2023-08-24 11:25:03 ET
Summary
- Copel's successful privatization has led to increased share value, driven by the potential for improved efficiency and profitability through private ownership.
- While the outlook is positive, the rapid share price appreciation and high valuation raise caution, especially if leverage remains high.
- Careful consideration is advised when considering investments in Copel's shares due to potential valuation adjustments.
After an extensive process, the former state-owned Companhia Paranaense de Energia - COPEL ( ELP ) has recently undergone privatization through a subsequent stock exchange offering in Brazil. The market has viewed this privatization process favorably, evident from the rise in Copel's share value this year.
This optimism stems from the expectation that private entities entering the company will revive Copel's investment capacity. This, in turn, is projected to enhance operational efficiency and refine the capital structure and projects, resulting in increased profitability, a higher EBITDA margin, more substantial dividends, and enhanced shareholder value.
However, despite my confidence in Copel's promising future after privatization, the rapid appreciation of its share price - leading to trading at valuations significantly above its historical average - raises a cautionary concern, especially if leverage remains above 1.5x. This leads me to exercise caution when considering investment in Copel's shares.
Copel's privatization
Copel has become the first state-owned company in Brazil to undergo privatization through a follow-on stock exchange offering. This strategic move garnered significant attention from foreign investors, resulting in a demand that exceeded a remarkable R$10 billion.
This pivotal transaction ranks as the third-largest offering globally within the electricity sector for 2023. It generated a substantial capital infusion of R$5.2 billion, including selling an additional lot.
Set for R$8.25, reflecting a premium of 5% over the reference price on the Brazilian stock exchange, this follow-on offering marked the conclusive step in Copel's privatization journey. Excluding the placement of supplementary shares, the current ownership of ordinary shares held by the State of Paraná—equating to 69.66% (which constitutes 31.07% of the total capital)—will undergo a reduction to 32.23% of ordinary shares while retaining a 17.9% stake in the entire capital.
Due to the substantial demand for the offering, the State of Paraná is poised to hold 26.96% of ordinary shares and 15.65% of the total capital if the supplementary lot is executed.
The proceeds from the secondary portion of the offer, stemming from the sale of existing shares, are estimated to contribute between R$2.6 billion (excluding the supplementary lot) and R$3.2 billion (encompassing the additional lot) to the State of Paraná's financial reserves. Correspondingly, the company is anticipated to raise between R$1.9 billion and R$2 billion through the primary portion of the offer, assuming the supplementary lot is exercised.
This infusion of capital will empower the company to honor its commitment of R$2.9 billion and the cash reserve to fulfill the R$3.7 billion grant bonus owed to the Federal Government. The grant bonus, as outlined by the Federal Court of Auditors (TCU), is tied to the comprehensive renewal of three major power plants that collectively contribute 55% of Copel's commercial generation capacity.
Initially, these power plant concessions were scheduled to expire in December 2024, September 2032, and March 2033, respectively. However, with the complete renewal and fulfillment of the concession fee, these assets are now set to be extended for another three decades. This extension will substantially elevate the weighted average term of the company's generation concessions, transforming it from 12.3 years to a robust 27.4 years. This, in turn, solidifies the sustained earnings potential as the primary positive consequence of the privatization endeavor.
Latest earnings results
Copel has reported a net income of R$308 million in the second quarter of 2023, a significant turnaround from the net loss of R$522 million in the same period of 2022.
It's important to note that the result for the previous year's second quarter was impacted by legislation, including a provision for the allocation of federal tax credits (PIS and COFINS), which had a net effect of R$1.2 billion on the quarter's result. Disregarding this effect, the net income for the second quarter of 2022 would have stood at R$680.1 million.
The adjusted EBITDA reached R$1.2 billion, representing a decrease of 14.7% compared to the R$1.4 billion recorded in the corresponding quarter of the previous year.
This figure indicates the reduced remuneration on transmission assets. However, it's partially balanced by Copel da Distribuição's improved results, enhanced performance of existing wind complexes, and the introduction of new generation assets. Excluding the equity equivalence result, the adjusted EBITDA experienced a 6.5% decline year-over-year.
The net operating revenue for the second quarter of 2023 reached R$5.35 billion, marking a 1.9% increase from the R$5.2 billion recorded in the second quarter of 2022.
This outcome is primarily attributed to a rise of R$251.7 million in revenue from the electricity grid's availability and an additional R$56.7 million in construction revenue. Furthermore, a growth of R$7.9 million resulting from sectorial financial assets and liabilities stemming from higher energy costs, charges, and other financial components, along with an expansion of R$5.9 million in the "other operating revenues" category, further justify the company's revenue in the second quarter.
Operating costs and expenses reached R$4.6 billion, signifying a 9.7% increase compared to the R$4.2 billion recorded in 2022 (excluding the effects of R$810.6 million related to the provision for PIS/COFINS credits).
The company's leverage is 2.5 times the net debt/EBITDA ratio, while the operating cash generation for the second quarter of 2023 amounted to R$1.5 billion, indicating a growth of 3.1% year-on-year.
Dividends: expect a 50% payout
According to Copel, the company has established a dividend distribution policy based on its leverage ratio. When the company's leverage ratio is below 1.5x, it will distribute 65% of its profits as dividends. If the leverage ratio falls between 1.5x and 2.7x, the dividend payout will be set at 50%. Beyond that range, a mandatory minimum of 25% would be paid out.
In the context of the anticipated privatization process, maintaining the 50% dividend payout ratio allows Copel to manage its leverage effectively. This approach ensures that the company's financial position remains controlled.
Continuing to demonstrate its prowess as a robust cash generator, Copel's Q2 results underscore its financial strength. Consequently, the company is projected to achieve a 5-6% yield by 2023. When observing the historical average since 2011, the yield stands at 6.6%, while the current yield is at 4.2%.
The bottom line
The tangible benefits of Copel's privatization revolve around safeguarding the existing earnings potential (achieved through comprehensive power plant renewal) and mitigating the inherent governance risks of a state-owned entity, where the company's trajectory could be completely reshaped with each change in government leadership.
This strategic shift aligns with the prevailing trend towards heightened efficiency within the private sector. Consequently, alongside the notable surge in share valuation observed this year, a consensus is emerging regarding a substantial 200% increase in EPS.
Consequently, the company's forward P/E ratio currently stands at 15.1x, a notable 185% increase from its five-year average. Although this valuation remains within a reasonable range compared to the industry average, I struggle now to label Copel as undervalued.
Moreover, with the completion of the privatization process, the trajectory for further share price appreciation is expected to level off. The focus has shifted towards crafting new strategic plans to navigate the altered landscape in the coming months, ultimately determining whether viable upside potential remains.
While I acknowledge the company's stability in generating an anticipated yield ranging between 5-6%, I do hold concerns regarding a potential correction in share price. This unease stems from the valuation implications of a relatively recent privatization endeavor that could continue to resonate in the market.
For further details see:
COPEL: Approaching With Caution In The Post-Privatization Era