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AES: A Utility at an Unwarranted Discount
06/17/2019 5:00 am EST
Less than two decades ago, AES Corp (AES) was one false step from bankruptcy. That’s when management dramatically slashed debt, streamlined its portfolio and modernized its fleet and systems with the most advanced power technology, recalls Roger Conrad, utility sector expert and editor of Conrad's Utility Investor.
Now, AES is on the verge of attaining its first ever investment grade credit rating. The company consistently generates its targeted 7 to 9 percent annual earnings growth from a highly transparent investment pipeline.
It’s a leading developer of solar energy as well as grid level battery storage. And it has achieved membership in the electricity sector’s most exclusive club: The 15-member Dow Jones Utility Average.
AES shareholders have certainly benefitted from the company’s progress, including a better than 40 percent total return over the past 12 months.
Nonetheless, the stock continues to trade at the heavily discounted valuation of 12.3 times expected 2019 earnings, by far the lowest in the DJUA. That’s despite consistent 8 percent plus earnings growth, second in the average only to NextEra Energy (NEE).
AES’ discount is due to two reasons. First, it’s the only DJUA member rated below investment grade. That should be remedied by an upgrade next year, though company bonds already fetch investment grade-level prices and yields.
Second, AES realizes nearly 60 percent of revenue from utilities and contracted power operations outside the US. Concern about foreign exposure has consistently triggered selling of company shares since the initial public offering in June of 1991. And it is again in the wake of US/China trade dispute worries.
AES’ operations abroad are not without challenges. For example, Brazilian regulators just recently rejected its $134 million purchase of a portfolio of wind farms.
By 2022, directed capital spending will push US operations to well over 50 percent of cash flow. But the real security for growth and dividends comes from a diversified, contracted and funded project pipeline of 6,225 megawatts of capacity.
That’s coupled with $100 million in annual cost savings, supplemented with timely asset sales such the April exit from the UK and Jordan that netted $211 million. The package here is consistent growth that’s worthy of a much higher valuation. Buy AES below $17.
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