Should You Buy Brazil's Electric Utilities For Their High Yield?

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 |  Includes: AES, AESAY, CEDWY, CESDY, CIG, CPL, CTPZY, EBR, ELPVY, ENEVY, ENGIY, EPUMY, EQUEY, LGSXY, TBLEY
by: Monty Spivak

This is actually a compound question. The answer to the implied first question "Should you Buy Brazil's Utilities?" is perhaps eventually, but not now! The second part, "Should You Buy Brazil's Electric Utilities for Their High Yield?" is the yield may be attractive on the surface, but hard to precisely determine. To begin our analysis, let's address the macro environment.

The "Big Picture"

Although Brazil is one of the BRIC countries, with projected high growth economies, there is substantial social and sovereign risk. Brazil has been financially rescued by the IMF and others in the past 25 years and defaulted on its debt 7 times in the past 175 years. Moreover, the country has experienced high and persistent inflation. On May 29, 2013, Brazil's central bank raised its benchmark interest rate 0.5% to 8%, as part of an effort to battle high inflation in an economy that is struggling with slow growth. If we employ an historic 6.5% average inflation rate, investors require a 6.5% return (or in my case, this amount as a dividend yield) to break-even. I further propose that high-yield investors require a greater return, in order to have a real annual return on invested capital.

In a recent SA article, Richard_Peterson provides a 2013 projection of Brazil's currency, stock market, and economy. He has a very interesting and well-described methodology; to summarize his conclusions, it may be premature to invest in Brazil:

Brazilian Real (BRL)... there may be a short-term rally, but in one year the value is likely to be lower. That is, BRL/USD long term outlook is weakening.

Bovespa (stock market index)... The Bovespa is down 11% so far in 2013... we see a continued weakening of the Bovespa versus developed world equity markets over the next 12-months.

Outlook for Brazilian Economic Activity... The Brazilian economy continues to weaken into May 2013... Likely to witness a decline in Brazilian Real ETF and the Bovespa long ETFs and versus the U.S. markets and currency... declines are likely to continue over the next 12-24 months.

Hale Stewart has similar reservations; his analysis suggests that they are still in economic turmoil:

While the economy is hardly in the throes of a cataclysmic slowdown, there are clearly major issues facing the country. The biggest is the decline in the "south-south" trade, or trade between raw material exporters (primarily in Latin America and Oceania) in the southern hemisphere and China. As Chinese growth slows and as China changes its economic model from one of exporting to the developing world to one based more on consumption, countries that have exported to China will see their respective GDP take a hit.

The greatest concerns of investing in a Brazilian utility may mirror the concerns of investing in any developing economy - the degree of economic inclusion of the populace and corruption. Social stratification - there is a small minority of rich, and large number of poor, although the poor are getting richer - remains a problem. This impacts consumption of electricity, and therefore, the value and return of one's investment; the growing income and middle class should increase demand. One of my favorite sites, which describes corruption perception, categorizes Brazil in the middle of the range, and their analysis suggests that the current government is working to improve the situation. That said, the comments (apparently from Brazilians) describe corruption as endemic and embedded in government regulatory organizations. This could impair the growth, return, and value of one's investment in a Brazilian electric utility. Alternatively, a mercenary position is that it may permit the utilities to avoid environmental protection, native rights, and other accountabilities through illegal means. For the record, I am strongly anti-corruption - for details, you can refer to my editorial article on U.S. banks' money-laundering and involvement in the LIBOR scandal.

Reports about doing business and/or investing in Brazil from PriceWaterhouseCoopers and Ernst and Young mention, but do not explore the more "difficult" topics in detail. Although the reports are somewhat dated, they provide an overview. For example, statements such as "and various regulatory agencies supervise the utilities" do not help the investor conclude that many of the utilities are being used as instruments of Brazil's economic policy.

The Electric Utility Sector

The electric utility sector is being treated as strategic by government policies. The government actively owns and/or controls most of the (publicly-traded) electricity utilities:

In Brazil, large government-controlled companies dominate the electricity sector. Federally owned Eletrobrás holds about 40% of capacity (including 50% of Itaipú), with state-companies CESP, Cemig and Copel controlling 8%, 7% and 5% of generation capacity respectively. About 27% of generation assets are currently in the hands of private investors.

Transmission has remained almost exclusively under government control through both federal (Electrobras) and state companies (mainly Sao-Paulo-CTEEP, Minas Gerais-Cemig, and Parana-Copel) until recently. However, under the new sector regulatory model, there are about 40 transmission companies. As for distribution, there are 49 utilities with distribution concessions and about 64% of distribution assets are controlled by private sector companies.. (Bear Stearns 2007)

What is not controlled is still tightly regulated:

The Ministry of Energy and Mines (MME) has the overall responsibility for policy setting in the electricity sector while ANEEL, which is linked to the Ministry of Mines and Energy, is the Brazilian Electricity Regulatory Agency ... ANEEL's function is to regulate and control the generation, transmission and distribution of power in compliance with the existing legislation and with the directives and policies dictated by the Central Government. The National Council for Energy Policies (CNPE), is an advisory body to the MME in charge of approving supply criteria and "structural" projects while the Electricity Industry Monitoring Committee (CMSE) monitors supply continuity and security. (Millán,2006)

The most recent regulatory electricity-pricing impact - announced in September 2012 - is an excellent example of how government policies have (and probably will) impact investment return and dividends in the Brazilian utility sector:

In order to stimulate economic growth, the government of Dilma Rousseff has announced plans to reduce taxes on electricity which will benefit consumers and businesses with lower electricity bills... After the above announcement, investors dumped electric utility stocks since their profit margins will be hurt.

Many countries have regulated utilities, and this feature may be more of an investment opportunity than issue. Regulated utilities often have monopolistic pricing power, excellent governance, "guaranteed" dividend payouts, and regularly-approved rate increases. Unregulated utilities typically have the benefits of lower costs, and can more actively manage both the revenue and cost lines of their income statement to improve results. Regardless of your investment preference, investors should be aware that Brazil's model is more interventionist.

Electricity producers and distributors are a big part of the Brazilian utilities sector. In this article, David Hunkar provides useful industry background:

Brazil has the third largest electricity sector in the western hemisphere after the U.S. and Canada. The majority of electricity generated in Brazil comes from hydro-power and the country is a net exporter of electricity. Despite privatization efforts launched in 1996, the bulk of the electricity sector remains under the control of the government. Eletrobras, the state-owned power company is still the dominant player in the market. The Brazilian government also owns almost the entire electricity transmission network. (Source: Energy Information Administration).

With the country and industry context understood, let's examine the investment opportunities.

Investment Candidates

Let's examine our Brazilian utilities investment target universe and determine their current dividend yields. I have excluded those that do not have an ADR, and often, the preferred share is traded as the ADR - for example, CIG.C is the common share for CEMIG. I have excluded multinationals - such as Enersis S A (ENI) - in order to examine pure-play Brazilian companies. Please let me know of any U.S.-traded Brazilian utilities that I may have missed!

#

ABBREVIATION - NAME - TICKER

CONTROL

SUB-SECTOR/ACTIVITIES

1

AES Tiete S.A. (OTCPK:AESAY)

AES Corp. (NYSE:AES)

Power generation

2

CELESC - Centrais Eletricas Santa Catarina (OTCPK:CEDWY)

State Controlled

Power generation and transmission; gas distribution; some waste and water

3

CESP - Comp. Energetica de Sao Paulo (OTCPK:CESDY)

State controlled

Power generation and transmission

4

CEMIG - Companhia Energetica Minas Gerais (NYSE:CIG)

State Controlled

Power generation and transmission; gas distribution

5

CPFL Energia S.A. (NYSE:CPL)

None

Power generation and alternative energy

6

CTEEP - Companhia De Transmissao De Energia Eletricas (OTCPK:CTPZY)

ISA Capital Do Brasil SA

Power transmission

7

Eletrobrás - Centrais Eletricas Brasileiras SA (NYSE:EBR)

Federally controlled

Power generation and transmission

8

COPEL - Companhia Paranaense de Energia (OTCPK:ELPVY)

State Controlled

Power generation and transmission; gas distribution; some waste and water

9

Eletropaulo Metropolitana Electricidade de Sao Paulo S.A. (OTC:EPUMY)

AES Corp.

Power distribution

10

Equatorial Energia (OTCPK:EQUEY)

Fundo De Investimento Em Participacoes PCP

Power generation and transmission; some telecom

11

Light S.A. (OTCPK:LGSXY)

CEMIG

Power generation and transmission

12

MPX Energia S.A. (MPXEY.PK)

Main Shareholder: Eike Fuhrken Batista

Power generation, exploration, and marketing

13

Tractebel Energia (OTCPK:TBLEY)

GDF Suez (GDFZY.PK)

Power generation

Click to enlarge

A few financial and key statistics comparison. Please note that all information is as at May 31, 2013 end-of-day. The basic information is from Barchart.com; bold is cobbled together from other sources (I plan to update this at a future juncture):

#

ABBREVIATION - NAME - TICKER

MARKET CAP (,000 USD)

P/E RATIO

PRICE / BOOK

E.P.S.

BETA

ROE

PRICE SALES

1

AES Tiete S.A.

$1,974,610

2.1

0.29

-0.09

0.00%

1.89

2

CELESC - Centrais Eletricas Santa Catarina

$230,200

3

CESP - Comp. Energetica de Sao Paulo

$97,370

0.02

0.03

1.23

157.00%

0.04

4

CEMIG - Companhia Energetica Minas Gerais

$10,323,970

4.9

1.66

2.04

0.79

3526.00%

1.14

5

CPFL Energia S.A.

$10,508,030

14.27

2.53

0.86

0.79

1464.00%

1.25

6

CTEEP - Companhia De Transmissao De Energia Eletricas

$1,600,000

7

Eletrobrás - Centrais Eletricas Brasileiras SA

$3,800,900

0.11

0.86

0.94

-1163.00%

0.24

8

COPEL - Companhia Paranaense de Energia

$1,800,000

13.1

0.32

1.58

0.95

557.00%

9

Eletropaulo Metropolitana Electricidade de Sao Paulo S.A.

$669,116

0.74

-0.02

10

Equatorial Energia

$2,000,000

15.8

1.31

11

Light S.A.

$1,700,000

8.9

2.06

12

MPX Energia S.A.

$2,568,170

0.22

0.28

13

Tractebel Energia

$11,400,000

14.06

4.44

0.86

0.82

4.32

Click to enlarge

The most difficult information to reliably obtain is for securities which are traded Over The Counter (aka OTC), which are 10 of the 13 securities in the table. Moreover, remember Benjamin Disraeli's adage "There are three kinds of lies: lies, damned lies, and statistics" - this particularly applies in the investment world!

Dividend Yield

As a high-yield investor, the distribution is a critical decision criterion. The following table identifies the dividend yield from different sources for the Brazilian electric utilities. When there was nothing available from my usual sources, I attempted to find another:

#

ABBREVIATION - NAME - TICKER

LAST PRICE (USD)

SA YIELD

GOOGLE YIELD

DAILY FIN YIELD

BARCHART YIELD

OTHER YIELD

1

AES Tiete S.A.

$ 9.73

11.18%

10.89%

10.60%

10.60%

2

CELESC - Centrais Eletricas Santa Catarina

$ 10.01

7.30%

3

CESP - Comp. Energetica de Sao Paulo

$ 11.70

6.84%

4

CEMIG - Companhia Energetica Minas Gerais

$ 10.42

7.40%

24.66%

5.80%

0.00%

5

CPFL Energia S.A.

$ 21.29

4.34%

5.29%

5.10%

8.02%

6

CTEEP - Companhia De Transmissao De Energia Eletricas

$ 18.64

10.44%

9.07%

9.10%

7

Eletrobrás - Centrais Eletricas Brasileiras SA

$ 2.58

26.12%

6.59%

8

COPEL - Companhia Paranaense de Energia

$ 13.15

4.95%

1.54%

1.40%

1.43%

9

Eletropaulo Metropolitana Electricidade de Sao Paulo S.A.

$ 3.50

0.04%

10

Equatorial Energia

$ 9.95

0.68%

0.68%

0.70%

11

Light S.A.

$ 8.53

6.91%

7.17%

7.20%

12

MPX Energia S.A.

$ 4.50

0.00%

13

Tractebel Energia

$ 17.34

6.77%

5.30%

5.10%

5.15%

Click to enlarge

The biggest challenges for yield-oriented investors is the reporting of dividend yield. There are several issues which create inconsistencies and confusion for South American (and many other global securities') yields. These include:

  1. Variable amounts - Typically Brazilian utilities pay a percentage of their income as dividends.
  2. Currency confusion - Those securities that are traded Over The Counter (aka OTC) seem to experience currency conversion issues (e.g., legacy conversion rates) pertaining to dividends. The choice of which conversion date is used (which would drive the currency conversion rate) could have a substantial impact on the reported yield.
  3. Frequency (quarterly, semi-annually, and annually) - the different periods (compounded by interim and final dividend amounts) can over- or understate the yield.
  4. Share dividends - Some of the companies pay part of their dividends in shares - much the equivalent of a Dividend Reinvestment Program (NYSEARCA:DRIP) - these often confuse the calculation of yield (they also dilute the equity, which is another undesirable investment decision input).
  5. One-time dividends - As a result of spin-offs or asset sales (or to avoid future legislation or taxes), these can overstate yield.
  6. Annualized yield - Investment sites employ their own methodologies to annualize yield. For example, some multiply the previous quarter's dividend by four, and others may take the previous four quarter's actual distributions. It is not that a methodology is right or wrong; the issue is that one sees inconsistent yields.
  7. Websites often use dividend payment date to determine annualized dividend yield. In many cases, the previous year's dividends are paid in the current year; for example, one often receives 2012 dividends in 2013, and may receive 1 payment in one year, and 3 in the subsequent year.
  8. Many investment websites do not report statistics, such as yield for Over The Counter (aka OTC) traded securities.

I will use AES Tiete as an example. Their website links to a spreadsheet of dividend payments. For the last 3 years, the total dividend payments are (in BRL): 2012 = 1.92; 2011 = 2.31; 2010 = 2.16; so the amounts vary each year. In their dates columns, one can see that the dividend payments for each year are spread over the subsequent years. Depending upon currency conversion rates and the other factors identified, the yield can be very different. I applied the current rate of 2.15 Brazilian Real BRL = 1 USD (or 1 USD = 0.466 BRL) for the 2012 dividend of 1.92 BRL against the current price for a yield of 9.18%... which, as expected, does not match any other reported yield. Therefore, yield-oriented investors need to examine the individual websites for their own calculations, or accept their favorite website reported dividend as a reasonable proxy.

The South American dividend "caveat emptor" is not a new topic. Jim Pyke, among others, also identified it as an issue in an article published in 2011:

The first and most critical observation is that two separate data sources showed significant differences in dividend yields. This is most likely due to the fact the many Latin American ADRs pay dividends based upon some set ratio to actual net income, resulting in variable cash amounts of dividends. Payment dates and timing often appear to be irregular as well. Some companies showed consistent quarterly payments while others showed slight irregularity. Still other companies showed differing numbers of dividend payments from one year to the next. A simple glance at the dividend yield without scrutinizing the dividend history could result in disappointment later on. A great current yield might simply be the result of an abnormally good year. Furthermore, a great yield might also be on the downturn if the actual dividend amounts are declining from one year to the next.

Despite the dividend reporting issues and inconsistencies, one can see that there may be a few high-yield investment candidates.

Conclusion

Brazil is not yet a developed country, has untamed inflation, an inconsistent economic history, and issues in the investment environment. The government directly owns large positions in the electric utility sector, and has leveraged regulation to achieve economic goals, rather than investment returns. The other side of the equation is that it is one of the few large growth-oriented economies, and these utilities are dividend-generating machines.

Investors, should they desire exposure, would be prudent to choose a few targeted securities, and restrict their positions to a very small part of their portfolios. Buy when the time (and yield) is right. With projected declines in economic activity, the Bovespa, and currency, that time is probably not in the immediate future, however, there may be opportunities for longer-term investors on price declines during the next year.

Income-oriented investors may obtain good, but variable yields from these highly regulated, state-controlled oligopolies. The risk is that returns can be diluted by declining stock prices, currency devaluation, inflation, and state-sponsored initiatives to attain non-business goals. Before making your investment decision, you will need to investigate the actual dividends, and align them with your calculation model.

I intend to examine this subject in more detail, including brief descriptions, investment theses, and links to the respective websites - stay tuned! Additionally, if you have better company information (qualitative information on investment opinions, or comparative quantitative statistics) on Brazilian electric utilities, please either email me, or share it with everyone through the comments.

Disclosure: I am long OTCPK:AESAY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.