Long-Term Opportunities in Brazilian Electric Utililites: Should You Buy?

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Despite the recent turmoil around emerging markets, Brazil still presents long-term opportunities within its energy sector. According to the Brazilian national agency's 10-year plan, electricity consumption in the country will grow 5.9% annually until 2019, showing a 40% increase from 2012. In addition, government spending plans will improve the current industry infrastructure, helping companies reach the desired growth. So, if you are willing to start a position in this sector, here are three companies to consider.

Increasing generation
First, we have Companhia Energetica Minas Gerais (NYSE: CIG  ) , also known as Cemig, which produces, transforms, transmits, and distributes electric power primarily to clients in the southeast and south of Brazil.

Some recent news concerning Cemig has been impressive. The company has undergone a $1 billion investment to enhance the quality of its distribution services. Plus, its recent partnership with Vale (NYSE: VALE  ) has raised expectations as it expands business opportunities. The agreement consists of the creation of a new company, with 55% ownership by Vale and 45% by Cemig, that holds assets capable of initially generating 1,158 MW. Regarding generation, Cemig's growth plans are aggressive, as it expects to reach a power generation of 239.7 TWh in 2035, giving the company a market share of 19%.

However, the company's high dependence on hydro sources for electricity could be a problem, as 97% of Cemig's installed generation capacity is hydro. In addition, government interference remains an issue, as the state of Minas Gerais is Cemig's major shareholder. The government has a history of interference in the company's affairs, affecting its performance.

Exposed to tariff cuts
Next is CPFL Energia (NYSE: CPL  ) , which generates electricity through hydroelectric plants, small hydropower plants and thermoelectric power stations. It is Brazil's largest private power distributor.

Fundamentals are solid for CPFL Energia, as its scale and distribution monopoly give it a sustainable competitive advantage. Plus, Brazil's young regulatory environment gives the company an additional competitive advantage, since about three fourths of its operating income is derived from regulated electricity sales, providing a steady and predictable cash flow stream.

However, this competitive advantage can turn into a problem. In March last year, the Brazilian government approved reducing energy tariffs on average by 20%, and for industry, agriculture, business, and the services sector, the discount could reach as high as 32%. Such a decision has a strong impact on companies like CPFL Energia, considering its high exposure to regulated tariffs.

Government interference
Finally, there's Companhia Paranaense de Energia (NYSE: ELP  ) . Also known as Copel, it produces, transforms, transmits, distributes, and sells electrical energy exclusively in the state of Paraná, Brazil.

Fundamentals for Copel are sound, as the majority of the company's earnings growth potential lies in its generation and transmission assets. In fact, at the beginning of next year, Copel's generation base should grow by 300 MW when the Colider hydroelectric plant is completed.

Nonetheless, the main issue with this company has always been related to government interference, as state-dictated pricing has historically nullified Copel's competitive advantage. The government possesses 59% controlling interest over the company, and its recent actions to suspend rate increases is affecting the firm's underlying metrics.

Bottom line
Risk-tolerant investors should be able to benefit from Brazil's long-term economic growth prospects. Lately, however, volatility and uncertainty within the region are making funds and investors stay away from stocks in the emerging world. The corrections taking course are not over yet, and you might see some more volatility further on. Plus, the recent devaluation of the real affects some operations for these companies, which have debt that is denominated in dollars.

Regarding Cemig, if it plans to continue its course the company will be a major player in the country, with sound improvements in its generation capacity and profitability.

CPFL Energia is well-positioned to benefit from increased demand during the next decade. However, given the country's pressure on the real and growing inflation, regulated tariffs could be modified again, affecting profitability.

Similar issues affect Copel, and for this company it could be worse than with its peers. Unfortunately, at any given moment the company's management, regulatory regime, or operational strategy could change, to the detriment of shareholders.

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Louie Grint

I am a curious economist who likes to investigate what is behind asset price movements across the globe. My articles range from industry analysis of various sectors to understanding global macro events that could trigger volatility in the markets.

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