Pampa Energia (NYSE:PAM) is the largest private integrated energy company in Argentina. It is trading at a deep discount to peers in other countries on almost any metric, and to replacement cost. The reason for this discount is the political situation in Argentina, which drives utilities regulation, especially pricing. Therefore, we will discuss the company-specific and market attributes here briefly. For in-depth analysis see the updated company presentation on their web site. Then I will go into the political/macro aspects, which will drive this trade.
Company: PAM operates in three segments of the Argentinian power market:
- Pampa has 2,181 MW of generation capacity (about 7.7% of the market), part- or full ownership of various generation plants throughout the country, gas, hydro, oil.
- Transener transmission, Pampa holds 26% of equity and close to 50% of debt ($105m). Over 16,000 km of high-voltage transmission (95% market share, co-controlled).
- Edenor, 52% owned, NYSE listed (NYSE:EDN) distributes power to about 2.6 million customers (20% share). Pampa also owns $136m in Edenor bonds.
The company has a market cap of around $813 million and no debt at the holding company level. Consolidated debt: $500m.
Management, which used to do deals for Soros in South America, started putting together these assets as a private equity fund. They then took it public in Argentina, and went on the NYSE in October 2009 (Symbol PAM, 25 shares = 1 ADR.) They still own over 20% of the equity.
The company’s main market is the Buenos Aires stock Exchange, where it trades under the symbol PAMP. It is the largest component of the Merval stock index.
Panpa has been buying back its own stock and debt of its subsidiaries at discounts. From 2008 to Q3 2010 PAM bought at 56% discount $372m face value of subsidiary debt. These bond holdings alone account for about 40% of PAM’s capitalization.
Valuation: Comparative valuation is not terribly meaningful, given that the asset's value depends heavily on how much the public regulator allows the owner to earn on it. But let's do a back-of-the-envelope, sum-of-the-parts calculation: market cap is about $813m, with no debt at the holding level. Subtract from that $372m in subsidiary bonds owned, and (discounted) market value of the Edenor and Transener equity holdings (both companies are listed) of $279m and $42m, respectively, and we end up with $120m. That is about $64k per MW generating capacity on their (holding-adjusted) 1,871MW. Other projects, expansion, JVs etc. would be free. For comparison, the company has acquired (usually at very favorable prices) its capacity for more than twice that, and publicly traded utilities in Brazil, Chile and Colombia trade at an EV of over $1mm per MW.
Normalized earnings recently were about break even: generation is profitable, losses in transmission and distribution. One-time items were forex, repurchase of debt and impairment of investment which swung results overall from slight earnings to minor losses.
Upside: New generation capacity is coming online and sold at market rates (Q1 2011). Expansion projects are profitable and result in attractive RoA. The government has imposed restrictions on exports, which would otherwise be highly profitable.
Distribution tariff revision should boost Edenor results; current RoA is one fifth to one sixth of neighboring country-peers. Residential electricity rates are severely compressed at around 10% of the per kwh cost in neighboring countries like Brazil and Chile.
Last distribution and transmission tariff adjustments in mid-2008, in a country with an (unofficial) inflation rate of around 20% p.a. The next adjustment should provide a significant bump, but rates will still be a fraction of tariffs in neighboring countries.
Macro and Political Considerations: Argentina is run by the populist Cristina Fernandez de Kirchner who followed her now-deceased husband Nestor into office. Since the couple took over in 2003, they have regulated the economy (which was deeply in crisis following a sovereign default and currency collapse) with a heavy hand. Steep Export taxes were imposed on agricultural products, price controls instituted, inflation data manipulated, foreign exchange savings plans forcibly converted into local currency, etc. As part of an effort to gain voters’ favors, and generally to keep inflation down, electric tariffs were kept to the low levels mentioned above. They are now, at least on the residential side, a fraction of what they are in other countries in the region, which in turn are similar (inflation adjusted) what they were in Argentina before the countries economic collapse of 2002.
Since that time, the economy has improved significantly. This was partly due to market adjustments following a 75% drop in the peso’s value, and more recently the boom in commodity prices, including soy beans, the country’s main export. Power capacity has not always kept pace with Argentina’s growing economy. This would seem obvious to anyone understanding markets. Artificially low prices will keep needed supply off the market. There are blackouts. In response, regulation tries to differentiate and subsidize. Residential tariffs are kept low and subsidized, new generation may charge market rates, etc. Overall, the system still has much red tape, is inefficient and slow. The market expects this to change should there be a regime change. This was obvious when both the entire stock market, and Pampa Energia specifically jumped when Nestor Kirchner, Cristina’s husband, predecessor and presumed puppet master, died suddenly last year.
Cristina is up for re-election later in 2011. While it is hard to make election predictions, it appears that the status quo is, practically speaking, the worst-case scenario. A more market friendly regime would make more than a subtle difference. I can see the following scenarios, all but one positive for the company and the stock price:
- Cristina will be replaced by a more market-friendly regime. The Argentine stock market in general, and utilities specifically would rally. Tariffs would be adjusted (albeit gradually) and might transition to a market-based system, unlocking tremendous value of Pampa’s assets.
- Cristina prevails. Status quo would continue. But this would include some tariff adjustments since the last one was in 2008, and inflation is rampant. Considerable upside to Pampa’s earnings, but not as favorable as scenario a.
- Cristina prevails and turns left. This could be a quasi- or de-facto nationalization of utilities. This seems highly unlikely since the country tried this in the past, with the predictably disastrous results.
The bottom line is that the upside seems much more likely than the downside risk. Even in a nationalization there would be some form of compensation to the current owners, so a total loss is not conceivable. The upside, on the other hand could be a multiple of today’s price. This is not a very precise prediction, and I am not providing an intricate financial model for all the outcomes, but that would seem like a waste of time, given that the company’s earnings will depend so much on future tariffs, which in turn will be heavily influenced by the political backdrop.
Other macro factors are important, as they would influence not only Pampa’s outlook specifically, but the overall Argentine stock market: (1) China’s slowdown would be perceived negatively for all commodity-exporting countries, including Argentina, (2) conversely, further rising soft commodity prices will be bullish (3) the peso is at risk of devaluation, lowering Pampa’s stock price in dollars, but helping the local economy’s competitiveness.
Elections are in October 2011. As the date approaches and polls are taken, this stock will react. Review the chart since the death of Nestor Kirchner in late October 2010. It has since eased from its high around 19 to the high 15s, and may drop further if the emerging market easing continues. I will add at current levels and below, and look for a double in 9 – 12 months.
Disclosure: I am long PAM.