The AES Corporation
Q2 2020 Earnings Call Transcript

Published: 6 Aug 2020

[Operator:]

Good morning. Welcome to the AES Corporation Second Quarter 2020 Financial Review Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask question. Please note that this event is being recorded. I would now like to turn the conference over to Ahmed Pasha, Treasurer and Vice President of Investor Relations. Go ahead.

[Ahmed Pasha:]

Thank you, Operator. Good morning, everyone. And welcome to our second quarter 2020 financial review call. Our press release, presentation and related financial information are available on our website at aes.com.

[Andrés Gluski:]

Good morning, everyone. And thank you for joining our second quarter financial review call. Today, I will spend some time on three near-term priorities, achieving our 2020 guidance, attaining a second investment grade rating and decarbonizing our portfolio. We believe that progress in these three key areas will allow us to reach a larger investor base in the near-term. They will also advance our longer term strategic and financial objectives. After discussing these three themes, I will provide an update on our sustainable growth initiatives and our efforts to create a technological competitive edge. Last quarter I indicated that we were well-positioned to withstand the impacts of the COVID-19 pandemic due to the resilience of our business model. I am pleased to report that our second quarter results demonstrate this resilience and keep us on track to achieve our full year guidance. We delivered adjusted EPS of $0.25 in the second quarter in line with last year. This reflects the strength of our business model, which is based on long-term take or pay contracts with credit worthy customers. As a result, we are very confident that we will achieve our 2020 adjusted EPS guidance of $1.32 to $1.42 and our expected parent free cash flow of $725 million to $775 million. At the same time, we have continued to grow our free cash flow. We ended the second quarter with the apparent free cash flow to debt ratio of 24%, which is comfortably above the 20% threshold required for investment grade ratings. As a reminder, we have already received one investment grade rating from Fitch and remain optimistic that we will attain our second investment grade rating later this year. Turning to our aggressive carbonization goals on slide four. As we have said before, we are very focused on reducing our generation from coal to less than 30% of total generation to comply with Norges Bank Environmental Investment criteria.

[Gustavo Pimenta:]

Thank you, Andrés. Today, I will cover three key topics, our resilient business model, our performance during the second quarter and our capital allocation plan. Let me start with our resilient business model on slide 14. As you can see 85% of our earnings are from Utilities and long-term contracted generation, with an average contract life of 14 years. This provides significant stability to earnings and cash flow. We have also reduced our exposure to volatility in foreign currency by growing the portion of our U.S. dollar earnings. As you can see on side 15, today 85% of our earnings are in U.S. dollars, as compared to approximately 60% a few years ago. For context through 2022, a 10% appreciation of the U.S. dollar would reduce our annualized EPS by only 1.5% or $0.02. Looking at Latin America specifically, almost all of our businesses in that region are contracted, as you can see on slide 16. Nearly 60% of these businesses have no volumetric risk as a result of the take or pay nature of the contracts. The remaining capacity is mostly contracted with large industrials and export-oriented mining companies that continued to operate despite COVID-19 as they are deemed essential. We intentionally work with high quality off takers and business strategy is also contributing to the resilience of our business model.

[Andrés Gluski:]

Thank you, Gustavo. Before we take your questions, let me close today’s call by saying that we remain very confident in achieving our guidance for 2020 and growth rates through 2022, attaining a second investment grade rating before year end and realizing our decarbonization goals to meet Norges Bank’s threshold by the end of the year. At the same time, we continue to make progress on the point innovative technologies that we believe will give us a competitive edge in today’s rapidly evolving and growing market. With that, I would like to open up the call to your questions.

[Operator:]

Our first question is from Julien Dumoulin-Smith from Bank of America. Go ahead.

[Julien Dumoulin-Smith:]

Thank you, Operator. Good morning, everyone. Thanks so much for the time. I appreciate it and congratulations on continued execution here. Perhaps just going back to the 2020 guidance and I know you guys just commented here in your prepared remarks about a little bit of your positioning, but I’d like to dig a little bit further into that. So you are saying that you are a few pennies ahead relative to initial expectations for the utility after last quarter’s update. You are saying your power outlook is not appreciably impacted from lower demand. Just help frame where you are within that ‘20 guidance range as a consequence of these updated assumption. And then, thirdly, I didn’t see you comment specifically on how the asset sales and our expected asset sales impact -- and the potential dilution from those impacts where you are within that range, if that make sense?

[Andrés Gluski:]

Yeah. Okay. Let’s put this into two objects, the first half and Gustavo can take the second half. Look, we feel confident that we are going to hit our numbers. We feel very good. We have a lot of good things happening. We are still, I think, all of us in uncharted territories. This has to play out through the second half of the year. I think our business model has demonstrated its resilience. I think very importantly both earnings and cash, our accounts receivable are very much in line from where they were last year. So we feel good about it and we have a lot of positive things, but there is some uncertainty. So we -- what we are saying is, we feel very confident we will hit these numbers and the model is resilient and let’s see what plays out in the second half of the year. With that, I will pass it over to Gustavo to talk a little bit about asset sales.

[Gustavo Pimenta:]

So, Julien, yes. Those asset sales there were already incorporated in our long-term forecast. So the associated dilution is already in the 7% to 9%, so no impact to our forecast.

[Julien Dumoulin-Smith:]

Nor the impact that in perspective further so…

[Gustavo Pimenta:]

No.

[Andrés Gluski:]

That’s already assumed...

[Gustavo Pimenta:]

The additional was to reach the $500 million are also in this plan the 7% to 9% growth.

[Andrés Gluski:]

Yeah. In other words they are assumed in our forecast.

[Julien Dumoulin-Smith:]

And if I can ask you just a step further here, I mean, you guys made a further commitment in Brazil in recent weeks. Can you talk to your thought process about realizing the full value there, I mean, as per this unique situation in backdrop where you all are, I suppose your peer shareholders just receiving a premium bid and you all are stepping into to basically, say, we see greater value. So can value -- can you elaborate on where you see that value coming and maybe further next steps in realizing that?

[Andrés Gluski:]

Sure. Look we have a, I think, a very good track record in Brazil of creating values in our separate company, if you think of the sale of Fluence, sale of Eletropaulo, of the sale of our telecom Angamos. So what we are doing here is, we -- BNDS wanted to sell part of its shares. So by buying BNDS’ shares we go from 24% ownership to around 43% ownership. This will allow us to list AES Gener on the novel Mercado. In the novel Mercado generally companies trade at a 10%, 20% premium versus where they trade on ordinary listing, say in Brazil you have your preferred shares, which actually don’t have a vote and receive a 10% dividend, then you have normal ordinary shares, which have votes. So our shares and BNDS’ shares are ordinary shares. So what we see here is an upgrade of the company, in terms of its market listing, in terms of who can invest in the company and we are able to go to novel Mercado, because now we own a much larger percentage of the company. So with one share one vote we still control this company. I say furthermore you might have seen there the Tietê is actually the good platform for growth. It has now almost 4 gigawatts or 100% renewable energy and we have been able to do some very innovative things there. So in terms of our big strategy it makes sense as well. So it makes sense from me money point of view, because we are buying it accretive. We are --it’s accretive at these prices. Second, I would say that, it’s a platform for growth and fits into our overall strategy of reducing our carbon intensity -- the carbon intensity of our footprint.

[Julien Dumoulin-Smith:]

Sorry. Last quick clarification, what’s the contribution from renewables in aggregate in 2020 and beyond just getting this question consistently.

[Andrés Gluski:]

Look, right now including again renewables for hydro, it’s about a third of our fleet.

[Julien Dumoulin-Smith:]

On earnings terms?

[Andrés Gluski:]

Earnings.

[Gustavo Pimenta:]

It’s the same.

[Andrés Gluski:]

Yeah. I think it’s pretty much in line.

[Julien Dumoulin-Smith:]

All right. I won’t press further. Thank you very much.

[Andrés Gluski:]

Sure.

[Operator:]

Our next question is from Angie Storozynski from Seaport Global. Go ahead.

[Andrés Gluski:]

Hello, Angie.

[Gustavo Pimenta:]

Angie.

[Operator:]

Angie? Our next question is from Stephen Byrd from Morgan Stanley. Go ahead.

[Stephen Byrd:]

Hey. Good morning. I hope you all are doing well.

[Andrés Gluski:]

Hey, Steve.

[Stephen Byrd:]

Great update on a lot of fronts. Just on the storage side of things obviously the size of this business and the growth is impressive. Could you just speak maybe generally to the capital needs for this business, strategically how you think about the growth of this business within AES and just it’s just an unusual business given the incredibly rapid growth rate. I am just curious sort of strategically how are you thinking about this business?

[Andrés Gluski:]

Well, we started 12 years ago. So we have a long history of energy storage and we have really been an innovator in applications. So we have decided to sell it to third-party via by Fluence and we are very happy with the partnership with Siemens, because it allows us to sell it in 160 countries. So what we are seeing saying is that there’s a very rapidly growing market. So Fluence itself we see a lot of new applications, not only the virtual reservoir, but I can see grid booster, which really reduces significant long-distance transmission expenses or investment. So that I think is the next front. So, I think, this is an area that’s going to grow very quickly. So how does it fit into, yeah, well, first and of course, we are happy with the investments we have made in Fluence. I think time will show that that was a very good investment. But it’s also good for us in the sense we are one of the big customers of Fluence. So today half of our product offerings have an energy storage component. So we have standalone storage, but we also have it integrated into solar as our award winning project out in Kovai. But we also have it in corporate, for example, wind. So when we talk about Green Blend & Extend and meeting customers’ future needs, if customers want a 24x7, for example, renewables, energy storage plays a big component. Now I am a believer in lithium ion batteries for -- our batteries, let’s say, electrical batteries because they don’t have to be lithium ion for the next five years to 10 years for many of the applications. And the reason is that it’s very -- as the batteries become more efficient, it become cheaper, you are basically going from electric to an elect -- in some cases a chemical back to electric and the losses are very low. There’s been a lot of talk about hydrogen, for example. Hydrogen has advantages and it has much greater energy density. So we see much -- many more applications in transportation where the weight of batteries precludes long distance, say, big truck using batteries. So I think this is a very interesting area. But if you are talking about sort of combining renewables with storage or day-to-day applications, we really think that battery seems to be the killer app. Now we have put a toe in the water into hydrogen as well. We have actually run some tests on old coal plants in Chile, basically cracking the hydrogen using renewable energy in around $35 a megawatt hour and it still comes out quite expensive. We do see it could be -- we have also run some tests on diesel and it might be interesting for micro-grids. So, we do have a electrolyzer in Chile where we -- actually in Argentina, excuse me, where we actually produce hydrogen for our own needs at the San Nicolas plant. So we have a foot into this. We are looking into this. But I just mention this, because there’s some people say, well, hydrogen will replace battery-based energy storage. And the reason we don’t see that is, at least in the short-term, is because you are going from electric to produce a chemical -- a chemical reaction then you have to store it cryogenically then you have to transport it, then you basically have to burn it again. So if you look at the energy from the original electricity losses to electricity again, you are talking about at least half, whereas with the battery you are talking about a much smaller percentage. Now of course, batteries don’t work for inter-seasonal differences. So, we are looking into it and we have some small experiments in some of our different units. And as I said, the one that looks more promising really are diesel units and we are certainly a believer of green hydrogen for transportation.

[Stephen Byrd:]

That’s a great description of market potential of storage versus hydrogen. Thank you. And I wanted to shift over maybe just to your corporate relationships. Maybe we could just briefly touch on Google to make sure we just talk through the sort of the commercial relationship. I guess, there’s sort of an element of near-term fees plus longer term margin potential. But then also just thinking more broadly and maybe more importantly just about the potential for other such corporate relationships given AES’ global footprint and ability to help customers globally to decarbonize, if you could just talk to that opportunity broadly as well, please?

[Andrés Gluski:]

Yeah. Thank you for that question. I mean, we are investing very heavily into the U.S., as Gustavo says about 90% of what we are investing but we do have this wonderful global footprint. So if a client has global needs, we can satisfy those. So when you talk about the relationship with Google, we are -- we do our supply them with renewable energy in Chile and we did have the RFP. We have the RFP out for 1 gigawatt of zero carbon energy in PJM. We are also, as I mentioned in my speech, looking at other possibilities with them. I really can’t comment on them -- about them at this time. But it goes beyond just a single sort of RSP or a single PPA in one country, because we are doing I think a lot of innovative things like they are and so we have commonality of interests in some areas. But just like Google, I mean, of course, there are other companies that are also interested in our global footprint and having a, let’s say, common high-tech approach to reducing carbon emissions among multiple countries and we can certainly supply that.

[Stephen Byrd:]

That’s great. Thank you so much.

[Andrés Gluski:]

Thank you.

[Operator:]

Our next question is from Charles Fishman from Morningstar. Go ahead.

[Charles Fishman:]

If I could firstly ask a housekeeping question on slide 18, while I guess, it’s a little more a housekeeping. But your receivable balance is going lower. Now, first of all, I assume that’s apples-to-apples, in other words you adjusted that from any businesses you divested between Q4 and Q2?

[Gustavo Pimenta:]

That’s correct Charles. This is Gustavo. That’s correct.

[Charles Fishman:]

Okay. I assume that, but just wanted to ask it now. And then, I guess, more of a big picture question, why do -- is there any particular reason you see your receivable balance going actually lower which is certainly great considering the environment, where among your -- there was nobody really appeared you guys, but other utilities, let’s say, which I realize are different businesses, most of them have T-Mobile balances going in the other direction. Anything that you are doing differently or I -- you probably have more contracted type generation I realize that, but is there anything else going on?

[Andrés Gluski:]

Yeah. No. I think you hit the nail on the head. It’s -- 85% of our business is contracted generation and we have creditworthy off-takers. So there are situations, for example, where say a currency depreciates, but the -- what they are exporting is actually then more attractive because they have a portion of their cost whether it be mining or other such things that they are exporting. So in general, our clients are doing well, much better than the markets than they are in. So I think that’s very important. But we are 85% contracted generation and that’s the big difference. So if you actually see why we got it down initially and we correctly forecast it that we would have a drop in demand with the quarantines at our utilities, at our distribution businesses. So that’s what’s going on. But other than that our plans are critical. So in those cases where we are selling to the creator or selling to which is in many cases backed by the government, we are make sure that we get paid, because we are absolutely critical to the grid or the low cost generator in that market. So we are very well-positioned in this crisis. So we don’t expect that to change certainly in the generation business given, say, the current outlook.

[Charles Fishman:]

Okay. And then, Andrés, if I can ask you one strategic question with respect to Fluence. Why a minority partner at this point? What is the thinking behind that?

[Andrés Gluski:]

Yeah. That’s a great question. Because this is a rapidly growing business and we think it has a great future and it’s coming up with new products. Part of it is that, both of us, Siemens and AES we would like to have a marker from a transaction. We are not going to sell down a very large stake we are talking around a 10% stake. So we think it would be just good to have to capitalize it, maybe 10% with an outside partner, and obviously, work towards a bigger sell down perhaps in two years, three years of an IPO, but ---- and then we will have to reassess strategically how we feel about this business. But we feel very good about that business. And as I said, I think that this is a market, which is growing very rapidly. Now something that people haven’t talked about, I think, so much is, if you do have a change in federal policies in the U.S. to promote green or carbon free generation, we are very well-positioned, Fluence is very well-positioned. But specifically, AES, because we have a pipeline of 15 gigawatts of potential projects in the U.S. and those run the range from quite advanced to medium advanced. If we looked at just hypothetical projects it’s a much bigger number. So we feel good that we have a pipeline that we could execute on and potentially double our rate of growth of renewable build in the U.S. should there be such a change.

[Charles Fishman:]

Okay. And the partner then very well could be financial rather than just somebody like yourself that’s also selling the Fluence product?

[Andrés Gluski:]

No. No.

[Charles Fishman:]

Correct?

[Andrés Gluski:]

Yeah. No. No. Absolutely. Absolutely.

[Charles Fishman:]

Okay.

[Andrés Gluski:]

So a lot of people are looking at just financials. We are looking at a good investment with an eye towards a potential IPO two years to three years from now?

[Charles Fishman:]

Got it. Okay. That’s all I have. Thank you.

[Andrés Gluski:]

Thank you, Charles.

[Operator:]

Our next question is from Angie Storozynski from Seaport Global. Go ahead.

[Angie Storozynski:]

Thank you. So sorry I missed my first presenter . So I have a number of questions. So first on Fluence, I mean, incredible results by the way. But on Fluence, so the attempts to monetize the business, which I don’t think that you are being paid in the current stock price for Fluence among others. So is there any EPS contribution for Fluence in 2020 or even in 2022?

[Andrés Gluski:]

No. No. I mean, this year it will -- it should be probably about 1 -- $0.01…

[Angie Storozynski:]

Okay.

[Andrés Gluski:]

And the reason for that is even though it’s like margin positive and we haven’t been putting more money in as that is very rapid growth is because R&D you have to spend. So, for example, all the design work…

[Angie Storozynski:]

Yeah.

[Andrés Gluski:]

… the production work of the next-generation of the sixth-generation, well, that is expense. So we have talked probably, I’d say, around two years for it to turn positive in terms of EPF and what basically happens is the fastest growth, the more new profit you have to come out with, you delay that turning to positive. So it’s a business. It could be positive if that was the objective but the objective is to create value. So we think of sales down, as you say, will give us a marker. So people say, well, how much does it worth, well, somebody just paid extra, like we did…

[Angie Storozynski:]

Yeah.

[Andrés Gluski:]

… for example with the gas business in the Dominican Republic, people weren’t giving us much value and we were able to show what it was worth to the third parties.

[Angie Storozynski:]

And the second question, so it’s a two part question. So one, is there’s like a rule of thumb that I can, say, for example, to 2021 you will have additional 2,000 megawatts of renewables in operation and granted it’s probably going to be scattered throughout the year. But can I say for instance that 100 megawatts adds X in EPS?

[Andrés Gluski:]

Well, it will depend a little bit, because it depends what you are inaugurating, right, and where. So there’s a difference between solar and wind, and there’s a difference outside of the U.S. because of tax. So it’s, there’s no rule of thumb for just like 100 megawatts. I don’t know Gustavo can comment.

[Gustavo Pimenta:]

No. What I will do is, we are putting on average $300 million, $350 million per year, right? So that’s our …

[Angie Storozynski:]

Okay.

[Gustavo Pimenta:]

… equity in the project, we have been partners so and so. If you assume, call it, 12% return on average, you are going to come up with the EPS accretion that those deals are bringing to us.

[Andrés Gluski:]

Yeah.

[Angie Storozynski:]

Awesome. Awesome. And now a bigger picture question, so I have been actually looking at it. So, as you become investment grade, I know you are already investment grade, by such, but you get those additional investment grade ratings, would you ever consider not a project finance but corporate level debt to fund the growth, I understand that there is the issue of finite life of the contract for the renewables, but I think that there is this growing conviction even among investors that the useful life of these assets is going to be longer than the duration of the original contract and under project financing you are in a sense the debt amortization, most the cash flows of the project and so the real equity attrition is only at the end of this contract. So in a sense you could help you help quite meaningfully from a cash flow perspective if you were started to rely on corporate level debt -- on corporate debt?

[Andrés Gluski:]

Yeah. Let me soft of answer philosophically and then I will pass it to Gustavo. Look, philosophically we like doing project level debt, because it’s an acid test. So since I have been CEO almost all of our major projects, I think, with the exception of Southland, we brought in a partner. And the reason was that bankers have first debt on the cash flow. So you have to convince somebody a third-party that you are going to operate this and that they think it’s a good project as well. So given that philosophically we like using project level debt and so I don’t see that changing for the time, there are advantages of certain roll ups. We can aggregate at the sublevel. Gener has debt, for example, Tietê has debt, which would get some of those advantages. But we think that the discipline of having to project finance is good and having to bring in partners is good. So…

[Gustavo Pimenta:]

I think, Andrés you covered well. I mean, it brings more discipline to the process. It also allows us to amortize the debt within the PPA timeframe, which we like. We don’t want to count on post-PPA period to pay for debt quite frankly. So it’s just more disciplined. I think the projects are more sustainable when we validate them at the project level, right, with the debt there and all the amortization within the PPA flow.

[Angie Storozynski:]

And just one follow-up if I can on Fluence, so we saw the results of the investigation by APS on the root cause of the storage system accident, and we also saw some response from LG and APS seems to suggest that their need to some changes in the configuration of those storage systems going forward. I haven’t necessarily seen the response on Fluence. But is there any fundamental change and how you think those storage designs need to be adjusted and if there is any need to make adjustments to your already existing operating systems?

[Andrés Gluski:]

Yeah. I think, look, that was a unit that was inaugurated in 2017. We are two generations away from that. The issue as we see it was with a series of LG Chem batteries, a specific series that we are produced in some factories. So we have operated for 12 years. This is the first, I will say, serious incident we have had. But really the best standards are, for example, UL 9045A and if you look at the best-in-class standards, the sixth-generation incorporates all these. So if you look at, for example, it doesn’t require -- it’s not contained, so it’s actually outside. The modules are separated, so you don’t have contagion. It has enhanced fire suppression systems on it. And in the worst case, should there be any type of thermal event since it’s not enclosed the heat and the any gases would rise. So, definitely we feel that, we have taken all the lessons learned from this event. We have incorporated into the new design and really safety was one of our number one priority. So, again, we have 12 years of operating these and we -- this is the one really event that we have had. Now regarding those cases which weren’t that many, I think, you can count on them one hand that all those units that had that series of battery in them. We immediately put out instructions of not to charge them like -- instructions you get on your Tesla car, not to charge them above 75% and we have taken corrective actions and we have given more information, more training for like local fire units, et cetera. So, yeah, we -- as you know, safety is number one value, super important for us. We have been very serious and very diligent, I think, about looking into this and supporting our clients and supporting our local fire departments on this. But I feel very good that the sixth-generation cube is the safest unit out there and incorporates all of the suggestions that are out there technically.

[Angie Storozynski:]

Perfect. Thank you very much.

[Andrés Gluski:]

Thank you, Angie.

[Operator:]

Our next question is from Richard Sunderland from JP Morgan. Go ahead.

[Richard Sunderland:]

Good morning. Thanks for taking my questions here.

[Andrés Gluski:]

Good morning, Richard.

[Richard Sunderland:]

Just starting off, with the opportunity around delinking PPAs, could you provide a little bit more color around that opportunity versus your current financing plan and you may be assumed asset sales as well. Is there an inter-player offset potentially with this new consideration or is it more of another tool in the tool bag down the road?

[Andrés Gluski:]

We have always said that and there had a lot of tools to address its financing needs, because it’s growing so fast, they have been so successful on Green Blend & Extend. We really can’t comment on some of these transactions until they close. But there are several transactions where we are delinking the PPA, which in some cases was specific to a given asset. So like this power plant has this PPA, we are delinking them and allowing us greater flexibility in terms of how we satisfy their demand or requirements of the customers. So I really can’t give you too much color on it other than saying that it will help us, it will help Gener with its financing plan. And so it’s very likely that any capital contribution from us will be in 2021 instead of 2020 this year. So we tend to be very conservative, so we saw that these have been advancing. So prior to having these as advanced as they are today, we had talked about AES putting in the money this year. So that I think is the main change. So I’d say stay tuned and we can give you more color as these transactions close.

[Richard Sunderland:]

Great. We will look forward to that. And then just a quick clean up question, the inclusion this quarter I believe it was recovery of expense payments from customers in Chile. Just -- was this in your plan specifically in the 2020 plan included in guidance?

[Gustavo Pimenta:]

Yeah. I mean this is at the AES Crop level, I mean this is above couple cents in this quarter when you normalized partnership adjustment and so on. It was included -- this is a good guy meaning cash and earnings from prior expenses, pass-through cost that we have with some particular clients and we are able to firm up those receivables back.

[Richard Sunderland:]

Yeah. But this was baked into the original guidance?

[Gustavo Pimenta:]

Yes.

[Richard Sunderland:]

Okay. Thank you very much.

[Andrés Gluski:]

Thank you, Richard.

[Operator:]

This concludes our question-and-answer session. I would now like to turn the call back to Ahmed Pasha for closing remarks.

[Ahmed Pasha:]

Thank you. Thanks everybody for joining us on today’s call. As always, the IR will be available to answer any follow-up questions you may have. Thanks. Thanks again and have a nice day.

[Operator:]

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.