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Executive summary:

  • CPFL Energia S.A. share performance is expected to remain weak in 2014.
  • Both internal and external factors contribute to poor performance of CPFL and its shares.
  • Global macro economic factors have created a heavy drag on Brazilian markets and economy in general and will continue to do so in this year.
  • China's credit bubble may burst and further adversely effect Brazil.
  • An Interesting Option trade is available on CPL shares.

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A reader recently wrote to follow up my article of last year on Feb 23, 2013 discussing CPFL Energia S.A. (NYSE:CPL). It has been a year since my last review and the company performance and outlook has changed markedly. Therefore, I thought I'd share this correspondence with you.

Hi Richard, After peaking out in May 2013 or so price has tanked and now the shares are 1t 14.38. Appreciate if you could look at technicals + fundamentals and advise with your fresh views on future prospects of this company.

My reply is as follows:

There are both internal and external factors which negatively impact CPL currently and for the near future. The continuing severe drought here in Brazil is curtailing hydro-electric production. The external macro economic environment includes a growing consumer activism (somewhat new for Brazil) putting pressure on the company to improve delivery infrastructure with more capital investment and maintenance and repair budget. At the same time, the movement is increasing pressure on the government to constrain consumer power prices.

Brazil continues to experience severe impacts of net investment draw down related to QE tapering. This is contributing to an overall weakness in the Brazil exchanges which will continue with the Fed tapering for another 18 months or more. Fed policy has also had a major negative impact on the currency exchange rates of the $BRL/USD and thus directly effects YOY performance for CPL when converted to USD. This currency weakness further drags on the overall Brazil market performance.

Another cloud on Brazil's horizon with the potential for direct impact on CPL is China's current credit bubble which threatens to burst and drag down the Chinese economy, lowering GDP by 1 full percent or more. China is Brazil's top trading partner these days, having surpassed the US about 18 months ago. CPL's service area includes Brazil's major industrial manufacturing areas and any downturn in trade will impact that production and its power demands. Further follow-on effects of any China economic weakness will impact the overall Brazil economy and increase the drag on the exchanges here.

On the technical side, CPL recently turned in a bottom on February 28th at $12.80. It is likely to retest this bottom before any possible sustained advance, possibly when the May financial reports and dividend information are released. There is strong upside resistance at about $20 which will be very difficult to break and no doubt take several attempts and a series of very positive reports. All this combines to make the current outlook weak and remaining weak for some time.

Long-term investors may use it as an opportunity to accumulate quality shares. I personally like Companhia Brasileira de Distribuição (NYSE:CBD), Ultrapar Holdings (NYSE:UGP), Ambev (NYSE:ABEV), CPFL and VALE S.A. (NYSE:VALE) for the long term. I suggest avoiding Petrobras (NYSE:PBR) due to its repeated failures to meet production targets and its steep development and production costs. This is true for the other super majors heavy in Brazil oil. I'm also uneasy about a possible follow-on effect from the collapse of Eike Batista's empire impacting Brazil's banking industry. Eike was one of Brazil's 5 richest people and probably the highest leveraged of them. With the burst of his empire (house of cards?), it is still unclear how many and how deeply banks may be impacted. For these reasons, I also would avoid Brazil index funds, such as iShares MSCI Brazil Index Fund (NYSEARCA:EWZ) and Market Vectors Brazil Small Cap ETF (NYSEARCA:BRF), since they tend to be overweighted in PBR and financial sector members.

Looking at CPL a bit further, I do find an interesting option available. The April $12.50 Put last traded at $0.35 on February 26th. This is below the recent bottom of $12.80 and would make an attractive entry price. Selling the Cash Covered Put at a $0.35 premium would give you a nice return on your sideline cash even if the shares do not pull back that far and get presented to you. The $0.35 premium you receive represents 0.35/12.50= 2.8% return for just 48 days investment. This is an annualized yield rate of 21.29%. CPL options trade rather thinly however, so your ability to find a trade may be limited. Any premium over $0.18 would be attractive to me, representing an 18%+ annualized yield on the covering cash.

If you find the use of dividend income equities boosted using covered option trading to be interesting as in this example, I suggest you read my current continuing series of articles beginning with part 1: Why You Should Invest Like A Tortoise, Not Like A Hare.

Part 2: $3/Day Can Buy $192,000 Annual Tax Free Income Using This Strategy, should publish later.

Part 3: Tortoise Strategy - Part 3: Building Your $192,000 Tax Free Annual Income Portfolio, and further installments of the series will follow every few days thereafter.

Disclaimer: I am not a licensed securities dealer or advisor. The views here are solely my own and should not be considered or used for investment advice. As always, individuals should determine the suitability for their own situation and perform their own due diligence before making any investment.

Disclosure: I am long CBD, UGP, ABEV. 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.

Source: The Outlook For Brazil: Is It Time To Take Another Look At CPFL Energia?