AES Corp (AES) — Q3 2017 Earnings Call Transcript

Thank you, Mike. Good morning, and welcome to AES’ third 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.

Well, good morning, and thank you for joining our third quarter 2017 financial review call. Today, Tom and I will discuss our results for the quarter and year-to-date as well as our progress on our strategic and financial goals. We are reaffirming our prior guidance for 2017 and our expectations through 2020. During the third quarter, we made significant progress on our construction projects and the integration of our renewable acquisitions. This morning, I will provide some color on the returns we expect to realize from these investments. I will also discuss our plans to accelerate and expand our asset sales program and cost-cutting and revenue-enhancement initiatives. Before turning to these areas, I’ll first discuss the impact of the recent hurricanes on our businesses in the Caribbean. Our sympathies are with the people of Puerto Rico, many of whom are still without power and water. Our number one priority before, during, and after the recent hurricane was the safety of our people and their families and the impacted communities. Fortunately, our people and their families are safe, and our two plants in Puerto Rico sustained only minor damage. Both plants are currently available to meet their obligations under their Power Purchase Agreements (PPAs). We expect the local transmission system to be energized and ready to take our much-needed power by the end of November. Tom will discuss the effects of the hurricanes on our financial results for the third quarter in more detail. Today, we’re announcing that we will be significantly upsizing our asset sales program. We now expect to realize $2 billion in proceeds during the 2018 to 2020 period. Approximately $1 billion of this is expected to occur by year-end 2018, including the sale of Masinloc, our coal plant in the Philippines. Interest remains very strong, and we expect to sign this sales agreement before year-end and receive the proceeds early next year. We’re also announcing that we are aggressively pursuing significant additional cost savings. These G&A and O&M savings are likely to be earnings neutral in 2018 due to one-time restructuring costs, but accretive to 2019 and beyond. We will provide more detail on our fourth quarter call. Turning to our construction program, which is the key driver of our growth. Milestones were being met across our 5 gigawatts of projects under construction, including Alto Maipo in Chile. Although the Alto Maipo project has experienced construction delays and cost overruns, it is making progress towards overcoming these challenges. First, the smaller of the two main contractors was terminated. The Tunnel Boring Machine they had been operating is now being operated by Robbins, its manufacturer. They’re progressing at a multiple of the historical rates achieved previously, and the Alto Maipo project is now 58% complete. Second, Alto Maipo is in negotiations with various contractors for a fixed price, lump sum EPC contract. The new EPC contract would include substantial capital and performance commitments from the contractor, incentivizing timely completion. The restructuring would also require additional concessions from the project lenders and meaningful contributions from AES Gener, which would be tied to construction milestones. The objective is to significantly reduce execution risks and preserve the value of Alto Maipo while, at the same time, remaining disciplined with additional equity from AES Gener. We will provide you with updates as Alto Maipo continues to make progress on these negotiations. Turning now to the rest of our construction program. Our 671-megawatt Eagle Valley CCGT in Indiana is on track to achieve commercial operations in the first half of 2018. Construction is 99% complete, and the project is now in the commissioning phase. In fact, this past weekend, the project achieved a major milestone with the first fire of the turbine. The unit was synchronized to the grid and produced its first electricity. Now turning to our 1.3 gigawatt Southland CCGT project, which is a repowering of our existing gas generation facilities in Southern California. Construction is ongoing, and the project is on track to be operational by the first half of 2020. Our remaining construction projects are proceeding as planned, including our thermal plant, OPGC 2 in India, and our CCGT and LNG regasification terminal, Colón, in Panama. These projects will be key contributors to our earnings and cash flow growth through 2020. Turning to Slide 7, we have been reshaping our portfolio to reduce our carbon intensity and deliver attractive returns to our shareholders. To that end, our growth initiatives beyond the projects under construction have been focused on investments in natural gas and renewable projects with long-term U.S. dollar-denominated contracts in our existing markets. On a portfolio basis, these investments are expected to produce average returns in the low teens. These compelling returns are driven by several factors, including investing in markets with lower renewable penetration and faster growth rates than the U.S.; using local debt capacity in the businesses to fund the investments; and using our business platforms and global scale to lower costs. Our project returns also benefit from bringing in partners to reduce our equity commitments while providing management and development fees. I’ll walk through some specific examples of how we have boosted returns on some of our recent investments. In July, we closed on our acquisition of sPower with the Alberta pension fund, AIMCo. We are encouraged by the quality of sPower’s people, operating assets, and development pipeline. In fact, we are well positioned to capitalize on sPower’s 10-gigawatt-plus development pipeline by closing on at least 500 megawatts of solar projects annually in the U.S. Additionally, we have received a number of inbound indications of interest to partner on a portion of sPower’s operating assets. We’re evaluating these proposals, which would increase our overall returns and allow us to redeploy the capital into sPower’s attractive growth pipeline. Turning to Brazil, during the quarter, Tietê moved forward on three growth transactions. Tietê closed the acquisition of the 386-megawatt Alto Sertão wind plant, finalized the acquisition of the 75-megawatt Boa Hora solar project, and signed an agreement to acquire the 150-megawatt Bauru solar complex. The wind plant is currently operating with an 18-year contract, and all solar projects are expected to be operational in 2018 with 20-year regulated contracts. The BRL1.6 billion of capital needed to fund these 611 megawatts of renewable expansions in Brazil has been secured by tapping into the available debt capacity at Tietê without any equity. Returns on these long-term contracted assets are in the mid-teens in U.S. dollar terms. Finally, turning to Mexico, we’re also seeing attractive returns for our development projects. With our partner, Grupo Bal, one of the largest business groups in Mexico, we have developed a strong 2.5-gigawatt pipeline of renewable and natural gas projects. We are targeting long-term bilateral contracts with creditworthy, large industrial off-takers. For example, we recently signed an agreement to acquire the 306 Mesa La Paz wind development project, which has a 25-year U.S. dollar-denominated PPA. The project site also has sufficient additional land to accommodate up to 200 megawatts of solar, which could be an attractive upside in the future. We expect to reach financial close early next year and begin construction of Mesa La Paz shortly thereafter. In summary, as you can see on Slide 11, we will be adding 8.4 gigawatts of new capacity by 2020. This includes almost 7 gigawatts of projects under construction or recently acquired. The remaining 1.5 gigawatts represent projects in advanced-stage development. As a result of these additions, our average remaining contract term will increase from 6 years currently to 10 years by 2020. We have sufficient internally generated cash to fund our equity contributions for both our projects under construction and the development projects I just discussed. The projects we have under construction and the more recent investments we have made are helping us to significantly reshape our portfolio to achieve our financial objectives. At the same time, we're reducing our carbon intensity and deploying tomorrow's technologies. As you can see on Slide 12, by the end of 2020, our coal generation will decline from 41% to 33%, while renewables and cash generation will increase from 55% to 63%. We've also been driving the adoption of energy storage in our markets as shown on Slide 13. We are a global leader in the industry with presence in seven markets, including 228 megawatts in operation and another 250 megawatts under contract or construction. In the Dominican Republic, we recently completed 20 megawatts of new energy storage. In September, these facilities performed flawlessly, working twice as much as normal to ensure the electric grid stayed online during Hurricanes Irma and Maria. We believe the integration of energy storage and renewables is key to accelerating a cleaner energy future. This is one of the most promising opportunities in our industry, and our businesses are leading the way. For example, in Hawaii, we're helping the island of Kauai reduce their reliance on diesel generators by delivering a 28-megawatt solar farm and a 20-megawatt, five-hour duration energy storage. Integrating energy storage to enhance the output of solar and wind facilities is a key focus area for Fluence, our new energy storage joint venture with Siemens. The Fluence joint venture received anti-trust approval from the European Commission in October and is expected to close by the end of this year. Once closed, we expect Fluence to deliver energy storage solutions and services to a broader group of customers, from commercial and industrial companies to utilities and power developers in 160 countries. Together with Siemens, our goal is for Fluence to be the market leader in this high-growth segment that is expected to grow tenfold in five years, reaching at least 28 gigawatts of installed capacity by 2022. With that, I'll turn the call over to Tom to discuss our third-quarter results, capital allocation, and guidance in more detail.

Thanks, Andrés. Good morning. Today, I'll review our third-quarter results, capital allocation, and guidance. Overall, our results were lower than the prior year for the quarter largely due to a higher intra-year tax rate and the impact of recent hurricanes. However, based on our year-to-date performance and outlook, we remain on track to deliver on our 2017 guidance and expectations through 2020. Before moving on, I want to provide a brief update on the hurricanes. As we disclosed in October, the estimated impact from hurricanes in 2017 is $0.03 to $0.05 a share. We recognized $0.02 in the third quarter, mostly related to reserves taken at our corporate captive insurance business for estimated property damage in our solar plants in Puerto Rico and the U.S. Virgin Islands. To a lesser degree, it also reflects a loss of operations at our thermal plant in Puerto Rico, which was down for 11 days in September. Our business in the Dominican Republic was not affected. Since mid-October, the Puerto Rico plant has been available to meet its obligations under its Power Purchase Agreement. The plant can resume delivering much-needed energy to the grid as soon as the local transmission lines are repaired. On that front, we're pleased with the resources and attention federal and local officials are allocating to restore the power grid, which is a top priority. Repair work is underway, and we're seeing real progress. Momentum should continue to build as various U.S. utilities have begun to assist in the power restoration efforts. We expect the majority of the grid to be operational by the end of the year. When the plant is reconnected to the grid, we expect it to be dispatched since it's the lowest-cost producer of energy, highly reliable, and its location is critical to maintaining grid stability. Now turning to adjusted EPS. Third-quarter results were $0.24, an $0.08 decrease from 2016. For the year-to-date, adjusted EPS was $0.66, $0.02 higher than 2016. The quarterly results reflect a $0.05 impact due to a higher quarterly tax rate of 35% versus 23% the prior year. We expect a lower rate in the fourth quarter, bringing our average annual rate in the expected 31% to 33% range. Third-quarter also reflects the $0.02 hurricane impact and lower margin at Andes, offset by positive results in the remaining SBUs. Now to our adjusted PTC and consolidated free cash flow. We earned $245 million in adjusted PTC in the quarter, a decrease of $27 million, due in part by the impact of the hurricanes. We generated $601 million of consolidated free cash flow, a decrease of $64 million from third quarter 2016, as higher working capital requirements in Brazil, U.S. and MCAC offset higher consolidated margins. Now I'll cover our SBUs in more detail in the next six slides. Adjusted PTC increased primarily due to equity earnings from sPower, following the acquisition in July. Lower consolidated free cash flow also reflects higher working capital requirements at DPL and IPL. In Andes, our results reflect lower margins primarily due to planned major maintenance and the impact of green taxes. This decline was partially offset by positive contributions from Cochrane Unit 2, which achieved commercial operations in October 2016. Adjusted PTC was also impacted by modest write-offs in Argentina and Chile. In Brazil, margins increased due to lower fixed costs, higher tariffs, and the recovery of prior tax payments at our distribution business. The increase in consolidated free cash flow reflects higher margins. Before continuing with the quarterly results, I'll provide an update on our efforts to simplify the ownership structure. We've now received approvals to migrate on the Brazilian stock exchange. As a result, we will no longer have a controlling interest and expect to deconsolidate the business. This will simplify our financial statements and also provide greater flexibility. We expect continued positive momentum. In Mexico, Central America and the Caribbean, our results reflect higher margins driven primarily by higher availability and higher contracted sales in the Dominican Republic, following the completion of the DPP project this year. Hurricanes were not a major driver for the quarter as most of the $0.02 impact previously mentioned was incurred in our captive insurance business. Consolidated free cash flow is flat as higher margins were offset by the timing impact of lower collections. Now on Slide 24, on the resolution of our filing, the order was consistent with the stipulation agreement with only minor modifications. DPL is in the process of selling or exiting all of its 2.1 gigawatts of coal-fired capacity. The commission's ruling is an important step that will enable DPL to transition to an investment-grade growing business. This year, we’ve prepaid $300 million of parent debt and refinanced another $1 billion with long-term debt at attractive rates, resulting in annualized interest savings. This represents a reduction in parent debt since 2011. Through disciplined debt reduction and strong growth, we expect to attain investment-grade credit metrics by 2020. Now to our 2017 parent capital allocation. Sources reflect $1.4 billion of total available discretionary cash, including parent free cash flow. We expect to be comfortably in the middle of our range of $575 million to $675 million. We plan to use our revolver to fund the temporary shortfall and repay the drawings in early 2018. Moving to uses on the right-hand side, including the dividend increase we announced last December, we’ll be returning almost $320 million to shareholders this year. We used $340 million to prepay and refinance parent debt. Now looking at our capital allocation from 2018 through 2020. We expect our portfolio to generate $3.3 billion of discretionary cash. After funding our dividend and construction projects, we have $1.6 billion of capital to create additional shareholder value. Finally, turning to our 2017 guidance, we reaffirm our prior guidance and expectation for average annual growth through 2020 for all metrics.

In summary, we’re taking a lot of actions at AES to deliver on our strategy and commitments to shareholders. Our sector is undergoing significant change, and we’re undertaking a further transformation of our business to take advantage of new opportunities. Specifically, we’re accelerating and increasing our asset sales program to achieve $1 billion in proceeds by end 2018 and a total of $2 billion by 2020. We’re on track to achieve our target in annual cost savings and revenue enhancements, and we’re aggressively pursuing additional savings that we will announce on our fourth quarter call. We’re advancing on our construction projects and are aiming to resolve the issues at Alto Maipo in the first quarter of 2018. We are pleased with our acquisition of sPower and see many attractive renewable opportunities across our portfolio. We expect Fluence to close this year, and our goal is to maintain our global leadership in a market that is projected to grow tenfold over the next five years. These actions will result in a simpler portfolio, earning higher risk-adjusted returns and a stronger balance sheet with improved credit metrics. Our overriding objective is to generate 8% to 10% average annual growth in earnings and free cash flow. When combined with our dividend, we expect to deliver a total shareholder return of at least 12% annually. Now we’ll be happy to take your questions.

Thank you. Good morning. First question, with regards to the 2018 guidance. Earlier in the year, you had talked about 2018, you had told us, net-net, it’s about $0.20 higher than 2017. But now you’re telling us low to mid-teens, which implies a lower implied number for 2018. So what has changed for 2018?

Yes. Good morning, Ali. It’s Tom. I mean, yes, if you cut through the percentage increase, it’s part of our adjustments. I’d say, there’s nothing major. There’s – perhaps, there’s a couple of cents in the U.S. DPLs may be a little softer from the regulatory outcome and some plant closure numbers. But we’re still grinding through it.

Okay. So I mean, could you get back to that $0.20 delta? Or do you think that’s a bit unrealistic here?

I mean, I think that’s certainly – we certainly always look for things to do more of. We’re still looking for efficiencies and savings across the company.

Right, right. Second question, with regards to the asset sales, I just wanted to be clear. So previously, we had thought there would be a $500 million sale this year, which you’ve confirmed will be Masinloc. But now what you’re telling us is that probably still gets announced by year end, but you get the proceeds next year. Did I hear that right?

Yes. Just to clarify, earlier on in the year, we put a placeholder in for $500 million. So yes, specifically with Masinloc, we expect to announce Q4 and expect to close it in the first half of 2018.

Yes. And broadly speaking, when you look at the $2 billion number, I mean, is the motivation to essentially exit non-core markets?

Yes, Ali. When we exit the Philippines, we’ll be in 15 countries. We’ve always said that somewhere between 12 to 15 countries is probably where we would end up. So it’s looking more like a dozen. Some of it will be exiting some countries, and some of it will be selling down from certain assets.

Okay. Last question, Andrés. I’m sure you’ve been keeping an eye on what’s been happening in the IPP merchant power space. Are there any lessons learned for AES?

I think we have a quite different strategy from most. We’ve significantly derisked. We’ve moved out of merchant generation, and we’re generally selling our assets at good prices.

Thank you, Andrés.

Hey, good morning.

Good morning, Julien.

So maybe let me follow up a little bit on the asset sale strategic positioning here. Can you talk about how you think about the overall market subsector there?

Our view is that we are very interested in ownership structures, which are win-wins, where we provide for people looking for long-term stable assets.

Would you be open to investing in a third-party structure to establish an independent acquisition vehicle? How would you think about establishing that?

If we think that there are acquisitions where we add value, we could look at that. If there are interested parties in taking a portion from the sPower joint venture, that’s fine as well.

Excellent. I’ll leave that there. Can I move a little bit further down to the Gener level? How are you viewing cash distributions back to the parent right now?

I would say that Gener will remain an investment-grade company, any equity contributions from Gener would maintain that investment grade. We expect cash distributions from Gener to continue.

We feel quite comfortable with the pipeline.

Is there any reason why you're not including the full $2 billion in your capital plan?

Traditionally, we put things up here when they're either announced or close to being announced. We feel very comfortable that we've got a good line of sight on $1 billion.

When you set expectations here, would you expect any of this to be EPS dilutive or accretive?

Yes. I think it's a mixture. Some could be accretive, some could be dilutive. But overall, it should align with our growth rate.

Our overriding objective is to meet that 8% to 10% growth rate. So there will be puts and takes, but it won't affect us reaching our objectives.

Just want to make sure I heard you correctly in response to Julien that you see cost-cutting supplementing your ability to hit the 8% to 10%. Is that a fair summary?

The additional cost cuts we’re working on will give us more comfort in hitting that range.

There is some modest dilution from asset sales, which we've factored into our overall growth rate.

I appreciate your feedback on the buybacks; we're not announcing any specific buybacks at this point.

Thank you.

Hi Andrés, Thanks for taking my question. I am very much opposed to share buybacks. Moving on, please. I'm assuming, since you're selling the Philippines, you're not doing Masinloc 2?

Masinloc 2 is under construction. We would finish the construction under our contract for the new seller.

Can you give us a view as to whether Argentina's new financial structure is working out?

Argentina has really made a comeback, and the reforms are moving forward. Our business is doing much better.

Is that energy storage facility part of Fluence? Or is that separate?

We have energy storage facilities on our platform. Those are not being sold. Fluence is a joint venture to develop and sell our energy storage products.

Does the DOE report concern you?

No, because our contracts provide flexibility, and we have been preparing for future regulations.

Great. Thank you very much.

We thank everybody for joining us on today’s call. We look forward to seeing many of you next week at the conference. As always, the IR team will be available to answer any questions you may have. Thank you, and have a nice day.