2023-11-09 09:48:24 ET
Summary
- Eletrobras, Brazil's largest utility company, underwent privatization in 2022, leading to hopes of increased efficiency and cost reduction.
- The company has faced political turmoil and potential nationalization efforts by the new Brazilian government, impacting its stock price.
- Eletrobras reported strong Q3 2023 results, including a robust recurring regulatory EBITDA and efficient cost management.
- The new CEO, Ivan Monteiro, brings valuable experience in managing large companies with government relations.
- Eletrobras is undervalued compared to peers and presents a potential low-risk investment opportunity, leading to a bullish outlook for 2024.
Eletrobras ( EBR ) is Brazil's largest utility company. It underwent a privatization process in 2022, transitioning from a state-owned company to a private one. This privatization was expected to improve the company's efficiency and benefit its shareholders through operational optimization and various measures to reduce costs and enhance cash generation.
However, with the new Brazilian government taking office in 2023 and displaying a preference for nationalization rather than privatization, significant political turmoil has engulfed Eletrobras, causing downward pressure on its stock price throughout the year. This unrest involves efforts to challenge the federal government's imposed limited voting cap through judicial review, which has hurt the company's stock price. Due to this ongoing political uncertainty, I have maintained a neutral stance on Eletrobras in my recent articles .
Despite the ongoing political turbulence affecting the now-private company and potentially influencing Eletrobras' valuation, which remains comparable to private companies in the sector, I believe that under the leadership of CEO Ivan Monteiro, the company is making progress in its pursuit of efficiency. These efforts are expected to yield more noticeable results by 2024.
Considering the positive Q3 results, which included a strong recurring regulatory EBITDA, robust revenues, and effective cost management, I am now more confident in adopting a more optimistic position regarding the company's investment thesis. This optimism is directed toward gradual upside potential in the upcoming quarters throughout 2024.
Eletrobras' 3Q23 Results
In my analysis, the Q3 results presented by Eletrobras were positive for the company's case. Once again, the company has reported a robust regulatory recurring EBITDA, which is the metric closest to the company's cash generation. As has been consistent in recent quarterly reports, the company continues to progress in its post-privatization turnaround, and we are now seeing these efforts reflected in the company's results.
In this quarter, the regulatory recurrent EBITDA was R$6.2 billion (compared to R$4.8 billion in IFRS), representing an increase of 51% YoY. Gross revenue reached R$10.59 billion, up 7% YoY. The most notable surprise came from the transmission segment, positively influenced by recent tariff revision processes in Transmission RAPs (Annual Permitted Revenue)/Contractual Revenues. The strong EBITDA was also justified by the results in the transmission business and lower provisions in the period (R$143 million compared to R$635 million in 3Q22).
I would also like to highlight the positive impact of recent PDV (staff reduction) and the company's improved cost management in the Management, Support, and Overhead ((MSO)) segment.
Total PMSO costs in 3Q23 amounted to R$2.3 billion. However, when excluding non-recurring events such as consultancies and layoffs, the figure dropped to R$1.5 billion, suggesting a positive outlook for future value generation.
The net profit reached R$1.4 billion, marking a substantial increase from the negative result of R$3.1 billion in 3Q22. This improvement was primarily driven by the consolidation of the Usina Hidrelétrica Santo Antônio debt, high current debt costs, and updates in the financial cost associated with Conta de Desenvolvimento Energético ((CDE)) payments, which are contributions that electric power companies are obligated to pay as part of their regulatory obligations in Brazil.
Lastly, the management of Compulsory Loans demonstrated a significant reduction in the total inventory, decreasing by an impressive R$3 billion compared to the previous quarter, closing 3Q23 at R$19 billion, as opposed to R$25.8 billion in 3Q22.
Looking ahead in the short term for Eletrobras, I believe the critical factors for the company's turnaround will be the opening of a new PDV (which still has potential), the completion of the incorporation of its subsidiaries Furnas and Eletropar, and the conclusion of Chesf's capital closure, which we anticipate will also be incorporated for corporate simplification purposes.
In the long term, in addition to restructuring and optimizing the corporate structure, one of the main factors to watch is the evolution of long-term electricity prices. Eletrobra's current price levels are being negotiated at unattractive levels (approximately R$90/MW compared to R$140-160/MW in recent years). However, the high degree of contracting in the company's portfolio for 2023 and 2024 should provide some relief until decontracting becomes a more significant concern for the company's cash generation.
Why I Became Bullish for 2024
Eletrobras, the company underwent privatization a little over a year ago, which allowed it to raise capital and transition away from state control. Today, Eletrobras is under private control and lacks a majority shareholder.
Just over a couple of months ago, there was a recent change in leadership. CEO Wilson Ferreira Junior resigned after serving for less than a year, and Ivan Monteiro assumed the role of CEO, having previously served as the board chairman, which makes him closely aligned with the company's perspectives.
The CEO Ivan Monteiro's career includes significant roles such as Financial Director at Banco do Brasil ( BDORY ), a state-owned bank, and later as the Financial Director of Petrobras ( PBR ), which is also a state-owned company. His tenure at Petrobras in 2015 was during one of the company's most critical periods, characterized by heavy debt and poor management. He played a pivotal role in steering Petrobras to its current profitable stage. Therefore, the new CEO has extensive experience managing large companies with government relations.
Although Eletrobras is no longer state-owned, it still maintains interactions with the government, including discussions with the Minister of Energy. Ivan Monteiro is a seasoned manager with significant expertise in handling such relationships.
Looking ahead for Eletrobras, it's evident that the company needs to undertake a comprehensive internal restructuring. This involves optimizing its corporate structure subsidiaries, managing liabilities, and reducing costs, personnel, and operations, among other aspects.
Over the past year, Eletrobras, although privatized, was progressing relatively slowly in this regard due to legislative restrictions. However, the recent developments indicate a shift towards a more pronounced restructuring phase.
Over the last two months, Eletrobras has made a significant announcement regarding initiating a restructuring process for Furnas. The company has also divested small stakes in Copel ( ELP ) and Cesp, although these holdings were of negligible significance. Additionally, Eletrobras has started optimizing its capital allocation. The next step in this process involves selling its substantial position in CTEEP - Transmissão Paulista ( CTPTY ), which will be available on the open market or offered to potential buyers. This move aims to free up idle capital that Eletrobras no longer requires and from which it does not generate any returns. The company does not actively participate in its operations or intend to make further acquisitions.
This optimization process that Eletrobras plans to embark on in 2024 is a thesis that primarily depends on the company itself. It is not contingent on external variables such as market energy prices or energy curve dynamics.
The critical question remains: When will these effects be reflected in Eletrobras' shares? It may not manifest immediately or in Q4, and it might not even be fully apparent in Q1 of 2024. Nevertheless, over the next few quarters, the company is expected to gradually demonstrate an enhanced ability to generate cash, optimize its debt, and efficiently manage the cash from its subsidiary companies.
Consequently, within the next 18 to 24 months, this restructuring process should positively impact Eletrobras' financial position.
It is important not to underestimate the risks and uncertainties associated with the Direct Action of Unconstitutionality filed by the Federal Government in the Supreme Court. This action pertains to the Federal Government of Brazil's voting rights limited to 10%. If this led to the reversal of Eletrobras' privatization, it could have catastrophic consequences for the company's restructuring process.
Valuation: Still Trading at State-Owned Companies Multiples
At the current price levels, Eletrobras is trading with an Implied Internal Rate of Return of 14% in real terms, significantly higher than the 5.5% offered by NTN-Bs (Brazilian government bonds). Furthermore, Eletrobras trades at a Price-to-Book (P/B) multiple of just 0.8x. This valuation appears considerably depressed for a private electricity generation and transmission company in Brazil compared to publicly traded companies like Companhia Paranaense de Energie - Copel ( ELP ) and Companhia Energética de Minas Gerais - Cemig ( CIG ), trading at 1.1x P/B.
Typically, private utility companies command higher Price-to-Book ratios, with some reaching as high as 3.9x P/B, as observed in the case of Engie do Brasil ( EGIEY ) and other international peers such as EDP - Energias de Portugal ( EDPFY ), along with its subsidiary in Brazil, EDP Brasil, trading at 1.5x. The American company Duke Energy also trades at a premium of 1.4x.
It's noteworthy that despite being privatized for almost a year, Eletrobras is still trading at a valuation level characteristic of a state-owned company. This is the case even though it is a private entity undergoing a significant transformation.
The Bottom Line
In the third quarter of 2023, Eletrobras delivered strong results from a recurring regulatory perspective. The notable increase in net revenue was primarily attributed to the readjustment of the Annual Permitted Revenue ((RAP)) for transmission, which resulted from the commencement of the 2023-2024 cycle in July.
The company's efficient cost management and reduction in operating provisions significantly drove substantial growth in recurring EBITDA. Eletrobras has also initiated a reduction in its workforce and effectively handled legal liabilities, leading to a decrease in the stock allocated to Compulsory Loan actions.
As Eletrobras progresses with its internal restructuring, it has optimized its capital allocation. This is expected to yield positive results in the upcoming quarters, with an improved outlook for the company's capital in 2024. While political risks, including the possibility of renationalization, still exist, the more optimistic thesis should be closely monitored, as regulatory risks could be pivotal.
Nevertheless, given that the company's stock price has remained subdued throughout 2023 due to political uncertainties, the current substantial undervaluation in comparison to both private and state-owned peers represents, in my opinion, a low-risk opportunity for investors. Consequently, I am revising my prior neutral stance to a bullish outlook on Eletrobras.
For further details see:
Eletrobras Q3 Earnings: Time To Turn Bullish