A High-Voltage Brazilian Dividend

10/26/2010 11:52 am EST

Focus: GLOBAL

Carla Pasternak

Editor, The Income Investor

Fast-growing utility CEMIG bolsters its solid cash payout with extra stock that should rise in value as Brazil prospers, writes Carla Pasternak in High-Yield International.

Energy Company of Minas Gerais (NYSE: CIG), aka CEMIG, is one of the largest electric utilities in Brazil with approximately 6.2 million consumers in Minas Gerais, the country's second most populous state. CEMIG sells power in one of the world's fastest growing economies. In fact, Brazil grew an astounding 9% in the first quarter of 2010 and 8.8% in the second quarter, compared with 1.6% growth in the US.

CEMIG's stock tends to mimic the general direction of the Brazilian stock market, albeit less volatile on the upside and downside. And the Brazilian market has been on fire. The iShares MSCI Brazil Index (NYSE: EWZ) has returned a remarkable 20% average annual return over the past 10 years and 25% per year over the past five.

CEMIG has a dividend policy of paying out at least 50% of net income. In addition, for the past few years the company has also paid a stock dividend or done a share split. Management typically pays two cash dividends per year, in mid-year and in December. The dividend paid in July totaled $0.38 per ADR and the company has declared the December dividend, which is estimated (depending on currency) to be $0.39 per ADR. The $0.77 in dividends paid in 2010 translates to a solid 4% yield at a share price of $17.92. Including the $1.59 stock dividend, the trailing yield is 13% ($2.37/$17.92). There is no withholding tax on dividends. Payments are made in Brazilian reals and converted to US dollars, so are subject to fluctuations with currency values.

The 10% stock dividend paid in May is a huge benefit in several ways. First, investors are not taxed when the dividend is received. But they have the choice to turn it into a cash dividend by selling the shares. If investors choose to hold the additional shares, they will be entitled to 10% more of future dividends. And since CIG shares are higher now than on the record date (May 4), investors can enjoy a more than 10% increase in the value of the position.

In the second quarter, CEMIG sold 12.5% more electricity than last year's quarter, as industry sales grew 9% in the strong economic recovery. However, net revenue was flat at R$2.95 billion because of higher cost for purchased energy, higher material costs and increased depreciation expenses. Net income decreased 13% primarily because of a 59% increase in the cost of financing, as money borrowed to fund expansions has not yet been offset because accretion from the expansions has not yet been fully realized.

CEMIG is in the process of aggressively expanding to meet the ever-rising energy needs of a rapidly growing economy. In the second quarter alone, the company made three acquisitions of energy transmission companies. These acquisitions will give CEMIG 57% more capacity in energy transmission than it had in 2008. Analysts' consensus estimates are for the company to grow earnings by an average of 7.5% over the next five years.

CEMIG pays a solid yield and offers stronger capital appreciation potential than most utilities.

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