2023-07-13 12:57:20 ET
Summary
- Cemig, a leading Brazilian energy company, reported weak financial results in the first three months of 2023, with operating performance falling below expectations.
- The company is considering privatization, which could bring significant benefits, but the decision hinges on the Legislative Assembly of the Brazilian state of Minas Gerais.
- Cemig plans to focus on distribution investments and relies on concession auctions for transmission investments, which are crucial for the company's future growth.
Companhia Energética de Minas Gerais - Cemig (CIG) is a prominent player in the Brazilian energy sector. It holds the leading position as a distributor and seller of energy and is the second-largest transmission company in the country. As a state-controlled company, Cemig has a strong track record of generating high cash flows and paying attractive dividends. However, the current performance could have been more favorable to ensure stability and enhance profitability.
While the possibility of privatization looms for Cemig, which could bring significant benefits to the company, the process hinges on the decision of the Legislative Assembly of Minas Gerais during its current term. Despite the potential advantages, there remain significant uncertainties surrounding privatization and the risks associated with state regulation in the energy market, operational constraints, and reduced financial flexibility.
As a result, I believe that a cautious approach is warranted when evaluating the prospects of Cemig in the near term.
Recent results
Cemig reported weak financial results in the first three months of this year. During this period, there was a growth in the amount of energy distributed, with a 3% higher customer base YoY.
Revenues increased 10.2% YoY to R$8.6 billion. This increase is primarily due to higher revenues from supply, gas supply, and energy distribution in Q1 2023. However, Cemig's power transmission revenues were hurt due to a reduction in the financial remuneration of the transmission contract asset.
The ugly side was due to the increased costs that Cemig had in Q1, where they rose 8.5% YoY, from $6.4bn to R$6.9bn. This increase is due to higher expenses with energy purchased for resale, high contract and material costs, and impairment loss of certain plants under disposal.
Still, Cemig increased its EBITDA by 12.8%, reaching R$2.16 billion, compared to R$1.92 billion in the first quarter of 2022. While the distribution segment contributed positively to this increase, the power generation and transmission segments had a negative impact.
Cemig also suffered due to the negative variation in the dollar and other financial hedging instruments, which generated a negative financial result of R$106 million compared to a positive R$314 million in the same period last year.
In the annual comparison, the debt gathered 1% in net debt in the first quarter of 2023, reaching R$7.18 billion. As a result, net debt/EBITDA for the last twelve trailing months was 0.93, a much lower leverage than other peers in the energy sector.
Finally, with the cost increase and a lower-than-expected operating result, Cemig's net profit fell to R$1.4 billion compared to R$1.46 billion YoY, down 3.9%.
Adequate leverage levels
Cemig has garnered attention for its impressive leverage recovery since the cycle began in 2019. Through strategic divestments between 2019 and 2022, Cemig successfully generated approximately R$ 6.5 billion in cash.
This enabled the company to achieve a more favorable leverage position, significantly reducing its net debt/EBITDA ratio from 5 times to 1. Such improvements demonstrate Cemig's ability to regain a more suitable level of leverage, bolstering its financial stability and enhancing investor confidence.
Also, Cemig managed to minimize operating expenses bringing them back within regulatory limits, demonstrating improved efficiency. The greater focus on operations within the state of Minas Gerais was one of the main drivers of this transformation, with the company focusing on investment in distribution and drastically reducing Cemig's investments in minority stakes and without proper control over the assets.
As a result of this optimization of Cemig's leverage over the last three years, its shares have appreciated about 75% during this period to the present day. In a long-term approach, returns tend to follow the positive advances made about leverage and risk reduction around Cemig.
The following steps that the company should take also seem to be appropriate. As signaled by the company's management, investments should continue to focus on distribution - a segment less susceptible to seasonal variations or market fluctuations. The company plans an annual investment of R$ 3.7 billion over the next four years, signaling high growth efforts.
Investments in Generation and Transmission are expected to continue at an annual average of R$3.3 billion. Cemig competes for approximately R$50 billion in transmission investments to be auctioned between 2023 and 2024. Winning these concession auctions is paramount for Cemig, considering that about 31% of its installed pipeline capacity has contracts expiring in 2027.
Steps toward privatization
Cemig is a state-owned company majority controlled by the state of Minas Gerais. As the governor of Minas Gerais, in office since 2019, advocates a liberal agenda, there is a high chance that privatization will be on the agenda.
Cemig executives even advocate that the Minas Gerais state government intensify mobilization around this agenda. According to the chairman of Cemig's board of directors, the company is focused on exiting assets with low or even negative profitability and sees working toward privatization as the best way out.
In addition, Cemig's CEO Reynaldo Passanezi has also made himself a staunch advocate of privatization:
It is terrific for Cemig to go through a privatization process to become a corporation. It will generate value. This value creation process accelerates even more in a movement where we must become a corporation and eventually be privatized.
The more immediate occurrence of privatization stalls on bureaucratic issues and local political challenges, which represents the unfavorable side. In the state of Minas Gerais, privatizations of state-controlled assets must go through a referendum, or else changing this requirement requires two-thirds approval of state deputies.
However, according to Cemig executives, there is a belief of a more favorable environment for Cemig's privatization to be debated and get off the ground "in this mandate" (2023 - 2027) of the deputies of the Legislative Assembly of Minas Gerais.
The bottom line
Despite trading at a forward EV/EBITDA valuation multiple of 4.4 times, below that of its Brazilian peer from the state of Paraná, Copel ( ELP ), currently at 6.3 times EV/EBITDA, Cemig appears to be undervalued.
However, it is essential to consider that, as a state-owned company, regulatory, operational restriction, and corporate governance risks are inherently factored into its valuation. Comparatively, Copel, also in the final stages of privatization , may face lesser challenges and hence commands a higher valuation multiple.
As energy companies often have substantial capital expenditures and complex financial structures, Cemig is no different. Its cash flow is sustainable and stable considering a forward price-to-cash flow ratio of 6.98, about 8% below the industry average, which is okay, but also not excellent.
Despite the discounted valuation, I see a possible negative impact on installed generation capacity as the relevant concession contracts come close to expiration, which leaves some uncertainty about the execution of the energy pipeline for the long term, especially considering the current lower energy prices.
While recognizing the potential positive impact of privatization on Cemig and its ability to drive a significant operational efficiency turnaround, the unpredictability surrounding this process necessitates a prudent and cautious approach. Therefore, adopting a wait-and-see stance is prudent at this stage.
For further details see:
Cemig: Neutral Outlook Amidst Privatization Uncertainties