2023-06-13 08:12:46 ET
Summary
- Brazilian utility company COPEL is expected to undergo equity restructuring, potentially leading to the State of Paraná losing control and reducing its equity to around 10%.
- Dividend distribution will probably decrease until 2024, but the yield will still be satisfactory at current price levels.
- Despite trading at historically high multiples, COPEL's share price still has potential upside in the medium term, and long-term operational efficiency could bring higher returns for investors.
- The restructuring is necessary for COPEL to raise funds to renew three important hydroelectric plant concessions, which are crucial for the company's future cash flows.
- Regardless of the scenario, those who own the stock now should stick to them for a couple more years for the almost certain rewards.
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Thesis background
Companhia Paranaense de Energia - COPEL ( ELP ) has already hired a group of financial institutions to coordinate a potential equity restructuring, which can lead to the State of Paraná not being the controller anymore. Since the latest news indicate that everything is moving towards this event, my recommendation is to current and potential shareholders hold the stock aiming for the years ahead because, when it comes to Brazil, the state stepping aside is almost always a good thing.
With the new structure, the equity from the state should retrace to up to 10% - currently, the state owns 31.1% of the company, 69.66% of common stocks and 6.9% of preferred stocks.
The equity restructuring should follow the steps of what happened to another Brazilian former public-owned company, Eletrobras ( EBR ), turning it into a corporation, that is, a pulverized capital company, without a controlling shareholder.
A brief description of COPEL
COPEL, short for Companhia Paranaense de Energia, is a state-owned mixed economy company, and one of the largest electric utilities companies in Brazil. COPEL's renowned position in the Brazilian electricity sector is the result of 64 years of experience and technical competence in the fields of generation, transmission, distribution, and commercialization of energy. The company directly serves more than 5 million consumer units in 395 municipalities and 1,068 localities (districts, towns, and villages).
COPEL owns 62 power plants (18 hydroelectric, 1 thermal, and 43 wind farms), and has interests in another 14 power generation projects (1 thermal, 8 hydroelectric, 4 wind farms, and 1 solar), totaling an installed capacity of 6,966 MW adjusted for COPEL's participation.
The only way is for the State to step aside
As I mentioned earlier, acquiring the three hydroelectric plant concessions is crucial to increasing the robustness and security of COPEL's future cash flows. Therefore, I believe that dilution of the state's equity is the only possible way to raise capital to guarantee the three plants.
With this in mind, there are two possible and expected scenarios so this event can actually happen. One of them would be the sale of the State of Paraná's stake, decreasing its equity in the company and losing its role as the controller. After that, but with a lesser chance of occurring, a new stock issuing to raise capital and increase cash volume, because now with the state aside, the company will need funds to implement a new and more efficient business model.
Even if only one of these scenarios happens, the state stepping aside is almost certain by now, which is a good sign for those who wish to hold on to the stock. As a native Brazilian, it's easy to see in my everyday life the inefficiency of the state when it's leading companies and operations, with rare exceptions. It is harsh to say, but this is the current reality of my country when it comes to public companies: corruption, political interference, unmotivated labor, and inefficiency in basically all departments.
That's why in Brazil, when a state-owned company announces that the government will step aside, its shares instantly rise, because the market also prices in the reality that I see. Although the current share price already includes this major change, the long-term potential for holders is much greater than the recent upside, as they will now be shareholders in a more efficient and well-managed company, which will consequently generate a higher cash flow for the years ahead... at least that's what's expected.
Dividends will probably be reduced in the near term, but you'll still get a fair share
COPEL's dividend policy currently considers the company's debt level. If the Debt/EBITDA is less than 1.5, the payout will be 65%, limited to the available cash flow.
If the company has a Debt/EBITDA between 1.5 and 2.7, the payout drops to 50%. Above 2.7, the company pays only 25% of its net profit. When the company doesn't profit, it doesn't pay dividends. Until the first quarter of the current year, COPEL's financial leverage was 2.5.
I believe that COPEL seeks the middle band, with a leverage of 1.5 to 2.7 times, which would imply a dividend distribution of 50% of the overall net profit in the coming years. COPEL's payout has fluctuated between 60% and 90% in recent years and, although 2023 may be below average, giving up dividends in favor of the new structural change seems to be a reasonable move.
Overall, COPEL has a diversified portfolio and predictable contracts, which offers the shareholder a good margin of safety in the investment and a slightly predictable cash flow.
Assessing the last earnings, which came a bit better than expected
According to the latest results , COPEL recorded a 5.1% drop in net profit in the first quarter of 2023 compared to the same period last year, falling from R$ 669.8 million to R$ 635.5 million. The drop is due to the increase of R$ 32.3 million in depreciation and amortization, mainly due to the kick-off of the Jandaíra Wind Complex, the acquisition of the Aventura and Santa Rosa & Mundo Novo Wind Complexes and the increase in investments in COPEL's distribution sector.
As depreciation and amortization have no impact on cash, the company actually posted a rise in net profit of around 3%, rather than the 5.1% drop. Adjusted EBITDA was R$ 1.617 billion, an annual increase of 10.7%. Net revenue totaled R$ 3,531 billion in the first quarter of this year, an increase of 0.3% compared to the same period of 2022.
Operating costs and expenses totaled R$ 4.420 billion, a decrease of 2.4% compared to R$ 4.530 billion recorded in the same period of 2022. The net financial result was negative at R$ 333.1 million in the first quarter of 2023, an increase of 56.2% over the financial losses of the same period of 2022.
Over the past two years, Brazil has been increasing interest rates to control inflation, which impacted the most indebted companies, partly explaining the negative performance of the company's financial results. This scenario was already priced in, since the period of increase in interest rates was also already expected by the market.
With this in mind, we can accept that the result was indeed a little better than expected and that the predictability of the company's revenue does bring a certain security to investors.
COPEL might not be that cheap now, but the future will probably pay off
As I write this analysis, COPEL is trading with a P/E multiple near 21, considering the past 12 months, which is historically high for the company. To give you a reference, the company closed the year 2012 with a P/E of 12.38, and that was the highest it has ever reached within the past 13 years.
The reason for that does not come from the price per se, but from the net profit, which was deeply impacted by the ramping interest rates implemented by the BCB (Brazilian Central Bank) that affected the financial results. As a naturally leveraged business, COPEL took the hit a bit more than other companies in different sectors. In fact, the revenue of the 1Q 2023 actually remained just about the same when compared to the 1Q 2022, and the adjusted EBITDA increased by 10%, as mentioned in the previous section.
This gives us some light on what we can expect for the medium term. COPEL will carry on generating the same robust revenue, as the company has a pretty stable cash flow, and the financial results will start to see better days as the BCB finally decides to start cutting the rates again. After all, Brazil has been bearing two-digit interest rates for too long, and the national CPI is considerably low by now at 3.94% (past 12 months, and quite low for Brazilian standards), so it's just a matter of time for them to drop to "healthy" levels again.
Now combine that with the State of Paraná stepping aside and providing a great and efficient environment for the company to grow further, which might happen sooner than we imagine. Everything seems to be leading to a fruitful future for those who have the patience to stick with the company a bit longer.
The biggest risk is not in the share price but in the dividend distribution
It's safe to say that the major risk in the near term is if the company doesn't move on with the equity restructuring and remains controlled by the State of Paraná, which will mostly make the share price retrace to its "pre-euphoria" level. Brazil is also famous for making promises and not sticking to them, especially when it comes to taking the control of the state away over something.
Bolsonaro's (previous president) mandate was filled with promises of privatization, but in the end, only one was actually made. Apart from that, if COPEL decides to go for a public offering, the stock cannot be priced too far from what we have now, or else they won't sell, so it's not wise to say with certainty that the company will be fully free from the hands of the government.
In my view, the major risk is actually in the dividends that the company has been paying until now. I mentioned previously that the company will carry on paying at least a fair share, regardless of the scenario, but everything points to a decrease until this uncertainty phase calms down, which I estimate will only occur around the end of 2024.
If COPEL remains state-owned, it won't have enough capital to renew and guarantee the valuable concessions at hand, so it will need to issue corporate debt to pay for them, which will affect Debt/EBITDA and therefore the payout (according to the company's dividend policy). The second scenario comes with the successful equity restructuring and capital raising, which will likely make the company retain the cash to be used in operational investments aiming for business appreciation in the long run. Hence, regardless of the outcome, the future does not look so bright for overall dividend distribution and income-oriented investors.
Conclusion
COPEL is on its way from being state-owned to public-owned, and everything points to this happening by the end of October. Although this is great news for most shareholders and the current share price had already included this event, I believe most returns will come in the years ahead, as a result of a more efficient business.
Regardless if the equity restructuring happens or not, COPEL's dividend distribution is almost certain to decrease until the end of 2024, whether because the company needs to guarantee the new public concessions, which are expensive, or because the new and more efficient management will prioritize Capex over payout to its shareholders. In any case, even with the mild dividends, COPEL will probably manage to generate a yield of about 4% (considering the current share price), which is still a great figure taking into consideration everything that's happening with the company right now. With the last quarter's results, COPEL proved to be a resilient business even when faced with ramping interest rates, which shows that the future looks bright when everything gets back to normal levels, and even better if the State of Paraná no longer owns the company by then.
Having said that, those who are current shareholders of the company should now more than ever stick to their shares aiming for the couple of years ahead, because in any scenario the stock price will most certainly appreciate. And those who are planning to long the stock now, understand that the company is trading at all-time high multiples and that there's a slight chance that COPEL remains state-owned, and if that occurs, the share will bounce back to its "pre-restructuring-announcement" price.
For further details see:
COPEL: Hold It Until The State No Longer Owns It And Receive Dividends Meanwhile