The AES Corporation (NYSE:AES) has been providing energy to its customers in the US and throughout the world for many years. Its international exposure has taught this company a few lessons about volatility, and AES is applying those lessons to deliver remarkably stable, predictable results in the midst of a decidedly unstable environment. Better yet, its investments in leading technologies will likely generate additional growth for years to come.
Managing growth is challenging
For well over 20 years, AES has been building and operating power plants in the US, along with places like Brazil, India, and Bulgaria. This level of international exposure has been rewarding for AES: Its track record, access to capital, and first-mover advantage in emerging markets has helped it win many bids and build a diversified $10 billion business, operating in 14 countries with over $34 billion in assets. But this level of growth and global expansion did not come without some hard lessons.
2015 wasn't a particularly great year for AES. It fell in the midst of a period later dubbed "The 2014-2017 Brazilian Drought." As a result of the drought, AES's hydroelectric plants in Brazil generated a lot less power than projected. Add to that a devaluation of nearly 50% in the Brazilian Real,and in Q2 2015 alone, AES's Brazilian business unit lost almost $74 million in adjusted pre-tax contribution, or adjusted PTC, a metric the company uses to measure the financial performance of its business units. In that same quarter, weak exchange rates and lower-than-expected generation in other parts of its business caused AES as a whole to lose a total of $89 million in adjusted PTC year over year, or about 26% of its total adjusted PTC. And AES' stock reflected these headwinds: Between the middle of 2014 and the end of 2015, the company's stock fell by almost 50%.
From challenges come key lessons
By the beginning of 2016, AES was ready to turn the page. During its Q1 2016 earnings call and in nearly every earnings call after it, the company declared it would be pursuing a "disciplined growth" strategy focused on two key initiatives: It would be seeking "long-term contracts," and it would be looking for "US dollar-denominated revenues."
That means the company would start walking away from selling energy to its customers at prevailing market prices, also called "spot prices." Instead, it would start selling its energy through "take or pay" contracts, which obligate the client to buy all the energy generated by a plant. The company would also start looking for customers who could commit to paying for that energy in US dollars.
The types of contracts AES set out to pursue weren't a new thing in the industry. They just required the company to find credit-worthy clients who would pay their energy bills regardless of economic ups and downs. To get them, AES gave up pricing power, since these contracts place a cap on how much the company can charge for the energy it sells through the duration of the contract. Given the events of the previous years, the company judged that a risk worth taking.
Add solar and storage
But these two initiatives alone could not maximize the predictability of AES' future cash flows. What if another drought caused a hydroelectric plant to generate less energy? In that case, AES would, well, sell less energy -- and make less money. And what if the cost of coal and natural gas went up significantly? In that case, AES's margins would be lower.
Enter solar energy. During its 2Q 2016 earnings call, AES announced its intention to add solar and wind to its Brazilian power generation. Just as hydroelectric generation is susceptible to droughts, solar energy tends to be more plentiful during dry seasons. Indeed, availability of sunlight in general tends to be fairly predictable. And solar power plants produce much more predictable margins as well, since unlike other fuels, the price of sunlight never changes.
While AES had been developing solar and wind projects for some time, its emphasis on these two sources since 2016, and more recently on energy storage -- or batteries -- has been key to turning its business around.
Between 2015 and 2018, AES went from 7% solar and wind to 17%. During its Q2 2020 earnings call, the company confirmed its commitment to achieve less than 30% generation from coal during the year -- a 15% reduction from 2019, and necessary for AES to meet the environmental investment criteria of Norges Bank, one of the world's largest sovereign wealth funds.
While AES has been focused on building a resilient business, it has also added potential sources of growth. In 2018 AES announced a joint venture with Siemens (OTC:SIEGY) to launch Fluence, a new company focused on bringing to market AES' energy storage technology.
The agreement is significant for two reasons: First, mass-producing these storage systems should reduce their cost to AES. Second, Fluence has quickly become a leader in the rapidly growing large-scale energy storage segment. And while Fluence's business does not add anything to AES's bottom line at this time, Fluence may be aiming for an IPO down the road.
What a difference five years make
Today, nearly 85% of AES's adjusted PTC comes from US dollar-denominated sources -- up from 69% five years ago. And nearly 70% of all its adjusted PTC comes from long-term, take-or-pay contracts. Its backlog and pipeline of renewable projects is nearly 100% solar, wind, or storage, which have proven more predictable sources of revenue than other technologies.
As a result of its focus on building a resilient business, the company has been largely unaffected by the downturn in energy demand resulting from COVID-19, with its Q2 2020 adjusted PTC coming down only $2 million, or less than 1% from a year ago. AES's stock price is actually up about 15% from a year ago, and up about 60% from three years ago, substantially above many of its peers in the S&P 400 Utilities index .
Because of its past volatility, AES has not been a traditional utility stock delivering predictable growth plus dividends. However, with its focus on disciplined growth and renewables, AES is looking much more like a utility stock with some nice growth -- and a healthy 3% dividend yield.
Fools interested in adding a utility to their portfolio should pay attention to how AES continues to increase the portion of its PTC that comes from dollar-denominated, long-term contracts. And Fools interested in growth should pay attention to the headlines and announcements around the company's investments in breakthrough technologies such as Fluence.