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Summary CEMIG seems very cheap, but faces several easy-to-spot problems. One of those problems is clearly cyclical and temporary. It’s the weather. Beyond a general overview of the issues CEMIG faces and offering a long-term opinion, this article also considers the importance of the weather in trying to establish a CEMIG position. On paper, CEMIG – Companhia Energética de Minas Gerais (NYSE: CIG ) is an extremely appealing equity. Here’s a utility that has a current dividend yield of 10.6% and trades for 4.4x its 2016 EPS consensus. Sure, CEMIG is in Brazil. And Brazil is in the dumper due to an implosion in commodity pricing (namely crude and iron ore), on which its exports long relied. Also, Brazil’s government budget is slowly turning into a deficit, on account of both the economy and higher social spending: (click to enlarge) Source: Tradingeconomics.com, government budget Plus, of course, CEMIG faces its own travails, having lost 3 hydroelectric concessions which are likely to drive its earnings down by ~50% . And then there’s the fact that CIG is an ADR, reflecting the behavior of CEMIG as quoted in São Paulo … in Brazilian Reais. You see, the real has been doing its best impersonation of a banana republic currency – both on account of the commodity implosion, the resulting economic slowdown and the slowly-eroding budget balance: (click to enlarge) Source: Xe.com There is, thus, a lot of trouble to go around. I could however say there’s one bright spot here on the currency front. While the commodity implosion had a very negative impact on exports, the Real implosion made sure that imports fell hard as well. The end result is that Brazil is still holding on to a positive balance of trade: (click to enlarge) Source: Tradingeconomics.com, balance of trade The main economic risk is thus reduced to the chance that the budget deficit deteriorates so much that Brazil resorts to money printing and turns this manageable situation into a Venezuela . Barring that, we could argue that the Real is fairly valued or even undervalued (if some of the commodity weakness in oil and iron ore goes away). At this point, we could thus argue that taking into account the economic outlook, Real, valuation (EPS consensus) and the loss of concessions, CIG should be at an attractive long-term level. And that would probably be right. But there’s yet another factor. The Weather You see, Brazil is supposedly in the midst of its worst drought in the last 80 years ( I , II ). A drought which was made worse by the weak 2014 rain season (starting in November 2014). Now, a drought here is a serious matter, because Brazil relies heavily on hydroelectric power – and CEMIG relies even more on it (though that will now be reduced by the loss of 3 hydro concessions): (click to enlarge) Source: CEMIG Presentation The drought, as I said, was made worse by a weak 2014 rain season. A drought is clearly a temporary factor, so buying stock affected by it could make sense long-term. But usually, you wouldn’t want to necessarily be doing so right away if you thought that there was still significant pain ahead. In that regard, it pays to check how this rain season is going, as it will affect hydroelectric power generation throughout 2016. We do have a way of monitoring how it’s been doing: Source: NOAA, National Weather Service As it were, the answer about the weather is “not so good”. The most important state for CEMIG is Minas Gerais and the adjoining smaller states, and those are clearly seeing under-average rainfall during this rain season as well. Source: Company Presentation So, for timing purposes, we do know that more fundamental deterioration likely still lies ahead for CEMIG even if the present share levels already look attractive for the longer-term. On The Other Hand CEMIG does get a lot of its profits from generation. But it also gets 1/3rd of EBITDA from transmission, and that ought to be defensible: (click to enlarge) Source: Company Presentation This is yet another factor telling us that, longer-term, CEMIG should be attractive – though it probably won’t mitigate further short-term fundamental weakness coming from the weather. Conclusion Some of the problems CEMIG faces are structural, like the loss of 3 important concessions. Others seem discounted, like the massive Real plunge (unless the government goes all Venezuela on us). Taking into account these problems and the earnings impact, it would look like CEMIG is already at an interesting level for longer-term investments (the 2016 EPS consensus puts the company at 4.4x earnings, and should already account for the concession losses – but not for further fundamental deterioration). However, to further refine the timing of buying CEMIG shares, one of the largest problems with CEMIG remains, though it’s clearly cyclical and temporary. I’m talking about the weather. On that front, it looks likely that the fundamental newsflow over the next 3-9 months will remain rather negative – since if it’s not raining a lot right now, it will be hard to compensate for most of 2016. On this account, it might also happen that CEMIG will further cut its dividend or entirely eliminate it (temporarily) – which is another possible “ugly newsflow” event. Putting it all together, CEMIG is trading at an interesting long-term level given the depressed valuation. Weather considerations are mainly for trying to establish the best possible entry point, in spite of the stock already looking attractive long-term. Scalper1 News
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