CEMIG: Brazilian Bargain?

12/16/2014 10:00 am EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

When President Rousseff won reelection in Brazil, traders dumped Brazilian equities indiscriminately; since September, the nation’s currency has fallen 15% relative to the US dollar, explains Roger Conrad, editor of Conrad's Utility Investor.

Shares of the country’s biggest electric utility Companhia Energetica de Minas Gerais (CIG), or CEMIG, have fared far worse.

It has given up almost 35% of its value since the start of September and now trades at 4.7 times the company’s trailing 12 months’ earnings and less than 1 times sales. At these levels, the American depositary receipt (ADR) yields more than 7%.

CEMIG has also added transmission infrastructure and renewable-energy resources in late October, securing antitrust approval to buy half of a giant 676.2-megawatt wind farm.

With a debt-to-assets ratio of 31.7%, excessive leverage isn’t a problem, either. Rather, CEMIG’s stock is cheap because of what Brazilian regulators may do to address the hydropower-dependent country’s worst drought in 80 years.

A year ago, the Rousseff government tried to impose massive rate cuts on hydropower producers in exchange for renewing expiring plant licenses. The strategy backfired; the drought bolstered power prices, enabling companies to obtain premium prices by selling their electricity in the spot market.

With water levels still dropping, the government has proposed energy quotas that would crimp producer sales.

Meanwhile, CEMIG is embroiled in a legal dispute over renewing contracts for three of its hydro-power plants in Minas Gerais, a case that the firm could lose.

On the other hand, massive investments in infrastructure represent the only viable solution to Brazil’s power crisis and these capital expenditures will only occur if the regulatory environment improves.

The pressure will be on the government to renew and extend power plant concessions and raise the industry’s weighted average cost of capital to at least 8%.

Although the way ahead is uncertain, CEMIG’s bargain-basement valuation means that it won’t take much good news to send the stock higher. Aggressive investors willing to take this bet should buy Companhia Energetica de Minas Gerais’ ADR up to US$7.50.

Prospective investors should note that the majority of CEMIG’s payout is considered a dividend and not subject to withholding tax. In 2013, a sliver of the payout was classified as interest on capital and taxed at a 15% rate.

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