The following segment was excerpted from this fund letter.
Currently, Massif Capital’s portfolio has roughly 11% allocated across two utilities, NYSE:AES and Polaris Renewable Energy (OTCPK:RAMPF). In the case of both equities, we have experienced disappointing 2023 market results, and in the case of AES, it is the long-book’s worst performer YTD, dragging down the overall portfolio by -2.09%. Polaris contributed a positive return of 0.21%. These two positions represent investments in similar assets but very different businesses, which explains much of the divergence in this year’s results.
The AES Corporation (AES)
In the case of AES, we have a heavily US-focused utility with significant exposure to regulated and unregulated markets and a significant commitment to building out renewable energy. The firm also has some exposure to electricity markets in South America and exposure to electricity storage markets in the form of its ownership stake in Fluence (FLNC). Despite being one of the larger US utilities, the firm has trailed the sector (as measured by the IXUTR Index) dramatically this year.
The IXUTR Index is down 5% while AES is currently down roughly 27%. In some regards, one might assert this significant relative underperformance is a negative catch-up to the rest of the industry, having outperformed the index last year by roughly 17%. The relative performance explanation is likely a reality but indicates more value-agnostic selling in the market than warranted. This explanation is supported, it would seem, when one breaks down the firm’s YTD performance in the context of a factor model, which indicates that factor exposure accounts for only 4% of the decline, with the rest explained by idiosyncratic companies’ factors.
From a portfolio management perspective, the questions thus become, “Are we holding a value trap and are there idiosyncratic reasons to justify this sell-off?” We think not.
At a very simple level, the value in AES versus the sector is clear. While the sector index traded at a P/E of 19.9x as of the end of the second quarter, roughly 21% above the industry quarterly average dating back to 6/2002, AES trades at a 28% discount to its quarter-end average P/E over the same period. Furthermore, when the stock peaked at approximately $29 in December 2022, it was trading at a P/E of 11x versus the index at 20x. Over the last 20 quarters, AES operating margins also outperformed the index’s operating margins by an average of 5.3% (and a median of 4.8%).
Digging deeper does not, in our minds, explain the relative underperformance in any more value-cognizant way. Admittedly, the global regulated and unregulated business of AES versus most traditional US peers carries with it political and currency risks. However, in our opinion, these are rather minor and offset by the non-recourse nature of the financial risks that occur at those entities. Furthermore, the firm’s 64-gigawatt project pipeline, of which 80% is US-based renewable and storage projects, which are all likely to benefit from tax-credit provisions of the Inflation Reduction Act (IRA), is one of the largest in the industry. We cannot explain the aggressive move to the downside via company-specific factors.
The firm hosted its 2023 investor day during the second quarter, and the critical takeaway across most sell-side research we reviewed appears to be the revision of EPS CAGR over the 2023 to 2027 period from 7%–9% to 6%–8%. Admittedly a downside revision, but it comes after the stock had already fallen 22%. There is no question the market is a forward-looking, discounting mechanism, so perhaps the fall represents the expectations of the market of that revision, subsequently confirmed. In our opinion, that seems to ascribe too much precision to the market’s rationality or lack thereof.
The stock price move to the downside seems overdone. Were it simply to trade in line with peers, on a P/E basis, it would be priced between $27 and $28 per share. We maintain our positive outlook and expect the firm to be worth $30 to $35 per share in the fullness of time.
|DISCLOSURES: Opinions expressed herein by Massif Capital, LLC (Massif Capital) are not an investment recommendation and are not meant to be relied upon in investment decisions. Massif Capital’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is limited in scope, based on an incomplete set of information, and has limitations to its accuracy. Massif Capital recommends that potential and existing investors conduct thorough investment research of their own, including a detailed review of the companies’ regulatory filings, public statements, and competitors. Consulting a qualified investment adviser may be prudent. The information upon which this material is based and was obtained from sources believed to be reliable but has not been independently verified. Therefore, Massif Capital cannot guarantee its accuracy. Any opinions or estimates constitute Massif Capital’s best judgment as of the date of publication and are subject to change without notice. Massif Capital explicitly disclaims any liability that may arise from the use of this material; reliance upon information in this publication is at the sole discretion of the reader. Furthermore, under no circumstances is this publication an offer to sell or a solicitation to buy securities or services discussed herein.
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