Eletropaulo Tops Short Sales as Expenses Surge: Corporate Brazil

Eletropaulo Metropolitana Eletricidade de Sao Paulo SA is Brazil’s most shorted stock, signaling investors expect the company to plunge further after the government forced it to cut prices and its costs surged.

The ratio of borrowed shares -- an indication of short selling -- in Brazil’s largest power distributor is almost 25 percent, the highest among companies on the benchmark Bovespa index, data compiled by Bloomberg show. The ratio reached almost 30 percent, the maximum level allowed, on Feb. 26, the day the Sao Paulo-based company reported quarterly earnings.

Eletropaulo is struggling with ballooning costs after the government forced it to cut electricity prices by 9.3 percent even as its own expenses to buy the power surged. The move triggered a selloff that made it the second-worst utility in the 824-member MSCI emerging markets index in the past year, returning 73 percent for short sellers. Eletropaulo risks breaching debt covenants for a second quarter as cash flow drops and costs rise, analysts at JPMorgan Chase & Co. and HSBC Holdings Plc say.

Leverage will “explode” this quarter because of the rate cut and energy costs, Pedro Manfredini, a JPMorgan utilities analyst who rates Eletropaulo a sell, said by phone from Sao Paulo. “For the first quarter we see a worse Ebitda number than in the fourth. There will be a negative Ebitda number.”

Fourteen of the 22 analysts who rate the company recommend selling Eletropaulo stock. Eight say hold and none say buy.

Eletropaulo rose 0.4 percent to 10.48 reais at 3:36 p.m. in Sao Paulo trading.

Debt Covenants

Net debt last quarter soared to 4.9 times the company’s earnings before interest, taxes, depreciation and amortization. That’s more than double the median for emerging-market utilities and higher than the maximum 3.5 ratio that’s allowed under the terms of the company’s outstanding bonds.

The utility is meeting with bondholders on March 26 to renegotiate the terms of its debt, just seven months after selling 750 million reais ($373 million) of bonds. The company, which in August issued the floating-rate notes due in 2018, is scheduled to make the first coupon payment on April 9.

Eletropaulo’s press office declined to comment in an e-mailed response to questions.

Other companies are facing having their rates cut in regular four-year reviews by the government. Brazil’s electricity regulator said this month it lowered the preliminary asset valuation to be used in the review for Cia. Energetica de Minas Gerais, Brazil’s second-largest power company by market value. Cemig, as the Belo Horizonte-based company is known, makes about two-thirds of its revenue from distribution.

Hydropower Shortage

Eletropaulo and other distributors, including Rio de Janeiro-based Light SA, have been hit by rising costs since generators were ordered in October to switch on thermal plants to preserve dwindling reservoirs at hydropower plants. Thermal plants produce electricity from coal, oil and natural gas that can cost eight times as much as hydroelectricity, according to HSBC.

Distributors, which buy the thermal power at variable rates and resell it at fixed rates, will have to shoulder the losses until their next annual rate review. Companies have lost at least 5 billion reais since October, the distributors’ association known as Abradee estimates.

The government announced March 8 that it would help distributors by using a special industry development account to offset the costs.

Ebitda Loss

“Even with the government help, it’s very likely that Eletropaulo will surpass the leverage levels again,” Eduardo Gomide, an utilities analyst at HSBC who rates Eletropaulo as a sell, said in a phone interview from Sao Paulo. “It is possible they will negotiate a new level.”

Eletropaulo posted an Ebitda loss of 14.5 million reais in the fourth quarter, compared with positive Ebitda of 1.13 billion reais a year earlier, according to Bloomberg data.

Even with weak results, short-selling the stock is risky after it already plunged more than peers in the past year, according to Saulo Sabba, who oversees 350 million reais as chief investment officer at Banco Maxima SA.

Eletropaulo “has dropped so much that if you run the risk of shorting it, it’s concerning,” Sabba said by telephone from Rio de Janeiro. “I at least wouldn’t venture to be short. If you are short, the only way to win is for it to drop.”

Naked Short-Selling

Regulations in Brazil prohibit so-called naked short-selling, when traders short shares without actually taking possession of them. Investors in Brazil borrow stock to use for short-selling, hedging and tax purposes. Short selling allows traders to profit from drops by selling stock and buying it later at a lower price.

Brazil on March 15 increased the maximum amount of a company’s free-floating shares to be borrowed on any given day to 50 percent from 30 percent. Eletropaulo neared the previous limit between Feb. 22 and March 1, when short sellers traded more than 29 percent.

“Eletropaulo is going through difficult, challenging times,” Manfredini said. “It’ll need patience from creditors to get some sort of waiver for the covenants.”