Business Context and Reporting Period
The AES Corporation filed an unaudited Form 10-Q for the quarter ended March 31, 2017. AES is a diversified power generation and utility company operating through six strategic business units: US, Andes, Brazil, MCAC, Europe, and Asia. Its businesses include power generation and regulated and non-regulated utilities.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $3.492 billion | $3.271 billion | Up 7% |
| Operating margin | $593 million | $509 million | Up 17% |
| Operating margin percentage | 17.0% | 15.6% | Up 1.4 percentage points |
| Income from continuing operations | $98 million | $83 million | Up 18% |
| Net income attributable to AES | $(24) million | $126 million | Declined $150 million |
| Diluted EPS from continuing operations | $(0.04) | $0.20 | Down $0.24 |
| Adjusted EPS | $0.17 | $0.15 | Up 13% |
| Net cash from operating activities | $703 million | $640 million | Up 10% |
| Free cash flow | $546 million | $490 million | Up 11% |
| Capital expenditures | $474 million | $640 million | Down $166 million |
Revenue growth was driven mainly by favorable foreign exchange effects, higher LNG sales in the Dominican Republic, and stronger Brazil and MCAC results. Operating margin benefited from higher tariffs at Eletropaulo, favorable spot sales at Tietê, improved availability in Mexico, and higher sales in Colombia.
Cash, Debt, and Liquidity
- Cash and cash equivalents were $1.588 billion at March 31, 2017, compared with $1.305 billion at year-end 2016. Short-term investments were $634 million, and restricted cash and debt service reserves totaled approximately $904 million.
- Total debt was approximately $20.3 billion, consisting of $4.5 billion of recourse debt and $15.8 billion of non-recourse debt. No recourse debt matures within the next 12 months.
- Parent Company liquidity was $719 million, consisting of $52 million of parent and qualified holding-company cash plus $667 million of available credit capacity.
- AES issued approximately $637 million of non-recourse debt and repaid approximately $414 million during the quarter. The Parent Company redeemed $300 million of senior unsecured notes and recognized a $47 million loss on extinguishment of debt.
- Approximately $3.2 billion of debt carried variable interest rates that were not fixed through derivatives. AES estimated that a one-time 100-basis-point rate increase would increase 2017 pretax interest expense by approximately $25 million.
- The company paid a quarterly dividend of $0.12 per share and declared another $0.12 per share dividend payable in May 2017.
Material Changes Versus the Prior Comparable Period
- GAAP earnings attributable to AES changed from $126 million of income to $24 million of loss, despite higher revenue, operating margin, consolidated net income, and operating cash flow.
- Q1 2017 included $168 million of impairment expense, primarily $94 million related to Kazakhstan plants held for sale, $66 million related to the planned retirement of DP&L’s Stuart and Killen generating units, and $8 million related to Tait Energy Storage. Q1 2016 included $159 million of impairment expense, primarily at Buffalo Gap II.
- Q1 2017 benefited from a $60 million legal settlement related to AES Uruguaiana’s gas supply dispute with YPF.
- Noncontrolling interests shifted from a $52 million benefit in Q1 2016 to $125 million of income attributable to noncontrolling interests in Q1 2017, reducing earnings attributable to AES shareholders.
- Brazil operating margin increased $64 million, Andes increased $23 million, and MCAC increased $12 million. Europe declined $3 million, principally because of lower contracted capacity prices at Maritza following a PPA amendment.
- Adjusted PTC increased to $190 million from $185 million, and Adjusted EPS increased to $0.17 from $0.15, reflecting improved underlying operating performance after excluding impairments, disposition effects, unrealized derivative and foreign-currency effects, and debt extinguishment items.
- On March 17, 2017, AES completed the Alto Maipo restructuring, acquired the former noncontrolling shareholder’s 40% interest, sold a 6.7% project interest to the construction contractor, and retained an effective 62% economic interest.
Guidance, Outlook, Commentary, and Risks
- Management highlighted 3,399 MW under construction, representing approximately $6.9 billion of total capital expenditures, with projects expected to come online through 2019.
- AES reported plans to reduce portfolio complexity, including the sale or shutdown of 3,737 MW of merchant coal-fired generation in Ohio and Kazakhstan.
- The company expects its cost-reduction and revenue-enhancement program to reach $150 million of annual savings by 2018, with an additional $25 million per year targeted in 2019 and 2020.
- AES agreed to acquire sPower with AIMCo for $853 million in cash, subject to adjustments, plus assumed non-recourse debt. Closing was expected by the third quarter of 2017; a reverse termination fee of up to $75 million could apply.
- The Kazakhstan CHP plants were sold on April 7, 2017 for net proceeds of $24 million. AES expected to recognize an additional pretax loss of approximately $48 million, subject to foreign-currency movements.
- Alto Maipo experienced construction difficulties and potential cost overruns of up to 22% of its original $2 billion budget. Failure to meet amended construction milestones could adversely affect project financing and value.
- Key operating risks include foreign-exchange and commodity-price volatility, regulatory and tariff decisions, power-price changes, environmental compliance costs, availability of non-recourse financing, and the ability of subsidiaries to distribute cash to the Parent Company.
- Material contingencies included accrued litigation liabilities of approximately $181 million and reasonably possible material contingency losses estimated at $1.6 billion to $1.8 billion, excluding accrued amounts. Parent-level guarantees, commitments, and letters of credit totaled approximately $678 million.
- Significant legal and regulatory matters include the Eletrobrás financing dispute, Brazilian tax proceedings, EPA and Clean Air Act matters, and land and easement claims in Panama. The filing states that outcomes of certain matters could materially affect results, liquidity, or subsidiary operations.
- Management stated that there were no defaults that resulted in or were at risk of triggering a cross-default under Parent recourse debt, and that Parent-level debt covenants were satisfied as of March 31, 2017.
- The filing provides no explicit GAAP earnings or revenue guidance for full-year 2017. Management cautions that quarterly results are not necessarily indicative of full-year results.
Important Facts for Investors to Verify
- Whether the Kazakhstan sale and expected additional loss were completed and recorded as anticipated after March 31, 2017.
- The financial and construction progress of Alto Maipo, including compliance with revised milestones and any further funding requirements.
- Whether the sPower acquisition closed on expected terms and the effect of assumed non-recourse debt on leverage and cash flow.
- The ultimate outcome and potential cash requirements associated with the Eletrobrás dispute and other Brazilian tax and regulatory proceedings.
- The sustainability of Parent Company liquidity, subsidiary dividend distributions, and the $0.12-per-share quarterly dividend given the Parent Company’s below-investment-grade rating and reliance on subsidiary cash flows.
- Whether the improvement in Adjusted EPS and free cash flow persists after excluding the one-time YPF settlement, favorable tax timing, foreign-exchange effects, and other nonrecurring items.
- Potential further impairments or environmental and retirement costs associated with coal assets, DP&L, Kazakhstan, and other merchant generation facilities.