AES Solar Investment is Waning

AES Solar, a joint venture between AES (AES) and private equity firm Riverstone Holdings LLC, is going to receive less backing from AES in the second half of the year. The goal of AES Solar is to produce large amounts of solar energy to allow utility grids based entirely on clean solar energy. However, as of the latest quarterly filing AES said that it has allocated only $40 million to AES Solar compared to the $126 million that the firm sponsored in the first half of 2009. The original agreement with Riverstone held that both parties would allocate up to $500 million in funding to the project through 2013. Furthermore, for the first time AES included this language in the filing, “it is possible that if we decide not to fund the joint venture in the future it could impact AES Solar’s development plans or operations.”

The shift in strategy was concurrent with the reporting of fiscal first quarter results on May 8th, which were much better than expected. The company earned 37 cents per share compared to consensus EPS estimates of 21 cents. Furthermore, the company’s free cash flow increased by $40 million in the quarter. It appears that despite the better than expected quarter, AES management is placing a premium on liquidity, which may be the primary reason for the dialing down on AES Solar. As Executive Vice President and CFO, Victoria Harker said:

“Over the past several months, we continued to enhance our corporate liquidity through refinancings of $1.3 billion, which extended our debt maturities well beyond 2009. This included a renegotiation of our senior secured credit facility and a $535 million bond offering. These proceeds were used to reduce our $600 million unsecured credit facility, which will no longer be needed. At the subsidiary level, AES Gener’s $196 million bond offering provided the funds needed to complete the construction projects in Chile.”

The stock was up more than 18% the day of the earnings beat, and at Ockham we see the balance sheet strengthening initiatives as a solid move at this juncture. As with many utilities and alternative energy companies, AES has a lot of long term debt. It is not uncommon for AES or its peers to maintain high debt levels, but it is a positive in our view to lower the debt burden while increasing cash flow. The solar projects are not going away, and as the global economy starts to grow demand for energy will ramp up again. In this circumstance we think it wise to tighten the belt a little, and continue to strengthen the company through a downturn.

AES is sacrificing growth in the short term, but we, at Ockham, still like this stock from a long term standpoint. We currently have the stock’s valuation as Undervalued, as price-to-cash and price-to-sales are well below their historically normal ranges. AES is up about 75% from the market bottom in early March, but we think there is still significant potential in these shares. Given the current fundamentals, if AES were to trade within the established historical ranges of price-to-cash and price-to-sales, it would trade around $18 per share. There is no guarantee that it will ever get back to those levels, but with the potential in solar energy we would not be surprised to see this company take advantage of the return to global growth. These are some of the reasons why AES is the most attractive electric utility according to the Ockham methodology.

AES Solar Investment is Waning

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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