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Summary COPEL’s business is sound, with slow growth, low debt, a good dividend, good fundamentals and a good, stable historical performance. Due to the situation in Brazil, there is still more downside potential for the stock. CEMIG is a much more risky play, but the upside is also much higher. Introduction I recently wrote an article where I analyzed investment opportunities in Brazil that are listed on the NYSE and gave an overview of the economic situation. I found four interesting companies, of which BrasilAgro (NYSE: LND ) and Brasil Foods S.A. (NYSE: BRFS ) are good, but their P/E ratio is too high. This leaves us with two electrical companies, CEMIG (NYSE: CIG ) and Companhia Paranaense de Energia – COPEL (NYSE: ELP ). I have already written about CEMIG here and here , so in this article, I will analyze COPEL. About ELP ELP is the largest company of the State of Paraná (South Brazil), and serves electricity to 4,370,200 units. The company uses 18 hydroelectric plants that give 99.5% of its own electrical production, 1 thermal plant and 1 wind plant, with total installed capacity of 4,754 MW, a transmission system with 2,302 km of lines and 33 substations, a distribution system which consists of 192,116 km of lines and network of up to 230KV, and an optical telecommunication system. The company was founded in 1954, and has been listed on the NYSE since 1997. The State of Paraná is the major shareholder, with 58% of voting shares. There has been a lot of regulatory turbulence in the energy sector lately, especially with CIG losing 45% of its electricity generation capacity due to lost concessions. Energy prices increased and are currently under the red flag 3 regime, meaning that the electrical utilities sector is under pressure. The result of this is that ELP’s revenues increased 32% in Q2 2015, mostly due to price increases. Operating expenses increased even more, around 38% in the same period. The Business One of the main issues in the sector is that all the assets are mostly under concession from the government, but with the latest news on concessions, where the Federal Audit Court authorized the government to renew for another 30 years the concessions for electricity distributors whose contracts expire between 2015 and 2017, the situation is more stable now as compared to that a month ago. This is good news for ELP, as in the Q2 earnings conference call, the company did not know if its distribution concessions would be prolonged. As for electricity production, the situation with ELP is much more stable than it is with CIG, because ELP has only 5% of electricity production in doubt for 2015, whereas CIG had 45% of production in doubt, and eventually lost it. According to ELP’s CEO , the company will bid to renew the concessions and are pretty sure it will happen. The two plants in question are the Parigot de Souza and Mourão plants. ELP is also developing new projects, building 2,000 km of new distribution lines and developing new wind farms, with three new farms expected to start up in upcoming weeks. Fundamental Analysis The current P/E ratio is 7.91, and the price-to-book value is 0.6. In Table 1, you can see the main fundamental indicators for ELP and their stability in the Brazilian currency. Table 1: ELP Fundamentals 2010-2015 (Source: Morningstar ) In the Brazilian currency, ELP is able to transfer the increase in prices to its customers, which shows it to be a great hedge against inflation. The net income is pretty stable for a regulated electrical company, and it can be assumed with a high degree of certainty that ELP will continue to operate less or more positively in the future. The dividend is also stable, and the company has a policy of paying at least 25% of its net profits in dividends. This means that with the trailing earnings, an investor can expect minimally US$0.25 per share at the current exchange rate. This would give a 3% dividend yield at current prices and exchange rates. The gross margin is slowly deteriorating, but we can expect it to improve as soon as the extraordinary circumstances in the Brazilian energy market pass. Technical Analysis The main issue here is not ELP’s business or its fundamentals, but the volatility of the exchange rate between the US dollar and the Brazilian real. In Figure 1, you can see that an end to the depreciation of the real is nowhere to be seen. Figure 1: Brazilian real per US$1 from 2005 to 2015 (Source: XE.com ) I cannot predict what will happen here in the next few years. Currently, the situation in Brazil is far from stable, but in the period from 2009 to 2011, the real appreciated against the US dollar by 60%. We could say that there is blood on the Brazilian financial markets now, and usually, these are the best times to buy. But the main question is: How low can the real go? On the other hand, if we see an improvement in the political and economic situation in Brazil, the exchange rate trend would quickly switch and create a point of stability at a certain level. This trend reversal could give a 25% currency gain and add an extra 25% to the dollar EPS of ELP. This is a scenario that would easily create a 50% return for international investors. But we would need a crystal ball to know when the bottom will be reached in Brazil. Conclusion If ELP were a European or US company, I would probably buy it at these ratios, expecting a healthy 13% yearly return and a 3-4% dividend that would allow me to repurchase shares. With the uncertain situation in Brazil and the real depreciating at a 10% monthly rate (August and September 2015), I want a much wider margin of safety. The margin of safety that I would look for to feel comfortable investing in ELP would be one that gives me a 15% return even if the real depreciates by another 50%. This means that for US$1, we would get R$6. In such a scenario, ELP’s EPS would be US$0.66, and to get a 15% return, the P/E ratio should be 6.66 – meaning that a safe entry-level stock price for ELP is US$4.4. We are still far from that, but everything is possible considering the current situation. ELP is very stable, and Brazil is very unstable for sure in the short term, but potentially stable in the long term. Such a situation makes me believe that there might be a chance of the stock falling a little bit more, and thus, increasing the safety margin for investors. My advice would be put this company on a watch list, estimate your required rate of return for such an investment, adding to that the potential further depreciation of the real, and thus get to a safe entry price for yourself. Comparison with CIG ELP’s price-to-book ratio is 0.6, and CIG’s is currently at the same level. The P/E ratio is 8 with ELP and 3 for CIG, but with the unclear future earnings stream for CIG due to the loss of the concessions on 40% of its energy production, the difference is justified. I do not see potential spectacular earnings growth with ELP, because it is a stable company that aims for sustainable growth, whereas with CIG, everything is possible due to the management’s more risky approach to business. CIG has the potential to bring EPS to $US1.5 per share that would give a P/E ratio of 1.13 at current prices and a dividend yield of around 40%. The risk-reward ratio is 50% downside and 50% upside with ELP, while with CIG, it is 50-100% downside and 600% upside. I will continue to follow the two companies, and if the divergence between the perception the investor community has about Brazil and the businesses’ results continues to grow, thus lowering the potential downside, I will start buying. So, for now, I will put both companies on a watch list and let you know more in the future. Scalper1 News
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