The Promise of Electrifying Brazil

08/05/2008 12:00 am EST

Focus: GLOBAL

Nick Lanyi

Editor, High-Yield International

Nick Lanyi, Editor of High-Yield International, finds a stock benefiting from the robust economy of Brazil…

CPFL Energia SA ADS (NYSE: CPL) is a Brazilian electric utility that has performed exceedingly well in the face of the US-driven market meltdown. Since I recommended the stock in early January, it's up nearly 30%, when you include dividends.

Brazil has been one of the world's most robust economies and stock markets (the Brazilian economy grew at 5.8% in the first quarter and its stock exchange, the Bovespa, has gained 29% in the past year—Editor) this year, and economists expect strong growth to continue. As the country's largest private electricity provider, CPFL is reaping the rewards of steadily increasing demand for power. Electricity usage is expected to grow about 5.5% annually over the next several years, according to the Brazilian government.

Not surprisingly, the company has had to make significant capital investments to expand its generation capacity—with plans to invest about $3 billion over the next three years. Most recently, CPFL Energia announced construction of four hydroelectric plants in the state of Rio Grande do Sul, to be completed over the next 30 months. And unlike many companies that invest heavily in plants and equipment, CPFL is doing so with a high level of confidence about the continued trajectory of Brazilian power demand.

To fund these investments, CPFL Energia has a strong balance sheet and excellent cash flows ($526.4 million in cash and $1.2 billion operating cash flow, as of December 31, 2007—Editor). Although the Brazilian utility regulators recently lowered utility rates, they did so because rapidly expanding revenues had increased the utilities' profit margins through economies of scale.

With excellent growth prospects, steady cash flow from its regulated utility operations, faster growth prospects from unregulated power-generation sales, a respected management team, and a strong balance sheet, CPFL would be a good long-term holding even without its 7.8% dividend yield.

Given that the Brazilian real is likely to continue to rise versus the US dollar—boosting the value of CPFL shares and dividends for American investors—the stock remains an excellent choice even though it has risen significantly over the past few months. (Its ADRs closed Monday at $69.95—Editor.)

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