The AES Corporation
Q2 2019 Earnings Call Transcript

Published: 6 Aug 2019

[Operator:]

Good morning. And welcome to the AES Corporation's Second Quarter 2019 Financial Review Conference Call. All participants will be in listen-only mode. . Also note this event is being recorded. I would now like to turn the conference over to Ahmed Pasha. Please go ahead sir.

[Ahmed Pasha:]

Thank you, Nancy. Good morning and welcome to our second quarter 2019 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; Gustavo Pimenta, our Chief Financial Officer; and other senior management of our management team.

[Andrés Gluski:]

Thank you, Ahmed. Good morning everyone and thank you for joining our second quarter 2019 financial review call. I am pleased to report that based on our year-to-day results and our expected growth in the second half of the year, we are on track to achieve our 2019 adjusted EPS guidance with the midpoint of $1.34 and our apparent free cash flow target with the midpoint of $725 million. We are also confident in our ability to deliver 7% to 9% average annual growth through 2022. Turning to slide four, since our last call, we have continued to make great progress on our three key strategic objectives. These are; first, becoming investment grade and enhancing the resilience of our portfolio. Second, positioning the company for sustained growth by increasing our backlog of contracted projects, and third, improving our competitiveness by deploying innovative technologies. Now allow me to provide some color on each one, starting with our first objective of becoming investment grade and enhancing the resilience of our portfolio on slide five. We have already achieved a key investment grade metric and we are on track to attain investment grade ratings in 2020. Our improved credit metrics reflect the growth of our free cash flow paying down 43% of our recourse debt and an almost 70% decrease in our exposure to foreign currencies, commodities and hydrology over the past eight years. A good example of this last point is bringing LNG to Panama with the commissioning of the AES Colón Terminal and combined cycle power plant. This new facility has reduced our exposure to poor hydrology in Panama by 70% by providing far less expensive energy to supply our hydro PPAs in times of drought, such as occurred in 2014 and is occurring again this year. It is not only good for AES but it is expected to save Panama more than $400 million a year in imported fuel expenses. We are further enhancing the resilience of our portfolio by decreasing our carbon intensity. This year alone we have announced the sale of 2.4 gigawatts of thermal generation in Northern Ireland, Jordan and Oklahoma. As you can see on Slide six, as a result of our actions, we expect to reduce our carbon intensity by 50% from 2016 levels by 2022. By that date, we also expect that coal will represent less than 30% of our total generation by megawatt hour. Now to our second objective, positioning the company for sustainable growth by increasing our backlog of contracted projects, beginning on Slide seven. We now have a backlog of 6.8 gigawatts of mostly renewable projects. This number encompasses projects under construction or with sign PPAs, all of which are expected to be online by 2023.

[Gustavo Pimenta:]

Thank you, Andrés. Today, I’ll go over our financial results, outlook for 2019 and capital allocation. Overall, we are very encouraged by our performance-to-date and remain confident in our ability to deliver on our strategic and financial objectives. As shown on slide 16, in the second quarter, adjusted EPS was $0.26 primarily reflecting higher contributions from the U.S. and a lower tax rates. This was partially offset by the impact of asset sales as well as planned outages in Panama and Northern Ireland. In the second half, we expected to post stronger results as we benefit from the plant in Panama returning to operations. Our continued cost savings initiatives and two gigawatts of new projects reaching COD. Turning to Slide 17, adjusted pre-tax contribution or PTC was $240 million for the quarter, a decrease of $15 million. I’ll cover our results in more detail over the next four slides beginning on slide 18. In the U.S. & Utilities SBU, increased PTC reflects the resolution of regulated rate cases last year, contributions for new renewable projects and higher energy sales at Southland. These impacts were partially offset by the exits of coal-fired generation at the DPL and Shady Point.

[Andrés Gluski:]

Thanks, Gustavo. Before we take your questions, let me summarize today's call. In the first half of the year, we made very good progress on our strategic objectives and expect to accomplish significant milestones in the remainder of the year. We are enhancing the resilience of our portfolio, and we are on track to attain investment grade ratings in 2020. We are increasing our backlog of long term contracted projects. The sustained profitable growth, including advancing renewables and LNG infrastructure, and we are deploying innovative technologies to maintain our competitive edge and market leading positions. Accordingly, we are confident in our ability to achieve our 2019 guidance. We're also confident that we will deliver 7% to 9% growth in cash flow and adjusted earnings per share through 2022. Therefore, we believe AES offers a compelling investment thesis, yielding double-digit total returns that will serve our investors well for years to come. Operator, we are now ready to take questions.

[Operator:]

Thank you. . And the first question comes from Angie Storozynski from Macquarie. Please go ahead.

[Angie Storozynski:]

Thank you. So first on Ohio, the DMR for DPL is still being challenged at the court. And secondly, given the successful challenge of percentages, DMR. Just wondering, if there is a way to either adjust the current rider that the DPL is collecting, and also have some improvements to the one that you were requesting to have extended so that it's not just susceptible to future legal challenges.

[Gustavo Pimenta:]

Hi Angie, Gustavo here. So just to provide a little bit of detail here. And so while it’s been challenged in the court is not the legality of the DMR. So we have a very specific and narrow claim there. The discussion is around if the DMR should be included or not in the SEET test. So from our perspective and there are precedents in Ohio in which charge similar to the DMR should not be included in the seat best. So we feel -- we feel good about that. In any case, we don't think this is a binary outcome, right. So we have to run this through the SEET test at the end to see what is the final impact. And you know, our view is that decision will probably become coming towards year end. But again, it's not a challenging regarding the legality of the demand, that's a very important clarification. The extension is a separate discussion, right. So, we've got the initial three years under the assumption that would be very specific in terms of the uses of the proceeds. So we've done, we've used 100% of the proceeds for that pay down. We brought -- we brought the complex back to investment grade, and from our perspective, it is necessary to secure the extension for the complex to maintain the investment grade, in position DPL for grid modernization. You may recall we filed last year an investment on his smart grid and for us to continue with those investments. It's fundamental that we secured an extension. So we feel, we have a good case, but that will have to run its two process.

[Angie Storozynski:]

Okay. And moving on to your cash value of allocation. So just wanted to make sure that the $395 million of proceeds from asset sales is independent of this pending process, where you're trying to raise third party capital and on the latter, given the low and falling interest rate environment, if you could comment if that is actually somewhat beneficial to the process either you're seeing actually more demand for partial sell down of equity of your operating assets and future assets.

[Andrés Gluski:]

Yes, hi Angie, this is Andrés. Yes, as we said this initiative is additional. It in no way affects the $395 million. It's progressing well, as Gustavo said. And you know stay tuned for developments in the latter half of the year. I would add that this is not like if we don't do this, we’ve already raised $3 billion of partner capital at very good rates. So what we're trying to do here is, do it in a more systematic and predictable way. But in either case, we have additional upside from incorporating partners into our businesses.

[Angie Storozynski:]

Thank you.

[Operator:]

Our next question comes from Ali Agha from SunTrust. Please go ahead.

[AliAgha:]

Thank you. Good morning.

[Andrés Gluski:]

Good morning, Ali.

[AliAgha:]

Good morning, Andrés. My first question I did want to come back to Ohio if I could. I hear the point you make that hey, you know the Supreme Court challenge for you is specific to the SEET test. Nevertheless, you know there is a Supreme Court decision in the state that you know basically went against the validity of the FE DMR. So there's a possibility that eventually something like that challenge happens to your DMR as well if it’s not happening today. So can you just simply summarize for us why you think your DMR would be different and should be treated differently than the way FE’s DMR is being treated?

[Andrés Gluski:]

Yes, I think, I mean it's very objective here. We've --that's not the discussion in our case, right. So discussion again in our case is regarding the SEET test and not the legalities, so that is not in this court today.

[AliAgha:]

I get that. I get that when I think of …

[Andrés Gluski:]

I think the potential implications would be for potential discussion on the extension of the DMR, which I think it's a more fundamental discussion if the DMR should exist or not. And again, we do believe we have a very good case when we got the first, but very clearly if you read the outcome there, one of the discussion is if the proceeds are clearly defined in terms of the uses. In the case of DPL this was very clearly defined. We used 100% for that paydown, so a lot of the fundamentals that were discussed in the other case. From our perspective, our solid from a DPL standpoint and again we need that from our perspective to maintain the investment grade and position DPL for grid mode.

[Gustavo Pimenta:]

Yes Ali, I think what's very important is also for you know for Dayton to have a grid equal to the other grids in Ohio. It needs an investment grade company and that is all wrapped together in this request for an extension of the DMR.

[AliAgha:]

Okay, separately Andrés can you also give us an update on what you're seeing in Puerto Rico right now with the political turmoil there any impact at all on your plant or your project out there?

[Andrés Gluski:]

Yes. Puerto Rico has been through you know removal of the governor and they are in the process of appointing a new governor. Look, whatever occurs will continue to be very important for Puerto Rico. We have the most reliable and by far the cheapest energy on the island. To replace our coal plant in Puerto Rico, by burning heavy fuel oil, which is what the other plants mainly burn, besides some gas would cost about an additional $300 million to $400 million a year in imported fuel bills. So Puerto would have to pay an additional $300 million to $400 million per year, which will be passed on to consumers. I think what's also very important is of the large plants. There are only two which are EPA compliant. Most of the plants in Puerto Rico because they're burning heavy fuel oil have excess emissions of sacs, so they're not EPA compliant. And for that reason the air in San Juan and Ponce, the two main cities is not compliant. So while there's been some you know noise of about our coal ash on the island, really this this plant is very necessary. You know we're working with the PREPA to see about green blend and extend as a way of reducing total emissions, you know emissions on the island. And we'll continue to work with them. So stay tuned. And you know this plant is important. It is producing the most reliable and the cheapest energy on the island.

[AliAgha:]

Okay. And last question Andrés you know the 395 million of remaining asset sales. Is the goal there still to exit out of non-core assets as part of that process, or is that more driven by partial sell downs of existing assets to rake in recycled capital. Are you thinking about the remaining assets sale process?

[Andrés Gluski:]

Well we have a number of objectives. So clearly, we have an objective of reaching less than 30% of our total generation by megawatt hour coming from coal. So you know that's something that we will keep in mind. We'll also keep in mind you know those markets which we think are growing most quickly and of course we've also been I think very successful in improving our returns for example even on renewables, by incorporating partner. So there's a combination of factors. But yes, obviously, reducing our carbon footprint will be one consideration in our additional sell downs.

[AliAgha:]

Got it. Thank you.

[Operator:]

Our next question comes from Greg Gordon from Evercore. Please go ahead sir.

[Greg Gordon:]

Thanks guys.

[Andrés Gluski:]

Good morning, Greg.

[Greg Gordon:]

Sorry to beat a dead horse on the DMR. I already understood that the nuances of your legal situation. But can you just tell us even though you in all rights you need this money to fulfill the capital needs of the distribution utility in Ohio, and should get the approval. Is your 7% to 9% expected earnings growth rate resilient to a negative outcome in that case?

[Gustavo Pimenta:]

The answer is yes.

[Andrés Gluski:]

Just to compliment Greg, just to compliment, I think you may recall first Q we have announced the additional $100 million of potential cost savings from digital, which was not in the 7 to 9. So you see that now our forecast has really resilience to manage some of the negative outcome. Having said that, we expect it to get the DMR extension.

[Greg Gordon:]

Right. And then my second question was with regard to Vietnam. You talked about how you're pleased with the movement towards potential realization of commercial opportunity there. I think, you know some of your investors are a bit skittish as it pertains to really large bets on highly concentrated investments out in Asia. So if this does come to a become a really viable commercial opportunity, do you see bringing in partners? How would you like decide that investment vis a-vis your overall capital business for AES.

[Andrés Gluski:]

Yes. Well you know of course we have a portfolio view of our capital and we don't want excessive concentration in any one particular market outside of the U.S. So I would say that to look at what we did with our Mong Duong facility in Vietnam, where we have been very successful. We were paid on time, it's a dollar contract. We're viewed as the premier operator and developer and builder of projects in Vietnam. So in that case, we didn't have an over concentration of capital. So in the case of Vietnam, we may have Vietnamese partners from the get go. But you know we'll be conscious of that. But I think it's moving very well and as you know Vietnam is a place where it takes time to develop the projects, because you require government consensus from many entities. But you know we're well on our way. So we feel very confident about this project, and you know we'll obviously we'll be conscious about over concentration in one country.

[Greg Gordon:]

Great. My last question is with regard to Fluence, I think that there was an incident where the technology had some issues in Arizona several months ago. Was that an isolated event or have there been improvements or modifications to the design of your of your offering as a result of that?

[Andrés Gluski:]

Yes this occurred in a two megawatt facility in Arizona. We've been working with the battery manufacturer, and the utility in that case, really investigating all the root causes and looking at all our facilities. I would say that we've taken a real prudent steps based on that, realize that we're now coming out with our fifth generation of energy storage, which will be a cube and it has all the latest safety requirements. For example, the state of New York, which is it's 95 48 and in addition to that realized that you know we continue to see very strong demand for Fluence even the operator of the one unit that did have that incident, we continue to go forward. So looking at that, we think this is something that there was some earning, we're working again with the battery supplier to really look at what was the root cause. And we're incorporating all learnings and we will have what we have, you know quite frankly, you know the safeties and most up to date units out in in operation, and in construction.

[Greg Gordon:]

Thank you guys, have a great morning.

[Andrés Gluski:]

Thank you.

[Operator:]

The next question comes from Julien Dumoulin-Smith. Please go ahead.

[Julien Dumoulin-Smith:]

Hey good morning, Kim.

[Andrés Gluski:]

Good morning Julien.

[Julien Dumoulin-Smith:]

Hey. So I just wanted to follow up a little bit different from from other here. First, just with respect to Vietnam and then just what's the latest progress on an LNG contract in there? What should we be expecting going into the fourth quarter here, anything in particular? And then separately, you mentioned IPL. There have been some issues in Indiana around these RP processes of late. Can you comment about what kind of generation shifts are reflected in that 1.2 billion. Would that be potentially incremental? Are you thinking about anything? I know that some of the modeling scenarios that have been released by IPL have talked about this a little bit, so just that if you can't on those two big capital budgeting items here. And then separately as the second question, I'll just ask you now, can you comment a little bit on the PTC contributions and the year-over-year increases from the renewables segment and how you're thinking about that scaling through the course of the year so I'll leave it there?

[Andrés Gluski:]

Okay let's take this multifaceted question part by part. I think regarding Vietnam, as you know when President Trump visited Vietnam, there was a letter of intent signed for this project, and it was you know I'll take one of the marquee projects that the two countries had agreed to. So Energy Demand in Vietnam is growing around 10%. Quite frankly, Vietnam is one of the beneficiaries of some of the trade dispute between the U.S. and China. So expect demand to grow even faster. Vietnam does not have sufficient domestic LNG, doesn't even have sufficient coal, and so it's Vietnam is moving towards LNG and renewables as well. So this is a very necessary project. It's going to start supplying not only the new combined cycle gas plants, which are part of this initiative, but existing ones, which are running out of offshore gas as well. So I think it's very necessary. It's also a project, it's very important for both countries for the U.S. and for Vietnam. So that the next things as you know expect no further progress in terms of you know announcements is a between the two countries and us that this is going to be moving forward with. And you know what Vietnamese partners are involved. Vietnam is a country of consensus as I said. So it takes time. But they move and they move in a very steady but very certain fashion. So that's what I would say sort of stay tuned, and it will of course. We have to -- we are part of the Vietnamese government's master electricity plant and that will also involve you know how much LNG is imported. And you know the phasing in of the combined cycle plants. On the second, I will pass this to Gustavo, what I would say is a big part of the $1.2 billion at IPL is actually to – and so it’s a smart grid infrastructure. So I'll pass it to Gustavo.

[Gustavo Pimenta:]

That's right. So Julien, Gustavo here. Yes. The 1.2 is all T&D. So you're the team is looking for opportunities on the generation side, but it's not in this number yet. So this is it's in the works. On your third question, regarding their renewable contribution in this quarter was not that material around the cent. And as we bring new projects on line towards your end, then we'll have an additional contribution.

[Julien Dumoulin-Smith:]

Just to clarify quickly, just on the PTC contribution for renewables, should we expect a material tax credit benefit in 4Q here to be kind of a big year of your uptake.

[Andrés Gluski:]

Not material, but some contribution, but not material.

[Gustavo Pimenta:]

Yes, Julien, I -- just just remind you that remember that we were split 50/50 between solar and wind, and we split 50/50 between U.S. and international. So you know something like HLBV is not as important for us as it is for other people.

[Julien Dumoulin-Smith:]

And just finally to read between the lines with IPL, we shouldn't expect anything too different from that 1.2 for the RFP process for the time being?

[Andrés Gluski:]

The things we are still working on that one. So that this 1.2 was exclusively on T&D and we are looking for opportunities on the RFP and we'll come back to you as we as we get this. Put this to bed.

[Julien Dumoulin-Smith:]

Okay. All right. Stay tuned. Thank you.

[Operator:]

Our next question comes from Charles Fishman from Morningstar. Please go ahead.

[Charles Fishman:]

Hi. Good morning. On Fluence, its certainly an emerging technology that we're still going down the cost curve. Andrés, would you say that your margins are holding -- per megawatt or however you measure it as this technology progresses down the cost curve.

[Andrés Gluski:]

Look I would say that the sales margin you know certainly are holding their different margins for different businesses. You know obviously we're in 20 countries today. We're selling you know for example in the Philippines where you have many isolated positions. You have different applications such as community solar, you had where frankly SunFlex, which is slightly different project product than our advancing product. So you know the margins will differ depending on the market depending on the exact product. But basically, we see the cost curve coming down, because as we come up with our next generation of product here, it's going to be more productized, it's going to be more prefab and it's going to be less customized as we've learnt more about what is optimal for our customers in different situations, so more customization will be on the software and less will be on the hardware. So I would say expect margins to continue to improve. Not not actually go down even though you know we're seeing some you know in some cases you know people are bidding very low prices for the integration of energy storage. Basically to say that, they have an approved product up and operating in many of those cases we don't. We don't compete because you know we would do require margin from our projects.

[Charles Fishman:]

Sure. And then one last quick question. The virtual reservoir, Alto Maipo, how is that different from pump storage, and doesn't involve any of the Fluence technology?

[Andrés Gluski:]

Good question. It's absolutely Fluence technology. So basically it changes. It differs from pump storage, well pump storage you need a reservoir. You've got to put that water somewhere, and you know you have to build pipelines and you have to use electricity get it up there. And so, there's friction, just the physics of storing electrons is superior to that of storing molecules. So the virtual dam is basically the idea to combine a run of the river facility such as you know the whole Alto Maipo complex is about 750 megawatts. And then you have associated energy storage. Now if you have only five hour storage, what I would remind people that means it's five hours at 100% discharge. If you discharge it at 50% you actually have energy storage capabilities for 10 hours. So what this will allow is you know the run of the river is constant. And what we will do doing is injecting energy into the grid when the prices are best. That's basically it. And really providing capacity. I mean the one big issue with renewables is that they don't really provide you around the clock capacity. So this will provide us you know our run of the river does have actually run around the clock capacity, but this will allow us to inject that energy when it's most needed. So this is a very exciting technology and it will be I'm sure copied. And if we end up with a 250 megawatt five hour facility at the Alto Maipo complex, that makes the economics much more attractive.

[Charles Fishman:]

That is fascinating. I would think that in the U.S. with the hydro and all the hydro we have but the limited opportunity to expand that might be a potential market if you can drive the Fluence cost down. Is that correct?

[Andrés Gluski:]

Yes, that's absolutely correct. I mean, we actually are have people looking at the virtual Hydro in places like India, because realize that nowadays getting the environmental permits to construct a reservoir you know that often means forest clearance. That means relocating people, is very difficult. These you can install you know within 12 months. So you know really the only barrier is getting the regulations in place as many on getting the proper capacity payments for this to work in and of course it works best in situations where you have a big penetration of solar for example. So you have that really that duck curve that you can take advantage of.

[Charles Fishman:]

Okay. Thanks Andrés. I can see why you're so excited about Fluence. Thank you.

[Andrés Gluski:]

I do.

[Operator:]

This concludes our question and answer session. I would like to turn the conference back over to Mr. Horn in Russia for any closing remarks.

[Ahmed Pasha:]

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

[Operator:]

The conference is now concluded. Thank you for attending today's presentation you may now disconnect. Enjoy the rest of your day.