes versus the prior comparable period
- Revenue fell $427 million in the second quarter and $914 million in the first half, primarily from foreign exchange and lower performance in Brazil, MCAC and Europe. Asia was the only SBU with higher first-half revenue.
- Operating margin fell $181 million in the second quarter and $393 million in the first half. Brazil operating margin declined 65% in the quarter and 70% in the first half; MCAC and Europe also declined materially.
- Interest expense increased 36% in the quarter to $390 million and 16% in the first half to $732 million, partly because the prior-year Eletropaulo regulatory-liability reversal had reduced interest expense.
- Asset impairment expense increased to $235 million in the quarter and $394 million in the first half, versus $37 million and $45 million, respectively, in 2015. Charges included $235 million at DPL and $159 million at Buffalo Gap II.
- AES recorded a $382 million after-tax loss from the impairment and classification of AES Sul as discontinued operations and held for sale. The company expects an additional after-tax loss of approximately $700 million when the sale closes, subject to sale proceeds and foreign-exchange adjustments.
- AES completed the sale of DPLER for $76 million and recognized a $49 million gain, sold a 40% interest in Jordan IPP4 for $21 million, and recorded a $20 million loss on deconsolidation of UK Wind.
- Adjusted PTC declined across the US, Andes, Brazil, MCAC and Europe SBUs, while Asia increased modestly. Brazil was the largest contributor to the decline.
Guidance, outlook, risks and unusual items
- No formal consolidated earnings guidance was provided in the filing. Management expects at least $50 million of savings in 2016 from a $150 million cost-reduction and revenue-enhancement program, ramping to $150 million in 2018.
- The AES Sul sale is expected to close in the second half of 2016. The filing estimates a cumulative earnings impact of approximately $1.1 billion, including the recognized impairment and expected loss on sale, and an approximate $100 million reduction in AES stockholders’ equity from cumulative translation losses.
- Brazil remains exposed to recessionary conditions, lower electricity demand, high interest rates, inflation and political uncertainty. The company also faces significant foreign-exchange exposure across its international portfolio.
- PREPA, AES Puerto Rico’s sole offtaker, faces substantial financial and restructuring risks. AES Puerto Rico had $91 million of receivables at June 30, including $28 million overdue; the overdue amount was subsequently collected.
- DPL’s regulatory framework and ability to refinance $445 million of bonds due September 2016 were identified as important risks. An unfavorable regulatory outcome could affect DPL’s earnings, cash flow, credit ratings and refinancing terms.
- Non-recourse debt defaults at Kavarna and Sogrinsk totaled $138 million. These were covenant or other technical defaults, not payment defaults, and management stated they did not trigger or appear likely to trigger a Parent Company cross-default as of June 30.
- Aggregate reasonably possible material contingency losses, excluding accrued amounts and uncertain tax positions, were estimated at $1.4 billion to $1.7 billion. Accrued litigation liabilities were approximately $208 million.
- Significant legal and regulatory matters include the Eletrobrás/Eletropaulo financing dispute, Brazilian tax proceedings, environmental and Clean Air Act matters, a Dominican Republic claim seeking approximately $270 million, Panama land claims seeking approximately $780 million in aggregate, and other commercial disputes.
- Environmental compliance projects at IPL were estimated at approximately $48 million for sulfur-dioxide compliance and $47 million for coal-ash handling. Recovery through regulatory mechanisms was not assured.
- Market sensitivities included approximately $10 million of pretax earnings exposure to a 100-basis-point increase in relevant interest rates for the remainder of 2016 and several-million-dollar exposures to specified commodity and currency movements.
Most important facts for investors to verify
- Progress, regulatory approval and final proceeds for the AES Sul sale, including whether the expected additional after-tax loss approximates $700 million.
- Whether the substantial first-half operating cash flow improvement reflects sustainable earnings or primarily collections and working-capital timing.
- DPL’s regulatory outcome, refinancing of its $445 million maturity, and the potential impact on AES distributions and credit metrics.
- Status and cure plans for the $138 million of technical non-recourse debt defaults and any risk of future cross-defaults.
- Changes in Brazilian demand, tariffs, regulatory liabilities, foreign exchange and the performance of Eletropaulo and other remaining Brazilian assets.
- Potential additional impairments from power prices, environmental requirements, regulatory changes and weaker market conditions.
- Developments in the $1.4 billion to $1.7 billion range of reasonably possible material contingencies and the Eletrobrás, tax, environmental and Panama proceedings.
- Reconciliation and comparability of non-GAAP measures, including Adjusted EPS, Adjusted PTC and proportional free cash flow, with GAAP results.