Achieving Economies Of Scale Will Decrease Costs, But Regulatory Changes May Impact Net Margins

Key Takeaways

• Strategic focus on larger, higher-margin projects aims to improve capital efficiency and profitability, enhancing net margins.
  
• Retaining select coal assets supports cash flow, funding new projects and bolstering EBITDA for stronger financial performance.
  
• Uncertain policy and weather risks, reliance on debt, and delayed asset transitions challenge AES's financial stability and strategic growth in renewables.

Catalysts

Operates as a diversified power generation and utility company in the United States and internationally.

• AES anticipates a substantial increase in renewables EBITDA, with over 60% year-over-year growth expected in 2025 due to projects like the 6.6 gigawatts of capacity added in 2023-2024. This growth is poised to enhance overall earnings.
  
• The company's strategy to focus on fewer but larger, higher-margin projects will allow for more efficient capital allocation and increased profitability, positively affecting net margins.
  
• Achieving economies of scale as the renewables sector matures will decrease overhead costs per megawatt, thereby improving profitability and contributing to higher net margins and earnings.
  
• AES plans to retain select coal assets beyond 2027 to support financial performance and fund new projects, maintaining steady cash flow and bolstering EBITDA.
  
• The company's credit metrics are expected to strengthen as more projects achieve operational status, enhancing the ratio of EBITDA-generating projects, which should bolster the balance sheet and credit ratings.

AES Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming AES's revenue will grow by 3.9% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 13.7% today to 12.3% in 3 years time.
• Analysts expect earnings to remain at the same level they are now, that being $1.7 billion (with an earnings per share of $2.24). However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $1.9 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 8.7x on those 2028 earnings, up from 4.7x today. This future PE is lower than the current PE for the US Renewable Energy industry at 19.7x.
• Analysts expect the number of shares outstanding to grow by 0.06% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.92%, as per the Simply Wall St company report.

AES Future Earnings Per Share Growth

Risks

• AES's stock price performance has been disappointing, indicating potential investor concerns that could impact the company's valuation and earnings.
  
• Policy uncertainties and potential regulatory changes pose risks to AES's renewables EBITDA growth, potentially impacting future revenue and net margins.
  
• Adverse weather events in South America, such as droughts, have negatively affected AES's financial performance, creating volatility in earnings.
  
• The company's strategy to defer new equity issuance and rely on debt could strain its balance sheet and affect net margins due to higher interest expenses.
  
• Retaining coal assets longer than planned may affect AES's strategic shift towards renewables and potentially result in missed growth opportunities or higher operational costs, impacting overall earnings.

Valuation

• The analysts have a consensus price target of $15.016 for AES based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $23.0, and the most bearish reporting a price target of just $7.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $13.8 billion, earnings will come to $1.7 billion, and it would be trading on a PE ratio of 8.7x, assuming you use a discount rate of 10.9%.
  
• Given the current share price of $11.25, the analyst price target of $15.02 is 25.1% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.