The AES Corporation

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 2/5

A global power generation and utility company, mainly powered by renewables, that faces a complex landscape with changing regulations, market risks, and macroeconomic challenges.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

AES Corporation operates as a global power generation and utility company, primarily focused on renewables. It is structured into four Strategic Business Units (SBUs): US and Utilities, South America, MCAC (Mexico, Central America, and the Caribbean), and Eurasia (Europe and Asia).

  • US and Utilities SBU: Includes the regulated utilities in US, Puerto Rico and El Salvador, alongside the U.S. based business. The business is mainly focused on generating and distributing electricity. The regulated utilities ensure a consistent stream of revenue.
  • South America SBU: Includes the generation facilities in Chile, Colombia, Argentina, and Brazil, with a focus on both thermal and renewable sources. The primary strategy in this region is to generate and sell power to both utilities and commercial consumers.
  • MCAC SBU: Consists of businesses in Mexico, Central America, and the Caribbean and covers a wide scope of energy solutions. It utilizes a combination of both renewable and thermal sources of energy.
  • Eurasia SBU: Includes the generation and utilities in Europe and Asia and the business operates across Europe and Asia, and focuses on both core and innovative energy sources.

The company’s operations are broadly involved in the entire energy ecosystem, including the generation of electricity using various technologies, distribution of power to end-users, and building energy infrastructure including power plants and grids. Their business units are therefore tied together and rely on one another to create an efficient energy supply chain.

Industry Trends & Competitive Landscape

  • Renewables Transition: There’s a major shift towards renewable energy sources globally, driven by climate change, decarbonization goals, and government initiatives. AES is positioning itself to capitalize on this trend.
  • Increasing Electricity Demand: Global electricity demand is projected to increase significantly. To cope with this demand, they must have consistent investment into power generation.
  • Growing Energy Storage: Battery technology is gaining importance as it helps to integrate variable renewables into the grid.
  • Market Volatility: Pricing in energy markets can be volatile and affected by various factors, including weather, government policies, and economic conditions. Therefore it’s important to have a diversified market.
  • Regulatory Factors: The company has to consider various rules, laws, and regulations imposed by different government bodies in every country they operate.

In 2023, AES continued its transformation into a low-carbon power generation company, with a strong focus on renewable energy.

Financial Analysis

AES’s financial performance is heavily influenced by its business units, and its recent financial results show mixed performance with a focus on expansion into renewable energy. Let us take a closer look at some of the aspects.

Revenue

For the nine months ending September 30, 2023, consolidated revenue increased by 4.1% compared to the same period of 2022. This increase is attributed to higher sales prices and new projects, specifically within the Energy Infrastructure SBU, while the decline in Utilities SBU, was partially affected by a decline in sales in Brazil. However, as it can be seen in their 2022 10-K report and the 2021 10-K report, there has been very steady growth in total revenue over the past years.

Margins

  • Operating Margin: The consolidated operating margin decreased to 10.8% in the three months ended September 30, 2023, down from 16.4% of 2022.

The decline was influenced by higher power purchase costs and lower regulatory rates in the Utilities SBU. This is the main reason why net income attributable to AES has declined compared to 2022. They also noted an increasing interest expense in the nine months ending September 30th, compared to 2022.

  • Adjusted EBITDA: For the three months ending September 30, 2023, adjusted EBITDA decreased to $518 million, compared to $608 million in 2022, mainly due to the decline in Utilities and Energy Infrastructure SBUs.
  • Profitability by SBU: Different business units display variations in profitability. The New Energy Technology segment showed an increase in operating margin, while other segments did not perform well. For long-term profitability, their focus should be in increasing the contribution from renewable energy generation and storage and the impact that may have on the operations.

Debt and Financial Structure

Debt is a major part of the capital structure of AES, with about $18 billion in outstanding debt at the end of September 2023. This is mostly due to significant infrastructure projects, as stated in the company’s 10-K report. Their debt-to-equity ratio is 1.8 as of September 2023, and they are aiming for a long-term target capital structure with a Debt/Equity ratio of 1 to 2. The company’s debt repayment schedule indicates a large repayment required between 2025 and 2027. Due to this higher amount of debt, interest expense has been rising, negatively affecting the earnings. It’s important to monitor the capital structure to evaluate how sustainable value creation is.

Balance Sheet Health: 2/5

While AES is actively investing in growth projects and focusing on expanding renewable energy, it does have a large amount of debt on its books, that is causing higher interest expenses and negatively impacting profitability. Moreover, they are dependent on new contracts to get the prices required to return capital investments, and if any of the projects are stalled or unable to reach projected performance, then their capital expenditures are going to be affected negatively. This, coupled with an unoptimized capital structure, renders the balance sheet rather unstable and not in the best shape.

Moat Analysis

Based on all the information provided by company’s filings, reports, and other sources, it’s possible to evaluate the economic moat of the company.

  • Intangible Assets (Brands and Patents): The company’s brand is not particularly significant in attracting or retaining customers. Customers are likely choosing based on a variety of factors, mainly their geographical location and the rates they are offered, instead of brand recognition. Also, as such, they are not a tech provider and as a utility, it’s very difficult to patent processes.
  • Switching Costs: Switching costs are not a major competitive advantage in the power generation business, as customers may have multiple suppliers and are not subject to a single power provider.
  • Network Effects: The company does not operate on a network-based model with network-type effects, so they are not having any benefit from such a competitive advantage.
  • Cost Advantage: Companies in energy production may have a cost advantage arising from economies of scale and unique resources. As a company operating around the world, the cost structure of the company may be higher than some of its competitors with more focused geographical operations.
However, their focus on renewable energy production could allow them to operate at a lower cost than traditional, fossil-fuel based energy generators.

Moat Rating: 2/5

Given all the factors, the company is assigned a narrow moat. While it is certainly able to sustain operations and has an advantage through scale in some locations, the company still faces pressure from increased competition, and its value is tied to its assets. This means that they can’t get above average returns because the ability to generate earnings is limited. This makes their business a low-margin business in which having a large amount of debt can be harmful.

Moat Risks & Resilience

  • Regulatory Changes: The regulatory landscape in the energy sector is constantly evolving with new laws and regulations being frequently added and existing regulations being changed. Any change could impact the company’s financial performance in an adverse manner, since they have to comply to those regulations. The most significant issue right now being compliance with greenhouse gas reduction, and the amount and timeline for that goal to be reached.
The company is very sensitive to any and all regulatory changes, and since they operate around the world, any regulatory changes in other countries will increase costs of operations and may force them to change their whole business strategy.
  • Commodity Price Risk: The company is exposed to price fluctuations in energy commodities. This could affect their revenues and earnings negatively because the profits of the company is tied to the cost and value of their assets and commodities. This means that if prices for coal, oil, or other similar commodities go down, their overall revenue also goes down.
  • Technological Disruptions: Technological advancements could render current generation technologies obsolete, and companies operating on old and out-dated tech could find themselves in unfavorable competitive positions. The shift to cleaner, more efficient, renewable energy technologies may require additional investment for the company to stay in pace with the transition.
  • Competition: The energy sector is intensely competitive, and many other companies are involved in similar operations to AES. As such, it is crucial that the company has strong points that would let them generate a higher profit than others.
  • Operational Risks: The power generation business is complex and has a high chance of major setbacks that can completely destroy the operations of a company. Natural disasters, mechanical failures, and other issues can significantly affect a company’s profitability and operations.
  • Economic Slowdown and Global Crisis: Economic slowdowns and global events such as the ongoing war and supply chain disruption can significantly impact the company’s financial performance and hinder operations.
  • Indebtedness: High levels of debt make the company sensitive to interest rate changes and have difficulty meeting its obligations if it can’t generate revenue. As has already been demonstrated, they also reduce overall profitability.
  • Counterparty Risk: The company is also exposed to risk from its suppliers and the parties involved in financing, including credit risk and risk of default by other parties.

Management Comments on Current Issues

During the latest earnings calls, management has highlighted some of the key initiatives they are focusing on:

  • Growth in Renewables: They emphasized their focus on the transition into renewable energy and that they are making deals to reduce emissions.
  • Capital Allocation: Management has stressed their strategy of generating and maintaining positive free cash flow, while allocating capital to its highest ROIC investment opportunities and for debt reduction.
  • Cost Control: The company has shown an improvement in its overall financial performance by cutting down expenses and improving efficiency in all aspects of their business.
  • Operational Stability and Safety: There has been emphasis on the safety of operation and their ability to deliver consistent and reliable electricity.

Understandability: 4/5

While the general concept of an energy company is not too complex, understanding the different nuances of AES’s operations across different SBUs and across different countries, as well as understanding their financial structure, requires substantial knowledge. Due to this, it receives an understandability rating of 4/5.

Conclusion

The AES Corporation is in a position that allows them to grow in a sustainable manner for years to come. However, their narrow moat and their sensitivity to external factors would always act as a check on their potential and profits. So even though the company has a bright future and positive growth trajectory, it still requires a comprehensive analysis to make investment decisions.