AES Corp (AES) — Q1 2017 Earnings Call Transcript

Thank you, Ryan. Good morning and welcome to AES’s First Quarter 2017 Financial Review Call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning are Andrés Gluski, our President and Chief Executive Officer; Tom O'Flynn, our Chief Financial Officer; and other senior members of our management team. With that, I will now turn the call over to Andrés.

Good morning, everyone, and thank you for joining our first quarter 2017 financial review call. Today, I will discuss our financial results and provide updates on our strategy to deliver attractive risk-adjusted returns to our shareholders. Since our most recent call in late February, we have made significant progress on a number of key objectives for 2017. We advanced our construction program, which will be the major contributor to our cash flow and earnings growth over the next four years. We capitalized on our existing platforms to further enhance future growth by targeting long-term US dollar-denominated contracts. We have taken steps to decrease our covenant intensity and merchant exposure. These steps will reduce our financial and operational risk. We continued our efforts to strengthen our credit profile by prepaying $300 million of Parent debt. This also increases Parent free cash flow by lowering interest expense. We are on track to achieve our $400 million per year cost reduction and revenue enhancement program. I will discuss these achievements in more detail in a moment, but first, I would like to summarize our financial results on Slide 4. In the first quarter, we earned $0.17 of adjusted EPS versus the $0.15 we earned in the same period last year. We generated $546 million of consolidated free cash flow, $56 million higher than last year. Based on our first quarter performance and our outlook for the remainder of the year, we are reaffirming our full-year guidance for all metrics. Now I would like to turn to our strategic accomplishments. As you can see on Slide 5, we have 3.4 gigawatts under construction and expect it to come online through 2019. Overall, we have achieved significant progress on all of these projects. Turning to Alto Maipo on Slide 6, as you may recall, Alto Maipo is an expansion of our existing Alfalfal plant in Chile. As we discussed on our last call, the project has been experiencing tunneling challenges resulting in cost overruns estimated in the range of 10% to 20%. Over the past couple of months, we have made significant progress on this project. First, we have secured additional financing commitment for up to 22% of the project cost equivalent to $460 million including contingencies, of which $117 million will be funded by AES Gener and the remaining $343 million will be funded by the project lenders, main contractor, and minority partner. Second, Alto Maipo is now about 52% complete and we remain on track to reach COD in 2019. Turning to Slide 7, at our Eagle Valley, CCGT in Indiana, the EPC contractor is sub-contracting some of the work in an effort to accelerate the recovery plan. On our February call, we revised the completion date for this project to the first half of 2018. However, the EPC contractor is projecting substantial completion before year-end 2017. Although any delay is unfortunate, we have a fixed price contract with the EPC contractor under which they are incentivized to finish the project in a timely manner. The CCGT has achieved several important EPC milestones, and we expect first fire to occur in the third quarter. Turning to Slide 8, in our 1320 megawatt OPGC 2 project in India, we continued to make steady progress on construction and the project is expected to come online by the end of 2018. Finally, turning to Slide 9 and Colón in Panama, I am pleased to report that we have reached a number of milestones on our Colón CCGT and LNG regasification facility in Panama. The LNG facility is efficient to handle 80 Terra BTU annually. Our CCGT will use about one quarter of the tank’s capacity leaving substantial upside potential to meet the fuel needs of additional power plants, ship bunkering services, and downstream commercial and industrial customers. We will continue to focus on providing cleaner, more cost-effective alternatives to oil-fueled power generation while at the same time satisfying a growing need for natural gas in Central America and the Caribbean. To that end, on Friday, we announced that we have entered into a joint venture with ENGIE to market and sell LNG from our Panamanian LNG terminal to third parties in Central America. This joint venture will help us monetize the tank’s remaining capacity as additional LNG is sold using our terminal. It also further strengthens the agreement we signed last year to jointly market LNG in the Caribbean from our Andres regasification facility in the Dominican Republic. With ENGIE as our partner, and both Colon and Andres online in 2019, we will have the leading position in Central America and in the Caribbean’s LNG regasification market. Turning to Slide 10, as you know, we are the world leader in battery-based energy storage. We currently have 394 megawatts in operation, under construction, or in late-stage development not including the 82 megawatts of our advanced energy storage platform that we have sold to third parties. Since February, we have delivered 37.5 megawatts of four-hour duration storage, the largest lithium-ion energy storage installation in the world, the San Diego Gas and Electric. Following our successful commissioning of this project, San Diego Gas and Electric has awarded us another 40 megawatts four-hour duration project. Although energy storage has significant potential for growth, at this point, we have not assumed any material contributions in our outlook. Turning now to Slide 11 and our cost savings and revenue enhancement initiatives. This year, we are merging our Europe and Asia strategic business units which will drive significant savings. We are also continuing the work we began last year on standardization and improved sourcing and reliability. These initiatives put us on track to achieve $50 million of incremental annual benefits in 2017 and to hit our $400 million annual savings target by 2020.

Thanks Andrés, and good morning. Today, I will review our first quarter results and 2017 capital allocation. Overall, we had a solid quarter benefiting from higher margins at many of our SBUs and lower tax rates. We also generated strong free cash flow and made good progress on Parent debt reduction. Turning to adjusted EPS on Slide 19, first quarter results of $0.17, a $0.02 increase from 2016. The increase was primarily driven by the tax rate, which was lower than the first quarter 2016 rate, but higher than our expectation for full year 2017. Operations were relatively steady as the benefit from a legal settlement in Brazil and foreign currency appreciation were largely offset by lower contributions at DPL in Ohio. Before moving on, I want to touch on $168 million impairment charges again this quarter that are not included in adjusted EPS. Almost all of this is related to the exit of merchant coal assets that Andrés mentioned namely, the 1.7 gigawatt sale in Kazakhstan and the planned shutdown of our 1.2 gigawatt Killen and Stuart plants at DPL in Ohio. Now to Slide 20 and our consolidated free cash flow and adjusted PTC. We generated $546 million of consolidated free cash flow, an increase of $56 million from the first quarter of 2016. That was also largely driven by higher margins, as well as lower tax payments in Andes and MCAC SBUs. We also earned $190 million in adjusted PTC during the quarter, an increase of $5 million largely driven by higher margins. Now I’ll cover SBUs in more detail over the next six slides, beginning on slide 21. In the US, our results reflect slightly lower margins primarily due to the impact of major planned maintenance at Hawaii and lower contributions from DPL due to lower regulated ESP rates. Adjusted PTC also decreased due to a gain on a contract termination that occurred in 2016 at DPL related to its competitive retail business. Lower consolidated free cash flow also reflects higher purchased power and fuel costs at DPL. At Andes, our results reflect higher margins primarily due to higher reservoir levels and generating volume in Columbia. Consolidated free cash flow also reflects lower tax payments at Gener in Chile. In Brazil, our results reflect higher margins, primarily driven by higher spot sales and energy prices at Tietê. Adjusted PTC also benefited from the settlement of the legal dispute at our CCBT Uruguaiana. Consolidated free cash flow benefited from these impacts but was partially offset by the recovery of high purchased power cost in 2016 from prior drivers and our distribution business Eletropaulo. It’s worth mentioning that while we are expecting the low hydro conditions this year in Brazil, the impact will be much less than it’s been in prior years due to changes we’ve made to our hedging strategy. We are now 83% contracted in 2017, which leaves us well-positioned to absorb hydro shortfall. In Mexico, Central America and the Caribbean, higher margins were driven primarily by higher availability in Mexico. Consolidated free cash flow also reflects lower tax payments in the DR. I’d also like to note that in the first quarter, the DR was awarded new five year PPAs to recontract 470 megawatts of existing capacity. The PPAs were awarded in a competitive option and our cost-efficient plant with the only capacity to clear. Pricing is in line with our existing PPAs and prior expectations. We are now 95% contracted for 2018 and 85% contracted for 2022. In Europe, our results reflect lower margins, largely due to the restructuring of the PPA at Maritza in Bulgaria in the second quarter of 2016. Consolidated free cash flow increased due to lower CapEx for environmental projects completed in 2016 and higher collections in the United Kingdom. Finally, in Asia, our results reflect steady margins and slightly higher working capital requirements at Mong Duong in Vietnam.

Thank you, good morning.

Good morning, Ali.

First, just a housekeeping item, perhaps Tom, you had a 41% effective tax rate in the first quarter, are you still targeting 31% to 33% for the year? Any reason why Q1 was so much higher than that?

Yes, we are still targeting 31% to 33%, first quarter was just the timing of certain events, but 31% to 33% is still what we expect to be for the year.

I see. And then, second on the asset sale front, the $500 million target that you have for the year, the Ohio sale of $50 million and this Kazakhstan sale of $24 million, do they count against that or are they separate from that? And related to that, in the past, you told us that you resumed about a $0.03 earnings dilution from the asset sale primarily from the timing. Given your comments that the timing maybe later in the year, is that $0.03 dilution still valid for 2017?

So, Ali, as we talk about asset sales proceeds, those are – that’s cash to corp. So the DPL money will all be used within DPL to retire debt, so that would not count into that. The Kazakhstan $24 million would, and yes, you are right, we had said $0.03 to $0.04 from dilution. We now expect that to be later in the year, some maybe $0.02 or somewhat less. That will be a bit of a help from a timing perspective.

Okay, and thirdly, in terms of mapping out your full year growth profile and as you point out, there is a fair amount of free cash flow that you’ll generate over that period as well. Can you remind us for the cash that’s unallocated at this point, what kind of return are you assuming on that cash that kind of gets you to that 8% to 10% overall annual growth rate CAGR?

Yes, we are assuming cash in the high-single digits on that, which is consistent with our – at the lower end of our return on investments that obviously we could look at other things such as paying down debt or repurchasing stock.

Okay, and last question, on the Colon project, with this ENGIE LNG contract, does that change your expected economics, the ROE that you resumed on that plant or was this already factored in into your overall ROE for that project?

Yes, Ali, we have assumed quite – say modest use of the tank in regasification facility in our numbers. So to the extent that we can use, make more use of what’s basically existing capacity in the tank and in the terminal, that will be upside. So, with ENGIE in the Dominican Republic where we are using about 50% of the tank’s capacity, and in Panama where we had basically 25% of the tank’s capacity being used, the sooner we fill this up, the better it will be. What is the upside potential? Well, if we utilize all of the existing tanks, say, by 2020 and 2021, that’s between – depends a little bit on the timing, but somewhere between, say $0.03 and $0.05 of upside. Furthermore, we have the land that we could – and capacity at the terminals that we could, in each location build the second tank and that would be further upside potential. So we are very excited about this opportunity. We’ve been quite successful on our own selling gas in the Dominican Republic for transportation and for industry. We’ve done our first shipments in thermal tanks or really containers of LNG to another island in the Caribbean. So, this is an upside. We see that in the future, certainly ship bunkering will be important. We also see again more conversion of plants, industry, transportation in the Caribbean and in Central America. And with a strong partner like ENGIE that can provide structured products to offtakers, we are very well positioned, but we are just starting and that’s why we have very modest assumptions in our numbers.

Hey, good morning.

Good morning, Julien.

So, quick couple of questions here to follow-up. First on the SG&A reductions, you announced sort of an acceleration. Is that already reflected in your guidance as you see it for this year, and just to clarify that? And then separate, just the distinction, as you think about the 2018 uplift of $0.20 you discussed, can you discuss some of the other puts and takes? I am curious as to what the net EPS impact is of the divestment and/or sale, and the retirement of the DPL asset?

Let me address the first question. Regarding the guidance we've provided previously, I believe we've consistently exceeded our expectations each year. We are confident in the $50 million we've mentioned for 2017, along with an additional $50 million for 2018. We also stated that this program of productivity improvements will carry on into 2019 and 2020, albeit at a slower pace. Essentially, this is merely a reaffirmation of our prior announcements. Now, concerning your second question about the dilution resulting from the sale of the DP&L assets.

Yes, I was thinking, sorry, go for it.

Yes, Julien it’s probably couple of things when you look at DPL it’s probably about a penny and obviously it depends upon terms et cetera. But maybe it’s about a penny in terms of the – what we are looking at, but that was all contemplated when we gave our guidance in February. I would say on a cash flow basis, DPL will be pretty neutrally cash flow EBITDA minus CapEx is pretty much breakeven as we see it through our forecast period even before other indirect costs.

Got it, excellent, and then can I just clarify, because I thought I heard you talk about an acceleration in SG&A. How does the classes of European and Asian business together fit within the context of SG&A? Is that still part of the 50 or is that actually going to potentially see some more of that 100 biased toward the 70?

No, Julien, that is part of the 50 for this year and part of the 100 for the end of next year. So we will continue to take steps, obviously, as we divest those assets, that also helps us to accelerate this process.

Thanks, Good morning.

Good morning, Greg.

I think most of this – most of my questions have been asked, but what I am looking at slide 53, and I am comparing it to your capital allocation slide. Your investments in subsidiaries is up $100 million versus the Q4 disclosure and it looks like your investment in Alto Maipo is up from $335 million of AES equity to $413 million. So that looks like it represents the majority of that increase. Am I correlating that correctly? And if so, does that in fact – taking into account the cost overrun or not because the footnotes still says it excludes the cost overrun.

Yes, that does take into account the full 20% cost overrun in Alto Maipo.

Greg, you are right. This includes the cost overruns. So there is a typo there, as you mentioned.

Hey guys, it’s actually Angie Storozynski. So, I didn’t hear any comments about Brazil. Could you say about – anything about economic recovery and the future of your utility there? Thank you.

Sure, hi, Angie. In Brazil, what we are seeing is, last quarter, we saw flattening of the decline and this year we might see a slight pickup in demand. But, more like 1% demand has decreased like 10%. So, overall, we are modestly optimistic about Brazil. The President is taking a number – on a number of the important reforms that it flow through, going very well for the country, but we expect a gradual slow recovery in Brazil. Now this year, they are having a drought and as Tom mentioned, I think, it’s a good example of how our change in commercial strategy and the level of contracting that we have had made it, quite frankly a very small issue, where two years ago it was a very big issue for us. And so, it’s basically the same asset I should say, but it makes a very big difference. So, with the acquisition of the wins that will help provide Tietê with basically assets which are not correlated with hydrology which are contracted at 18 years at good prices. Now regarding our utility, which is Eletropaulo and remember we sold, Sul. What we are doing is moving forward on listing it on Novo Mercado and that is going well. And so basically, being on the Novo Mercado means, one share one vote and therefore we would no longer consolidate Eletropaulo in our numbers. Now the company has had a significant recovery in its share price this year and it’s continuing to make improvements operationally.

Thank you. I wanted to ask a strategic question in a sense that, what – is it going to stay 2.5 to 3 gigawatts of new construction projects per year would jump your growth rates from around 10% to 20% a year?

That will depend a little bit on – to what extent we have partnerships in those deals. This year, with the acquisition of sPower and some of the new things we’ve commissioned, we’ll be close to that number in terms of new projects and acquisitions. So, but it will depend on how much of those projects we own and whether it’s 50%, whether it’s 80%. We continue to plan to basically include partners on most of our big projects.

No, that seems awfully high, quite frankly, no. One thing is very important, we will continue to be very disciplined in terms of our capital allocation and we were committed to growing the dividend, reaching investment-grade and continuing to decrease our risk on this portfolio from all factors. So, that seems high. I mean, to get there, I mean if you had some dramatic improvements in some of the economies and commodity prices, perhaps, but we do have significant upside as I mentioned on LNG and which we’ve quantified. And on energy storage, we are continuing to work on that. We are making good progress and when we feel confident that we can provide some numbers, we will do so. But, again, this is our plan. We will be disciplined and ensure that when we grow, it’s profitable growth.

Well, when I think of the new strategy that we announced, based on the prior five-year strategy, it would be an evolution of it. We think that the key elements are really having platforms, integrating renewable with existing capacity from thermal and hydro. And also being a leader in new technology.

Thank you, and good morning. Yes, I had the same question, Greg did about the $100 million. But I can assure you I never would have seen the footnote error on Slide 53. Here is my other question that I got left. Andrés, you talked on Slide 6, Alto Maipo, the problem is the tunnel. And tunnel on these type of projects can be certainly – you are not the first to experience tunneling challenges. Of the 52% complete right now, what percent of the tunnel is complete? Or is that – are you talking about the tunnels? Is that the main part of the project or how should we look at that?

That’s a very perceptive question. It’s 52% complete that includes all of the works and all of the equipment. On that tunneling, we are more than a third complete on the tunneling. And basically what happened here is that the rock ended up being less crusted than all of our projections and that’s what’s really slowed us down, because when you have to do more reinforcements you have to go more slowly and it was a bit surprising, because this is an expansion of an existing facility Alfalfal. So it’s in the same mountain. It reterminates some of the same water. But that is what it is, and as you are right, we are not the first to have encountered a different lock and what was expected once you start tunneling.

Yes, thank you. Can you walk through the details around the EBITDA guidance reduction for DP&L? I think it was obviously, you sold some of the generation assets, but it looks like it was down around $60 million from the fourth quarter?

Yes, so, I think, what you are referring to is about a $50 million drop, I mean, part of this is, as you know, Gregg, we have announced the sale of our coal-fired generation that accounts for about $30 million to $40 million. The total shutdown plus sale and then we also have incorporated updated non-bypassable, which is now $105 million versus what we were expecting, which was slightly higher than that. So net-net, I think that accounts for most of the change.