Must-know: Risks to AES Corporation’s business
Risk factors for AES
AES Corporation (AES) operates as a power company in nearly 20 countries across five continents. Given the nature of its business, AES faces the following risks:
- Currency fluctuations
- Fuel prices
- Interest rates
- Scattered business model
Currently, AES generates close to 63% of its profits before taxes in US dollars. This means that 37% of the company’s profits pose FX, or foreign exchange risks. As AES hedges a part of its earnings that is exposed to FX risks, some portion of profits will remain exposed to FX fluctuations against the US dollar.
After hedging, AES anticipates a negative impact of $0.03 per share for a 10% appreciation in US dollars next year.
The cost of fuel is a major issue for AES. Oil, gas, and coal prices change with variations in demand and supply. Hedging mitigates the short-term risks of commodity price fluctuations. However, long-term risks still persist.
AES currently has long positions on natural gas and short positions on coal futures open. These hedged positions are positively correlated for the company’s earnings in the medium to longer term. For each 10% rise in the commodity price of coal, natural gas, or oil by 2017, AES Corporation’s earnings will gain $0.06 per share.
As mentioned in a previous article, AES is highly leveraged compared to Northeast Utilities (NU), Edison International (EIX), Ameren Corp (AEE), and other power companies. This goes negatively against AES when interest rates rise.
The interest payments on debt will increase when interest rates rise. AES says that a 1% rise in interest rates in 2015 could impact its earnings negatively by $0.03 per share.
Scattered operations affect AES
AES has a presence in many countries. In most countries, the company’s power generation units are small and do not help the company achieve economies of scale.
Plus, the fuel mix for AES is not balanced regionally. In some regions, operations depend heavily on a particular source to generate electricity. For instance, the drought situation in Latin America has lowered the company’s earnings in 2014 because hydroelectricity forms the bulk of this region’s power generation.
Each of the power companies within the Utilities Select Sector SPDR (XLU) has its own set of risk factors. Potential investors should evaluate each of these risks carefully.