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Enersis Is A Defensive LatAm Play With Attractive Yield And Significant Growth Potential

Enersis S.A. (NYSE: ENI ) Fundamentals (FYE- Dec. 31 st ) Enersis S.A. is a Chilean integrated electricity holding company and a subsidiary of Italy-based multinational energy group Enel (60.6% stake). Enersis is the largest private power platform in Latin America owning 17.3 GW of installed generation capacity spread between Chile, Argentina, Brazil, Colombia and Peru. Enersis controls six distribution companies that service 15.1 million clients: Chilectra (Chile), Ampla and Coelce (Brazil), Edesur (Argentina), Edelnor (Peru) and Codensa (Colombia). Enersis’ main subsidiary is listed generation company Endesa Chile (60% stake). Enersis corporate restructuring – The spinoffs will become effective in 1Q16, creating six companies: ENI Chile and Americas, EOC Chile and Americas, Chilectra Chile and Americas. ENI Americas will launch a tender offer for EOC Americas’ minority shareholders in 2Q16. The second EGMs to vote the merger of the Americas entities to create ENI Americas will occur 90 days after the split – 60 days of trading plus 30 days prior to the session. Minority shareholders will have a withdrawal right period of up to 30 days after the second round of EGMs. The merger of Enersis Americas is expected to complete in 3Q16 (around July/August). In order to persuade the AFPs (Chilean managers of pension funds) to vote in favor of the restructuring, which proved successful, ENI’s Board of Directors resolved to amend the proposal for the tender offer for EOC Americas’ shareholders (post-split), raising the price from CLP (Chilean Peso) 236/sh to CLP285/sh. Financials FYE- Dec. 31 FY10 FY11 FY12 FY13 FY14 In US$ mn Revenue 9,393.9 9,352.9 9,297.20 8,965.86 10,381.96 Revenue growth (%) 1.41 (0.44) (0.60) (3.56) 15.79 Gross profit 3,817.4 3,746.8 3,492.8 3,966.7 4,113.4 Gross profit margin (%) 40.6 40.1 37.6 44.2 39.6 Operating profit 2,439.2 2,241.7 2,105.0 2,491.9 2,562.5 Operating profit margin (%) 25.9 23.9 22.6 27.8 24.7 Net profit 695.9 537.4 540.1 942.5 873.3 Net profit margin (%) 7.4 5.7 5.8 10.5 8.4 EPS (GAAP) 1.04 0.80 0.83 0.96 0.89 Dividends per Share 0.33 0.53 0.41 0.30 0.48 Capital Expenditures 1,003.5 978.7 1,008.2 1,106.0 1,554.9 Cash & ST Investments 1,387.1 1,747.3 1,445.9 3,375.1 2,570.1 Total Assets 18,614.4 19,656.3 18,958.8 21,722.7 22,787.1 Total Debt 5,269.3 5,643.9 4,778.7 4,971.8 5,132.7 Total Equity 5,346.4 5,575.7 5,572.9 8,828.6 8,876.4 ROA 8.40 6.53 6.62 7.83 6.62 ROE 13.41 9.84 9.69 13.09 9.86 No. of Employees 12,264 10,844 11,087 11,574 12,275 Competitive Advantage The company owns a difficult-to-replicate network of transmission and distribution assets providing essential electricity to its customers. Its hydroelectric generating plants, around 50% of its generating fleet, are some of the lowest cost power-generation sources and have extremely long operating lives. Chile represents almost 25% of consolidated EBITDA net of minority interest and is widely recognized as the most stable market in Latin America. It also has the region’s most predictable and reliable regulatory framework. Enersis’ true earnings power has been masked by recent droughts in several countries and hence gross margins are expected to improve once normal rainfall returns. Major Risks Hydrology risks – In a scenario of continued scarce rainfall, lower hydro load factors would be compensated by higher thermal load factors leading to higher expenses and lower margins Deteriorating Brazilian economics and utility sector fundamentals – Further deterioration in macroeconomic conditions in Brazil, power rationing and unfavorable regulatory changes are some of the risks that could negatively impact and may lead to substantially lower demand Rationing in Chile – A scenario of extremely low rainfall and thermal shutdown (due to unavailability of fuel) could lead to power rationing which would negatively impact the company Corporate restructuring remains an overhang Outlook Targeting growth in Brazil – Enersis has US$1.2B left from the 2012 capital increase to be used in M&A in Brazil, and the company’s priority is to grow in the distribution business. Its holding is targeting distressed distribution concessions from Eletrobras (NYSE: EBR ) that is likely to be privatized in 2016. The first in the pipeline is Goiás-based disCo Celg whose lengthy privatization process has just kicked off. Brazil is expected to be the main growth platform for the future Enersis Americas, as Colombia and Peru impose market share restrictions for the company which restrict growth potential while Brazil doesn’t have such restrictions. Colombia and Peru forbid Endesa Chile from having a market share in generation of more than 25%. Enersis has a market share of 22% in the Colombian generation sector and 24% in the Peruvian sector, and hence, Enersis could add no more than ~470 MW in Colombia and ~100 MW in Peru, while in Brazil, the growth potential is hypothetically unlimited. Environmental and social issues in Chile limit the approval and construction of new generation projects while Argentinean macroeconomics remained as an impediment to new investments in the past several years. Sound dividend stream in the near future – Post the conclusion of El Quimbo (late 2015), the only Greenfield project under construction will be Los Cóndores which is expected to start-up in late 2018/early 2019 with a capex budget of US$662M to be spent over four years. Hence, a boost in cash flow generation that should allow Endesa Chile to pay higher dividends, with an estimated dividend yield of 3-4% from 2016 onwards, could be attractive to defensive investors searching for yield. Investment Rationale & Conclusion LatAm consolidator poised to grow – Post the ongoing corporate reorganization, Enersis will focus on growth in Latin America and will prioritize Brazil which is hiking return rates for new investments. Low levered at 0.9x net debt/EBITDA, and with US$1.7B cash left from the 2012 capital increase, Enersis will also look for growth outside Chile and has declared interest in acquiring Brazilian distribution assets. Argentina is an important optionality for Enersis – The Argentine generation units El Chocón, Endesa Costanera and Dock Sud represent 26% of Enersis’ generation capacity but only 6% of the genCo business EBITDA. The distribution company Edesur accounts for 24% of Enersis’ distribution sales volumes but contributed with only 10% of consolidated disCo EBITDA in 9M15, and hence, its margins in Argentina are expected to significantly improve over the next few years. Enersis’ stock provides an attractive valuation and, most importantly, offers the greatest upside potential coming from regulatory improvements in Argentina and growth in Brazil (Greenfield and brownfield projects). It provides a direct exposure to the benefits of El Niño and recovering hydrology in Chilean utilities. Colombia and Peru are expected to outperform their South American peers in terms of GDP and power demand growth, offering opportunities for Endesa Chile which is the most relevant player in both countries behind the local players. Enersis currently trades at $12.77 (closing price as of Feb. 22, P/E TTM of 11.76), with its 52-week range of $10.33-$18.72, and looks attractive with strong potential to outperform over the medium to long term for reasons outlined below – The impact of a stronger El Nino phenomenon will results in normal rains and will decrease operational expenses, resulting in higher margins. Margin gains resulting from lower fuel prices to drive profitability. Significant potential from Brazil and Argentina markets to drive growth. Endesa’s experience and track record in Peru and Colombia will be key drivers for capturing growth opportunities in those markets. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: References : Company Annual Reports, Company Press Releases, Investor presentations, SEC Filings -Form 20-F and 6-K, Morningstar, BNamericas, Yahoo Finance

Top 10 Drivers Of Valuation

Business Valuation Framework Over the years I’ve spent a lot of time thinking about and working on business valuations across a broad range of transactions. Given that I’m a visual learner, I thought it would be helpful to illustrate my thoughts in a diagram. Click to enlarge Source: CFI Top Down vs. Bottom Up As I look at the diagram it logically flows from top to bottom, however, when building a financial model to value a business I usually think about it bottom up, and in an iterative way. I start in the bottom left corner of the diagram with historical financials, working my way up to the top, then back down again to build the forecast financials (and repeat the process again). 1. Historical Financials The first place to start when valuing a business is usually with historical financial statements. The past matters a lot when performing a valuation as it informs a view of the future and what’s realistically possible. The future, of course, is heavily influenced by what the company’s assets, management team, competition and markets will do going forward. 2. Assets Examining the asset base in conjunction with the historical income statement will paint a picture of the business’ ability to generate a return on those assets (“ROA” net income divided by total assets), and most importantly, generate free cash flow (operating cash flow less capital expenditures). When evaluating a business’ assets it’s important to look at both tangible (property, plant, equipment, etc.) and intangible assets (brands, customer lists, intellectual property, etc.). 3. Management Track-record Assessing management can be quite challenging, especially if you don’t have the opportunity to meet them in person (which is the case for most retail investors). An easy way to evaluate their performance is to look back at historical guidance (if a public company) and measure it against results achieved. Do you see a consistent trend of missing, meeting, or beating guidance? Measuring the track-record combined with in-person meetings to assess integrity, honesty, work ethic, etc. will be the best way to decide whether you assign a “management premium” or “management discount” to the business. 4. Competition What is the current state of competition in this industry? Are barriers to entry high or low, and how much pricing power does the company have? Answers to these types questions (and others listed in the diagram above) will help shape your view of risk and the company’s ability to protect profits (which will be reflected in the forecast financials). 5. “Moat” Warren Buffett and Charlie Munger are notorious for buying business that have wide moats around them, or more literally, have durable competitive advantages. Examples of companies with big moats around them include Google (NASDAQ: GOOG ) (NASDAQ: GOOGL ) (Alphabet), railroad companies (infrastructure), Coca Cola (NYSE: KO ) (its brand), and business with network effects like Facebook (NASDAQ: FB ) and Amazon (NASDAQ: AMZN ). The wider the moat, the longer the company will be able to earn above average profits, and the lower the risk of the investment. The inverse it true for companies with little to no moat. 6. Culture & Strategy I group these two together because they are two of the main objectives of the CEO. Culture is critical as it drives the “Why” of an organization (see Simon Sinek) and motivates people to create a business that can change the world (even if in some small way). Culture is also critical for driving company behavior such as honesty and integrity, which lowers the risk of the business. Next in importance is strategy (i.e. “strategy eats culture for breakfast” ?) as this will be critical in maintaining any durable competitive advantage that a company has, or is attempting to gain/increase. 7. Future Assets Based on the strategy of the business, what will the assets look like in the future? Will the company have to significantly invest to grow the asset base, and if so, what types of ROA will they earn? It’s important to think carefully about how much capital is required to sustain and grow the assets (based on the strategy) and how those assets will create value in the form of free cash flow generation. The details/inputs behind these assets will generate the “principles” or drivers of the financial model. 8. Forecast Financials With a deep understanding of the industry, management (culture & strategy), and the business’ assets it’s now possible to forecast future financial statements. A good model will dis-aggregate the various drivers of revenues, expenses, etc. and present them as inputs that can easily be changed. Depending on the industry or maturity of the business you may forecast out anywhere from 5 years to the end of an asset’s life. 9. Discount Rate Once the financial forecast is in place, setting up the discounted cash flow (“DCF”) model is just simple mechanics in Excel. The most challenging and subjective part of the DCF model is determining what discount rate to use. There are specific formulas you can use based on interest rates and relative volatility, but the essence of the discount rate is captured in most of the qualitative issues discussed above: stability of assets, durability of a moat, competence of management, risk of changes in competitive dynamics, and risk of changes in markets (i.e. government regulation). Taking all of these into account will determine what discount rate you think is appropriate to account for the riskiness of the investment. To the extent you have risk-adjusted the cash flows directly in the model (for the risks discussed above), you don’t need to include those risks in the discount rate (i.e. a perfectly risk adjusted cash flow forecast would be discounted at only the appropriate risk free government treasury rate). 10. Price The net present value (“NPV”) of future cash flows gives you the value of the business, but how much are you willing to pay for it? Value investors will typically want to build in a margin of safety (say 20-30%) by paying less than the intrinsic value. Other investors pay full value if they are willing to accept the discount rate as their internal rate of return (“IRR”). Investors typically look at comparable companies or past transaction (acquisitions) to see what other people are willing to pay for similar business (this adds an element of game theory or “greater fool theory” and moves away from intrinsic value). Conclusion This is how I think about valuation when building a financial model and I hope you found it insightful. I’m a visual learner and find it useful to organize mental models, like valuation, on paper. The key takeaway for me is that valuation is an iterative process — you really have to cycle through things like markets, competition, management, and assets multiple times before you can build a reliable financial forecast and discount it back to today. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.