3 Electricity Picks From Brazil

Louie is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The resumption of economic growth and industrial development in Brazil is increasing demand for electricity. Forecasts predict that electricity consumption in the country will grow 5% annually through 2019, which is a 40% increase from 2012. This higher demand will prove advantageous for Brazilian electric energy operators, backed by an approved government 10-year plan to build 167 gigawatts.

But not all the companies will equally benefit from this outlook. Here, I will analyze three big electricity producers and distributors to identify which is better positioned to enjoy higher profits.

Good performance despite some risks ahead

Companhia Paranaense de Energia (NYSE: ELP), also known as COPEL, produces, transforms, transmits, distributes, and sells electrical energy exclusively in the state of Paraná, Brazil.

The company posted a 25% increase in net earnings in local currency for its first quarter, driven by an 18% increase in net operating revenue. EPS was $0.73, $0.07 higher than the year-ago quarter. Final customer demand for electricity grew 27% while sales to distributors increased 27%.

COPEL plans to invest $1.9 billion this year to improve its internal generation capacity and distribution network. Management plans to expand outside Paraná state, and become operational in new areas by mid-2014.

However, 58.6% of COPEL’s outstanding common shares are held by the government of the state of Paraná, giving it a great amount of power to direct the company’s future in terms of activities and expenses. The state controls the election of the majority of the company’s Board of Directors, allowing high regulation. This meddling has already caused delays in execution of regular operations of the company, so I would not be surprised to see more issues of this kind.

One last factor to consider is COPEL’s dependency on rainwater to source 99% of its hydroelectricity as unpredictable weather may affect the company’s energy supply.

Cash flow is key

CPFL Energia (NYSE: CPL) generates electricity through hydroelectric plants, small hydropower plants, and thermoelectric power stations, which it then distributes and sells.

The company posted a 4% increase in energy sales in its concession area for its first quarter of 2013. The conclusion of a tariff review for CPFL Paulista subsidiary re-positioned tariffs 5.48% up, which improved results.  

CPFL Energia enjoys a scale and distribution monopoly that gives it a sustainable competitive advantage. Brazil’s fairly young regulatory system gives CPFL Energia three-fourths of its operating income, as it derives from regulated electricity sales. This provides a steady cash flow for the company.

Within CPFL Enegia’s regulated customer base, about 25% of customers could migrate to other suppliers when their contracts finalize. But since the company offers competitive rates, I expect that only a small fraction will eventually switch. Plus, the company’s commercial department makes strong efforts to retain customers, recapture the ones that opted out, and recruit new clients that are outside the company’s regulated areas.

Companhia Energetica de Minas Gerais (NYSE: CIG), also known as Cemig, constructs and operates systems that produce, transform, transmit, distribute, and sell electric power.

The company’s first-quarter results were impressive. Net earnings increased 37% and revenue 15% year over year. Long-term growth for Cemig looks bright as well, backed by government’s plans to improve the industry’s infrastructure.

For Cemig’s area of operation, the Brazilian Energy Research Institute EPE expects a 4.5% average consumption growth from 2011 to 2021. This should mean better profits for the company. Cemig’s $1.58 billion investments in hydro plants, wind farms, and distribution services should help realize them.

However, government interference and dependence on hydro sources for electricity could become higher risks for the company. Margin was impacted by a 7% increase in expenses this quarter, partially offsetting the revenue increase. So, this stock has to be carefully watched.

My conclusion

COPEL is well-positioned in its home state. I find it hard to think that the company will manage to successfully expand in the short-term. Meanwhile it is an interesting stock to consider and buy, but do not expect outstanding returns.

CPFL Energia is an attractive option for risk-tolerant investors who would like to benefit from Brazil’s economic stabilization and growth. The company’s solid is backed by its steady cash flow, so even if growth moderates, CPFL Energia should provide gains.

If Cemig’s growth drivers do not follow the Brazilian recovery and expenses keep increasing, I would not invest in the company. For now, I would monitor the company’s results very closely.

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