The recent sell-off in shares of state-owned Brazilian electricity generator Companhia Energetica de Minas Gerais (NYSE: CIG), also known as CEMIG, seems overdone. Just thinking about the massive growth potential in Brazil's power markets, CEMIG's status as the nation's largest combined power generator and distributor, and the company's solid dividend leaves me feeling incredibly bullish. Alas, Wall Street doesn't seem to agree.
In recent months, investors have fled emerging markets, as the world economy stalls amid fears of a U.S. recession. Furthermore, CEMIG reported that regulators had proposed a 9.7% tariff reduction on its businesses, and lower-than-expected rainfall in the beginning of January raised concerns regarding CEMIG's generating costs. The result? The stock has dropped more than 16% in the past three months.
Sounds kind of grim, no? Well, call me a Fool, but I believe that the company's long-term fundamentals remain intact, and that the recent decline is nothing more than a temporary short-circuit. Let's address the issues behind the meltdown.
The economic climate
Despite investors' consistent knee-jerk reactions, Brazil's economy doesn't look like it's catching much of a cold from the U.S. According to a recent report from the World Bank, the country's economy is expected to grow 4.5% in 2008, down only slightly from the 4.8% notched in 2007.
Similarly, according to recent estimates by the Brazilian National Agency for Electric Utilities (ANEEL), demand for electricity in Brazil is expected to increase by an average annual rate of 4.5% for the next few years. Outpacing that growth, however, CEMIG has grown its revenue 15.9% annually over the past three years, while earnings per share expanded by 11%.
The tariff reduction
There's no denying that ANEEL's proposal of a 9.7% tariff reduction on CEMIG will affect the business. However, the possible effects of this reduction have already been priced into the stock, even though there's no guarantee that it will actually be imposed. ANEEL will issue its final recommendation early this spring.
The dry spell
Since CEMIG's 51 hydroelectric plans represent roughly 97% of its installed capacity, I do understand that a shortfall in rainfall can be unnerving to investors. Of course, dry spells don't last forever. Once the rain returns, operations can revert back to normal.
Obviously, CEMIG's use of a cheap, renewable source for the majority of its generating capacity gives it competitive input-cost advantage in the long run, compared to traditional coal- and gas-fired producers.
An added inducement
CEMIG's recent decline has the stock selling at an attractive eight times fiscal 2008 earnings. Compare that with other emerging-market players: Enersis (NYSE: ENI) is selling at 21 times forward earnings, while Huaneng Power (NYSE: HNP) and Korea Electric Power (NYSE: KEP) sell for 11 times forward earnings.
All in all, I view CEMIG's recent decline as a result of a temporary power outage. As we all know, power is inevitably restored. Power-generation companies may not return electrifying results, but just as electricity is a staple of everyday life, electricity stocks should have a place in every portfolio.
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