AES GENER. Initiating Coverage. Investment Thesis and Recommendation. Risks

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1 AES GENER Target Price: CLP 32 Recommendation: Hold Risk: Medium July, 9th 212 Sector: Electricity & Energy Analyst: Sergio Zapata T: Company Information Ticker: AESGENER CI Equity Closing Price (CLP/share): M Price Range: Daily Vol 12M (CLP mn): 1,2 Shares (mn): 8.69,7 Market Cap (USD mn): 4,74 Shares / ADR: NA 24M Stock Performance IPSA GENER 8 jul-1 mar-11 nov-11 jul-12 Initiating Coverage Investment Thesis and Recommendation We are updating our recommendation on AES Gener stock to Hold (Medium Risk) and introducing a 212YE target price of CLP 32 per share. This target implies a 9.8% increase over current price and a total return of 13.%, including dividend payment to 212YE. Our valuation considers the new expansion projects and the new scenario regarding to fuel prices, marginal costs and hydrology on the markets where the company operates. New Projects. AES Gener and its colligate Guacolda have MW of generation capacity in Chile, Argentine and Colombia. Currently, last stage of Campiche project is been developed and construction contracts on Guacolda 5 are in the allocation process. Both units will add 8.8% of new capacity. In addition, AES Gener s projects Alto Maipo and Cochrane are already environmentally approved and they should add 22% of new capacity but the company has not decided yet about their construction so they are not included in this valuation. The green light for them could have a positive impact in our view. Fuel Prices and Marginal Costs. After reaching high levels in 211, coal price main component of company s generation mix- has started showing a 15.3% average price decline between May and 211. We expect this trend will continue this year, with a positive impact in its cost structure. Regarding hydrology, our base scenario considers a normal to normal-wet season, which could increase SIC s hydro generation and could hold down marginal costs. The startup of Endesa and Colbun coal-plants expected by 2H-212, should also help to keep down marginal costs. Operating figures in 212E should show a contraction at EBITDA s level. Based on the aforementioned scenario, we estimate lower spot prices would contribute to normalize revenues from the spot market in SIC s operations which reached USD 195 mn (+151% YoY) in 211. This could be the main driver to the lower consolidated EBITDA level expected for 212 after the historic 211 figures. Valuation. AES Gener stock currently shows a 212E EV/EBITDA multiple of 1.8x, in line with the historical average of the last three years of 1.7x, level we consider reasonable. Finally, our target price implied a VE/MW multiple of USD 1.6 million per MW, which is lower when compared to replacement values of thermal units around USD million per MW. This could be explained because of the inclusion of non-efficient diesel/lng assets generation with low dispatch factor located in the SIC. Risks Investment plan. Start-up of new generation projects -such as Alto Maipo and Cochrane- should favorably affect the company value and, therefore, our target price and recommendation. Fuel Prices and Hydrology. AES Gener and Guacolda installed capacity in Chile is 93% thermal type, mainly coal and diesel/lng. A fuel-price level significantly different form our base scenario could affect our estimates for Chile, which provided 7% of EBITDA in 211. Also, a more wet or drier than normal hydrology deviation from base scenario, should affect its thermal unit dispatch, marginal costs, and the company spot market position, thereby their results and our valuation. A similar effect should occur with hydrology deviations in its subsidiary Chivor (1, MW reservoir). AES Gener Initiating Coverage Sergio Zapata M. July, 9th 212

2 AES GENER Company Description - It is the second largest electricity generator in Chile and it is controlled by Inversiones Cachagua Ltda., with 7.7%, which is a subsidiary of Aes Corp. - It has a total of 4,821 MW capacity and operates in the SIC (2,355 MW), SING- SADI (1,465 MW) and Colombia (1, MW), which contributed 33%, 37% and 3% to 211 EBITDA, respectively. - As of year 211 its market share in Chile and Colombia reached 22% and 7%. Since 26 it has increased its installed capacity by 1,424 MW and with Guacolda (5% owned) will add 422 MW between 213 and 215. Target Price (CLP): 32 Recommendation: Hold Profit & Loss Statement (USD m e 213e 214e Sales 1,82 2,13 2,171 2,398 2,468 Gross Margin Gross Margin % 36.4% 4.% 35.6% 32.3% 32.6% Operating Income Operating Margin % 16.9% 25.4% 19.2% 17.8% 18.8% EBITDA EBITDA Margin % 26.3% 34.6% 28.7% 27.1% 27.8% Net Financial Expenses Non-Operating Result (17) (14) (78) (75) (74) Net Income Controller's Net Margin (Controller) % 9.4% 15.3% 12.% 11.3% 12.1% EPS (USD/acc) Ownership (Jun-12) Provida; 2% Bco Chile (3os); 2% EBITDA 211 Breakdown (%) SIN 3% Celfin CdeB; 3% SING 37% Otros; 23% Inv Cachag ua Ltda; 71% SIC 33% Balance Sheet (USD mn) e 213e 214e Cash & Equivalents Other Current Assets PP&E 4,179 4,375 4,37 4,79 4,569 Other Non-Current Assets Total Assets 5,657 5,829 5,885 5,944 6,232 Financial Debt 2,198 2,393 2,395 2,395 2,645 Total Liabilities 3,18 3,3 3,294 3,343 3,62 Total Equity 2,549 2,529 2,591 2,61 2,63 Minoritary Interest Flujo de Caja (USD mn) e 213e 214e Operating Income Adjusted Taxes Depreciation & Amortization Capex Δ Working Capital Free Cash Flow Equity Raised (Purchased) Dividends Debt Issuance (Repayment) Comparables Ratios e 213e 214e ENDESA Stock Price (CLP) COLBUN P / E (x) ECL Liabilities / Equity (x) GENER EV / EBITDA (x) EBITDA / Financial Expenses (x) Net Financial Debt / EBITDA (x) ROA (%) 3.% 5.6% 4.4% 4.6% 4.8% β (vs IPSA): 1. ROE (%) 6.7% 12.9% 1.1% 1.4% 11.4% WACC:.% Dividend Yield (%) 4.8% 7.6% 5.8% 5.6% 6.2% Source: CorpResearch, Bloomberg, Company Financial Reports AES Gener Initiating Coverage Sergio Zapata M. July, 9th 212 2

3 Lower marginal costs in the SIC would explain lower 212 expected EBITDA Historical operating figures in 211 (with revenues and EBITDA reaching US$ 2,13 mn and US$ 737 mn, respectively) were mainly explained by the start-up of Angamos project in the SING and the high level of energy marginal costs in the SIC. In our base scenario we expect a lower energy price level in the SIC spot market, after a lower coal price starting from 2H-212 and the start-up of two new coal fired plants Santa Maria and Bocamina 2 from Colbun and Endesa, which in turn should add 71 MW of base capacity, displacing less efficient diesel plants. This scenario should reduce revenues from the spot market sales in the SIC and would explain the 15% EBITDA decline expected for this year reaching US$ 623 mn at consolidated level. This should end up in a decline of 6 bp for EBITDA margin down to 28.7%. Fuel Prices (base = 1 as of Jan-28) 25 2 COAL (US$/TON) BRENT (US$/BBL) LGN (US$/MMBTU) Jan-8 Feb-9 Mar-1 Apr-11 May-12 Source: CNE, CorpResearch Commercial policy and operating earnings estimates For the medium and long term strategy, we expect a company s margins stabilization and a harmonious growth of its sales. This should be the result of the commercial policy implemented in order to hire only the block produced with their efficient thermal units (coal units) and with their run-of-the river units considering an average hydrology condition. In addition, sales to regulated customers (which accounted the 4% of total revenues in 211) have a price indexation mechanism based on coal price and exchange rate, the current Gener s main costs. In our opinion, this situation should allow an adequate coverage for Gener s operating margin. As a result, we expect a 5.9% average EBITDA growth and a 28.4% average EBITDA margin for the three-year period Gener: EBITDA and EBITDA Margin estimate 1. 8 EBITDA (US$ MM) EBITDA Margin (%) 5% 4% 6 3% 4 2% 2 1% E 214E 216E Source: Company Reports, CorpResearch % AES Gener Initiating Coverage Sergio Zapata M. July, 9th 212 3

4 Last 6 years expansion plan (1,424 MW increase or 41% of its total installed capacity) Since 26, AES Gener has incorporated 1,424 MW (+ 41%) of new generation capacity in Chile. This expansion was based on thermal units: coal (79%), diesel (19%) and batteries (2%). Coal projects include 1,121 MW from Angamos plant (two SING units of MW each, which started operations in 211), Nueva Ventanas plant (27 MW generation in the SIC grid system starting from year 21), Guacolda 3 and 4 (2 units of 152 MW each from its nonconsolidated subsidiary with start-up date of years 29 and 21 respectively). Diesel projects include 271 MW in the SIC provided by power stations Los Vientos (132 MW, in service from year 27) and Santa Lidia (139 MW operating since 29). Batteries expansions include a 12 MW unit and a 2 MW unit in Norgener and Angamos, respectively. Gener: Expansion Plan (MW) Hydro Coal Diesel/NG Forestry Projects currently under construction (422 MW, will raise 8.8% of total capacity as of Dec- 211) Source: Company Reports, CorpResearch In addition, AES Gener and Guacolda are progressing in Campiche and Guacolda 5 projects, which should be starting by 2Q-213 and 2H-215 respectively. Campiche is a 27 MW coal fired unit, which is located in the industrial complex Ventanas in Puchuncavi, V Region. Its construction has been delayed as ruled by the Supreme Court. Initial ruling regarding land use and regulatory expansion were solved by concerning Government authorities. Given its operation costs, this unit will be considered by the CDEC- SIC as a base power unit, which would imply a high dispatch factor, which in turn we estimate, will be about 8%. Under this operation scenario it would contribute with 2, GWh per year, this is 26% of Gener s total energy produced in the SIC as of the end of year 211. Guacolda 5 is a new unit with 152 MW capacity to be located under the same nonconsolidating subsidiary industrial complex in Huasco, III Region. With the same consideration for Campiche plant, it will also be considered as a base unit, with a 85% load factor and an estimated 1,1 GWh yearly generation. Gener: Projects under construction (MW) Hydro Coal Diesel/NG Forestry E 213E 214E 215E 216E Source: Company Reports, CorpResearch AES Gener Initiating Coverage Sergio Zapata M. July, 9th 212 4

5 Valuation We have valued the company using a DCF methodology and a sum of parts for its operations in the SIC, SING-SADI and Colombia. For WACC calculation we have considered a risk free rate of 5%, a beta of 1x, a country risk spread of 18 bps, a 5.5% market premium, a target capitalization factor of 5% and a 7.3% debt interest rate. At its current level, AES Gener stock shows a reasonable 212E EV/EBITDA multiple of 1.8x, in line with the historical average of the past three years of 1.7x. Finally, our target price implies an EV/MW multiple of US$1.6 million per MW, which is compared with a replacement value of thermal units of US$ 2.-US$2.3 million per MW. This lower multiple for current market transactions is explained after the inclusion of non-efficient or low factor diesel/lng generation plant assets in the SIC. Asset Value Equity PEV SIC US$ mn 2,578 2,32 2,32 SING US$ mn 2,66 1,392 1,392 SING US$ mn 1,51 1,34 1,34 Guacolda US$ mn 1,539 1, Target Equity US$ mn 5,281 Total Shares mn 8,7 Exchange Rate Dec-212 CLP/US$ 49 Target Price Dec-212 CLP/share 32 Current Price CLP/share 292 Potential Upside % 9.8% Dividend Yield Dec-212 % 3.3% Total Expected Return % 13.% SIC Operational Scenario SIC generation shows a 7.2% YoY increase in 1H-212. Hydroelectric power generation increased its SIC contribution offsetting diesel generation. AES Gener shows a rise in coal generation offsetting the lower LNG production (Nueva Renca) and diesel production. The Central Interconnected System (SIC) is the largest Chilean electric grid system (supplying more than 9% of the population and with a 75% share of the total energy produced during 211, including the other main electric grid system SING). In addition, the SIC operations concentrate 41% of the company's total installed capacity and 39% of its total generation in 211, thus its operating conditions have a significant impact on Gener s results. The current SIC s operational scenario, including water reservoir levels and generation mix is as follows. Electricity generation. For the six months ended in June the SIC has generated 24,36 GWh, showing a 7.2% YoY growth, which even exceeds the growth shown by the economy in this period. In addition, rainfall seen during June allowed a slight improvement in water reservoirs levels, which has allowed hydroelectric plants to increase their contribution up to 51% to the mix in June and up to 4% for this year. Meanwhile, coal has remained as a relevant source, reaching 23% of this year mix, level that we expect will be higher after the start-up of 71 MW new coal capacity scheduled for 2H-212 coming from Endesa and Colbun new plants. On the other hand, diesel generation the most expensive units, which also determines the spot price- has contributed only 12% in 1H-212. During this year, AES Gener generation mix has been mainly composed of coal generation with a 69% share with an increasing trend (in June the contribution reached 83%). SIC: 24M Mix Generation (%) Gener: 24M Mix Generation (%) Hydro Diesel Coal Forestry NG Wind 1% 8% 6% 4% 2% % Jun-1 Dec-1 Jun-11 Dec-11 Jun-12 Source: CDEC-SIC, CorpResearch Hydro Diesel Coal Forestry NG Wind 1% 8% 6% 4% 2% % Jun-1 Dec-1 Jun-11 Dec-11 Jun-12 Source: CDEC-SIC, CorpResearch AES Gener Initiating Coverage Sergio Zapata M. July, 9th 212 5

6 Current hydrology shows a normal to normal-wet condition. Even we have seen a recovery on water reservoir s volume (+ 26% YoY), they are just at 5% of the historical levels reached in 26. Hydrology and Water Reservoirs. After the start of the rainfall season in May and considering only those water reservoirs used exclusively for electricity generation, data shows a trend of recovery after a dry hydrology in the previous years. Water reservoir s level reached 3,91 million of m3 on June and showed a 26% growth YoY which is positive when compared to the 1% YoY decrease posted in April 212. However, we highlight reservoir s level are just at 5% when compared to the volumes observed in 26-27, so we estimate the CDEC-SIC could keep a conservative policy regarding on the dispatch of this units, at least until they have more conclusive data on the hydrology season. Water Reservoirs: Current Volumen and YoY var Reservoir Volume (millions of m3) YoY % var 6% 3% 6. % 4. -3% 2. -6% Jun/5 Mar/7 Dec/8 Sep/1 Jun/12 Source: DGA, CorpResearch Marginal costs showed a large contraction in June and should continue showing the same trend in 2H-212 Marginal costs. After the high level for the three months between March and May (average of US$ 25 per MWh), spot prices have shown a decreasing trend, with a MoM fall of 42% in June. The current level of US$ 143 per MWh is not only lower than the beginning of 212 data, but it is also a 29% YoY decrease. Our base scenario for 2H-212 considers a level around US$ 16 to US$ 18 per MWh, which is based on fuel prices without significant volatility, a normal to normalwet hydrology conditions and the start-up of new efficient generation plants scheduled for 2H212. SIC: Spot Prices 24M (US$ per MWh) 4 32 Spot Price_SIC (US$ per MWh) Jun-1 Dec-1 Jun-11 Dec-11 Jun-12 Source: CDEC-SIC, CorpResearch AES Gener Initiating Coverage Sergio Zapata M. July, 9th 212 6

7 Glossary Term Definition / Translation Calculation EBITDA EBITDAR Earnings Before Interests, Taxes, Depreciation and Amortization Earnings Before Interests, Taxes, Depreciation, Amortization and Rents Operational Income plus Depreciation and Amortization Operational Income plus Depreciation and Amortization plus rent of fixed assets. It is used the at transport industries to reverse the rent of airplanes or ships. EV Enterprise Value Market capitalization plus Net Financial Debt plus Minority Interest EV/EBITDA Valuation multiple. While greater it is, more expensive it is the stock EV divided by Ebitda FCF Free Cash Flow Operational Income plus Depreciation and Amortization minus tax minus capital expenditures plus (minus) working capital variation. Free-float Margin Operational Ebitda Net Percentage of stocks that can be freely traded in the market Percentage of sales Percentage of stock that does not belong to controller s shareholders. Operational Income / Revenue Ebitda / Revenue Net Income / Revenue P/E Price / Earnings Market Price divided by EPS P/B Price to Book value ratio Market price divided by the accounting value of the stock. Dividend Yield The return in terms of dividends of investing in equities FCF yield Free Cash Flow Return. FCF / Market Price Dividends distributed in a year divided by the market price. ROA Return on Assets Net Income / Total Assets ROE Return on Equity Net Income / Accounting capitalization EPS Earnings Per Share Net Income / Shares outstanding YtD Year to Date Percentage variation year to date x Times Stocks recommendations are established according to the stock yield relative to the IPSA Index. We recommend Hold when we expect the share to have a yield in line with the IPSA; Buy, when the yield expected for the share is above to that expected for the IPSA; and Sell, when the yield expected for the share is below to that expected for the IPSA. We define a yield to be In line with the IPSA when it is within a range whose scope is equivalent to a third of the variation expected for the index, with a 5% minimum. AES Gener Initiating Coverage Sergio Zapata M. July, 9th 212 7

8 CorpResearch Álvaro Donoso Director CorpResearch Economic Research Sebastián Cerda Executive Director CorpResearch & Economic Studies Nicolás Birkner Senior Economic Analyst Natalie Charles Investment Analyst Juan Ortiz Economic Analyst Equities Research Cristobal Lyon Director of Strategies Vicente Meschi Senior Analyst. Sectors: Banking, Forestry Sergio Zapata Senior Analyst. Sector: Energy Pedro Letelier Analyst. Sectors: Transport, Food & Beverages Andrea Puebla Analyst. Sector: Retail AES Gener Initiating Coverage Sergio Zapata M. July, 9th 212 8

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