Cheapest Utility No Lure as Eletrobras Sinks: Corporate Brazil

The 54 percent tumble in Centrais Eletricas Brasileiras SA that has made the state-run Brazilian company the cheapest electric utility in the world is failing to persuade analysts to abandon their sell ratings.

Eletrobras, as the company is known, has the highest ratio of sell recommendations among all Brazilian stocks, three months after the government unveiled energy price cuts that the utility said will almost erase its earnings. Six of 11 firms, including JPMorgan Chase & Co. and Banco Itau BBA SA, have either advised clients to sell the shares or placed their ratings under review in the past six months, according to data compiled by Bloomberg.

The energy rate cuts, part of President Dilma Rousseff’s efforts to shore up economic growth, have driven electric utility stocks down 22 percent since August, more than 10 times the slump in the benchmark Bovespa index. While Eletrobras trades at 0.12 times its book value, the lowest ratio among the world’s 3,000 biggest companies by market value tracked by Bloomberg, it’s not cheap enough to compensate for the company’s earnings outlook, according to Banco Safra SA.

“The problem is they don’t manage to make profit out of their book value, that’s why the price-to-book value is quite low,” Sergio Tamashiro, an analyst at Banco Safra who has a recommendation equivalent to sell for Eletrobras, said in a phone interview from Sao Paulo. “There are doubts about returns.”

Interventionist Policy

The lower electricity rates will almost wipe away Rio de Janeiro-based Eletrobras’s earnings before interest, taxes, depreciation and amortization, Chief Financial Officer Armando Casado de Araujo said on a conference call with analysts Nov. 19. As part of the government’s energy industry changes, which were first announced in September and became effective Jan. 24, electricity rates were cut by as much as 32 percent.

Brazil amended electric utility contracts as Rousseff intervened in the economy to tame inflation and rekindle growth that economists surveyed by Bloomberg estimate slowed to 1 percent last year. The government also forced state-controlled oil company Petroleo Brasileiro SA to sell gasoline below market prices and pressured banks to reduce borrowing costs.

Market ‘Overreacts’

Finance Minister Guido Mantega said in a Feb. 26 interview at Bloomberg headquarters in New York that the magnitude of the Eletrobras selloff is unwarranted.

“The market always overreacts,” Mantega said. “Eletrobras is a strong company that has kept all its concessions for more than 30 years. It will continue investing. Stocks fall one day and rise the next.”

Shares rose 0.6 percent to 12.48 reais at 3:19 p.m. in Sao Paulo. The Bovespa index added 0.6 percent.

Eletrobras’s press office declined to comment in an e-mailed response to questions on the stock’s value.

Pedro Galdi, the chief strategist at Sao Paulo-based brokerage SLW Corretora, said Eletrobras may rebound if it is able to sustain an “attractive” dividend policy.

“It’s still too early to say now is a good time to buy, but I think we have to wait at least for its next financial report to see what’s really going on,” Galdi said by telephone. “The payout probably won’t be as high as it was before, but if it manages to convince investors that dividend will still be attractive, that could be a positive for the stock.”

Dividend Outlook

The effect lower electricity rates will have on the company’s dividend policy is one of the reasons Itau BBA rates Eletrobras underperform, meaning the stock is forecast to post lower returns than the market average.

“We remain skeptical about Eletrobras’s dividends, and continue to see the need for capital injection in order to accommodate the company’s heavy” investment plan, Itau BBA analysts Marcos Severine and Mariana Coelho wrote in the firm’s most recent report about the company, dated Dec. 3. The bank’s press office didn’t respond to an e-mail request for an interview with the analysts.

Gabriel Salas, an analyst at JPMorgan, who rates Eletrobras underweight, declined to comment on his recommendation.

Eletrobras’s dividend yield was 7.3 percent in 2011, compared with an average 4.2 percent among the Bovespa’s members, according to data compiled by Bloomberg. The company is scheduled to report its fourth-quarter earnings March 27.

While valuations may appear inexpensive, investors are still concerned about the changes Brazil imposed on the industry and the risk of similar interference in the future, said Fausto Gouveia, who helps manage about 380 million reais ($192.4 million) at Legan Administracao de Recursos.

Cost Cuts

“The government destroyed the electric sector,” Gouveia said in a phone interview from Sao Paulo. “It’s not clear if they achieved the results they were seeking when making the changes, or if something else will come after that. Prices may look attractive, but I don’t see a strong flow of buyers going to those stocks anytime soon.”

Eletrobras is planning to cut its workforce by as much as 15 percent as it tries to reduce costs to help compensate for the lower rates. The company may also sell assets under a corporate restructuring as it seeks to cut total expenses by 30 percent in the next three years, Chief Executive Officer Jose da Costa Carvalho told reporters in Brasilia on Feb. 20.

The utility “didn’t have a choice” other than to try to cut costs now that it sees lower rates pushing revenue lower, said Felipe Rocha, an analyst at Curitiba, Brazil-based brokerage Omar Camargo Investimentos.

New Plans

“Eletrobras is revising its plans and trying to cut costs,” Rocha said in a phone interview. “But as in most state-run companies, this will probably take some time to produce actual results. We’ll probably have to wait a few more months, maybe a year, to see if things are really moving forward.”

Because of the new electricity rate structure, it is difficult to assess the company’s valuation. The changes complicate profit projections because past results can no longer be used as a reference, said Henrique Kleine, the head analyst at Magliano SA brokerage.

“The company is in a totally different situation than it was six months or a year ago,” Kleine said in a phone interview. “It looks cheap, but it can get cheaper and cheaper. I’d stay away from this stock for a while.”

Before it's here, it's on the Bloomberg Terminal.