Tag Archives: management

COPEL Is Much More Stable Than CEMIG, But The Potential Upside Is Also Lower

Summary COPEL’s business is sound, with slow growth, low debt, a good dividend, good fundamentals and a good, stable historical performance. Due to the situation in Brazil, there is still more downside potential for the stock. CEMIG is a much more risky play, but the upside is also much higher. Introduction I recently wrote an article where I analyzed investment opportunities in Brazil that are listed on the NYSE and gave an overview of the economic situation. I found four interesting companies, of which BrasilAgro (NYSE: LND ) and Brasil Foods S.A. (NYSE: BRFS ) are good, but their P/E ratio is too high. This leaves us with two electrical companies, CEMIG (NYSE: CIG ) and Companhia Paranaense de Energia – COPEL (NYSE: ELP ). I have already written about CEMIG here and here , so in this article, I will analyze COPEL. About ELP ELP is the largest company of the State of Paraná (South Brazil), and serves electricity to 4,370,200 units. The company uses 18 hydroelectric plants that give 99.5% of its own electrical production, 1 thermal plant and 1 wind plant, with total installed capacity of 4,754 MW, a transmission system with 2,302 km of lines and 33 substations, a distribution system which consists of 192,116 km of lines and network of up to 230KV, and an optical telecommunication system. The company was founded in 1954, and has been listed on the NYSE since 1997. The State of Paraná is the major shareholder, with 58% of voting shares. There has been a lot of regulatory turbulence in the energy sector lately, especially with CIG losing 45% of its electricity generation capacity due to lost concessions. Energy prices increased and are currently under the red flag 3 regime, meaning that the electrical utilities sector is under pressure. The result of this is that ELP’s revenues increased 32% in Q2 2015, mostly due to price increases. Operating expenses increased even more, around 38% in the same period. The Business One of the main issues in the sector is that all the assets are mostly under concession from the government, but with the latest news on concessions, where the Federal Audit Court authorized the government to renew for another 30 years the concessions for electricity distributors whose contracts expire between 2015 and 2017, the situation is more stable now as compared to that a month ago. This is good news for ELP, as in the Q2 earnings conference call, the company did not know if its distribution concessions would be prolonged. As for electricity production, the situation with ELP is much more stable than it is with CIG, because ELP has only 5% of electricity production in doubt for 2015, whereas CIG had 45% of production in doubt, and eventually lost it. According to ELP’s CEO , the company will bid to renew the concessions and are pretty sure it will happen. The two plants in question are the Parigot de Souza and Mourão plants. ELP is also developing new projects, building 2,000 km of new distribution lines and developing new wind farms, with three new farms expected to start up in upcoming weeks. Fundamental Analysis The current P/E ratio is 7.91, and the price-to-book value is 0.6. In Table 1, you can see the main fundamental indicators for ELP and their stability in the Brazilian currency. Table 1: ELP Fundamentals 2010-2015 (Source: Morningstar ) In the Brazilian currency, ELP is able to transfer the increase in prices to its customers, which shows it to be a great hedge against inflation. The net income is pretty stable for a regulated electrical company, and it can be assumed with a high degree of certainty that ELP will continue to operate less or more positively in the future. The dividend is also stable, and the company has a policy of paying at least 25% of its net profits in dividends. This means that with the trailing earnings, an investor can expect minimally US$0.25 per share at the current exchange rate. This would give a 3% dividend yield at current prices and exchange rates. The gross margin is slowly deteriorating, but we can expect it to improve as soon as the extraordinary circumstances in the Brazilian energy market pass. Technical Analysis The main issue here is not ELP’s business or its fundamentals, but the volatility of the exchange rate between the US dollar and the Brazilian real. In Figure 1, you can see that an end to the depreciation of the real is nowhere to be seen. Figure 1: Brazilian real per US$1 from 2005 to 2015 (Source: XE.com ) I cannot predict what will happen here in the next few years. Currently, the situation in Brazil is far from stable, but in the period from 2009 to 2011, the real appreciated against the US dollar by 60%. We could say that there is blood on the Brazilian financial markets now, and usually, these are the best times to buy. But the main question is: How low can the real go? On the other hand, if we see an improvement in the political and economic situation in Brazil, the exchange rate trend would quickly switch and create a point of stability at a certain level. This trend reversal could give a 25% currency gain and add an extra 25% to the dollar EPS of ELP. This is a scenario that would easily create a 50% return for international investors. But we would need a crystal ball to know when the bottom will be reached in Brazil. Conclusion If ELP were a European or US company, I would probably buy it at these ratios, expecting a healthy 13% yearly return and a 3-4% dividend that would allow me to repurchase shares. With the uncertain situation in Brazil and the real depreciating at a 10% monthly rate (August and September 2015), I want a much wider margin of safety. The margin of safety that I would look for to feel comfortable investing in ELP would be one that gives me a 15% return even if the real depreciates by another 50%. This means that for US$1, we would get R$6. In such a scenario, ELP’s EPS would be US$0.66, and to get a 15% return, the P/E ratio should be 6.66 – meaning that a safe entry-level stock price for ELP is US$4.4. We are still far from that, but everything is possible considering the current situation. ELP is very stable, and Brazil is very unstable for sure in the short term, but potentially stable in the long term. Such a situation makes me believe that there might be a chance of the stock falling a little bit more, and thus, increasing the safety margin for investors. My advice would be put this company on a watch list, estimate your required rate of return for such an investment, adding to that the potential further depreciation of the real, and thus get to a safe entry price for yourself. Comparison with CIG ELP’s price-to-book ratio is 0.6, and CIG’s is currently at the same level. The P/E ratio is 8 with ELP and 3 for CIG, but with the unclear future earnings stream for CIG due to the loss of the concessions on 40% of its energy production, the difference is justified. I do not see potential spectacular earnings growth with ELP, because it is a stable company that aims for sustainable growth, whereas with CIG, everything is possible due to the management’s more risky approach to business. CIG has the potential to bring EPS to $US1.5 per share that would give a P/E ratio of 1.13 at current prices and a dividend yield of around 40%. The risk-reward ratio is 50% downside and 50% upside with ELP, while with CIG, it is 50-100% downside and 600% upside. I will continue to follow the two companies, and if the divergence between the perception the investor community has about Brazil and the businesses’ results continues to grow, thus lowering the potential downside, I will start buying. So, for now, I will put both companies on a watch list and let you know more in the future.

How Would Your Portfolio Do In A 50% Market Decline?

By Ron DeLegge Prudent investing in a reckless world has become a long-forgotten idea. And the 6-year run-up in U.S. stock prices (NYSEARCA: VOO ) has certainly been a contributing factor. After love, risk might be the most misunderstood and misinterpreted word in the English language. Today, people’s perverted sense of risk management is making sure they don’t miss the next big run in Netflix (NASDAQ: NFLX ) or Tesla (NASDAQ: TSLA ). Forgetting History People have let their guard down and are once again repeating the same mistakes investors in previous eras have made by underestimating the risk character of their investments. The only difference between now and previous bear markets like 2000-02 and 2007-09 is that everybody today is older and not necessarily wiser. As a result, I felt a certain obligation to help the investing public to have a multi-dimensional and complete view of their entire investment portfolio. But figuring out how to do it on just a single written page that anyone could understand took me years to develop. When I first introduced the idea of assigning a written grade to investors’ portfolios back in 2010, I had my doubts. Would people embrace my Portfolio Report Card concept? Would people send me their portfolio data for diagnosis? How would I fit their final grade onto just one page? Would my grading system be robust enough to work on all portfolios, regardless of the size and tax status? Would people be motivated to eliminate the weaknesses inside their portfolios identified by the Portfolio Report Card? A Crucial Grading Factor In case you didn’t know, risk is one of the most important grading categories of Ron DeLegge’s Portfolio Report Card grading system. And over the past year, I’ve diagnosed more portfolios than the typical investment advisor sees during their entire career. One of the most consistent patterns I’ve seen from the Portfolio Report Cards I’ve recently executed is that people are jacked up on risk because of overallocation to stocks (NASDAQ: QQQ ). Back on Aug. 18, 2004, Bridgewater Associates (run by billionaire Ray Dalio) made a similar observation and classified it as the “biggest investment mistake.” Bridgewater pointed out that over 80% of a typical investor’s risk is in stocks and that because of that overexposure, owning other asset classes like municipal bonds (NYSEARCA: MUB ), Treasuries (NYSEARCA: TLT ), and REITs (NYSEARCA: VNQ ) does little to balance out the portfolio’s risk profile. According to Bridgewater’s analysis, the overallocation to equities at the expense of other asset classes penalizes investors by roughly 3% in expected value, which could be used to cut risk. Put another way, Bridgewater’s original assessment of investors’ portfolios back in 2004 was true and it’s still true today. A Lazy Approach The fairyland idea that prudent risk management is simply a function of doing nothing during a dreadful bear market is popular but ignorant view. First, it incorrectly assumes that bear markets (NYSEARCA: SPXS ) will be short-lived. Second, it incorrectly assumes that bear markets will only happen during non-emergency moments or when we least need our money. More importantly, the do-nothing approach of “staying the course” badly misses in the biggest way because it erroneously assumes that Joe and Jane Investor have well-designed investment portfolios. My data shows quite the opposite; that Joe and Jane Investor have poorly constructed portfolios that are one-dimensional, under-diversified, and not the least bit equipped to deal with a severe market decline of 20% or more. Figure 3, which will be in my upcoming book, provides a sober look at the math of market losses. As you can see, if your portfolio suffers a 50% cut, you’ll need a 100% return just to get back to even. And since the velocity of bear markets happen faster compared to bull markets which tend to happen over a period of years, it often takes many years for an investor to recoup their losses – that’s if they ever recover at all. And that’s exactly why having a margin of safety within your portfolio is imperative. I am grateful to the many people – individual investors just like you – who have allowed me to analyze and grade their investment portfolios. I also want you to know that my Portfolio Report Card grading system just quietly passed a new milestone: over $100 million of investments have now been analyzed and graded. How would your portfolio do during a 50% market decline? Remember: Bear markets have happened in the past and will happen again in the future. And the time to find out if your investment portfolio is architecturally sound and read for the fire is before not after the market event. Original post Disclosure: No positions

SRV And SRF: Playing Games In Closed-End Funds

Summary Cushing Royalty & Income Fund and Cushing MLP Total Return Fund have both gone through a reverse stock split. The press release suggests it was done for shareholders. That’s sort of true, but you shouldn’t thank the CEFs for it. On September 14th, the Cushing Royalty & Income Fund (NYSE: SRF ) (now known as the Cushing Energy Income Fund ) and the Cushing MLP Total Return Fund (NYSE: SRV ) effected 1 for 5 reverse splits. That changes very little for shareholders except the price of the closed-end funds, or CEFs. That said, a higher price is better in some ways, but you still shouldn’t be thanking the funds for this move. What changes? The first thing to keep in mind with any stock split is that it does nothing to a shareholder’s ownership in a company. Your proportional ownership remains unchanged. So, in many ways, a stock split is mostly about theatrics. But that can be important. For example, some companies split their stocks two for one when the stock gets to around $100 a share. The idea being that people are more likely to buy shares in a company with shares selling at $50 than one with shares trading hands at twice that level. Maybe, maybe not… but clearly it’s about the show since the split would just turn a $100 share into two $50 shares. Reverse splits like the ones SRF and SRV just did are a bit trickier. Sometimes a company’s shares are trading at such low levels that they risk being delisted by their exchange. In that case, the split has a very real purpose, but that’s normally only an issue that impacts true penny stocks. In other cases, the move is just a show. Investors often avoid low-priced companies because of a concern over the risk of owning a company with a low share price. Institutional accounts, for example, often have minimum share price limitations. That’s not an unfounded fear, but it isn’t always realistic either. So companies with relatively low share prices will sometimes do a reverse split to prop up the price to attract more investors. Reversing the above example, a company that did a one for two reverse split would simply take two $50 shares and turn them into one $100 share. An Investor’s stake in the company isn’t altered, just the share price and the number of shares he or she owns. What about SRF and SRV? So a split doesn’t really change anything, even though there may be good reasons to do them. Are there bad reasons? The answer is yes. The reverse split at SRF and SRV has been billed as: The intent of the reverse share split is to potentially increase the Fund’s market price per common share and trading volume, thereby reducing the per share transaction costs associated with buying or selling the Fund’s common shares in the secondary market. Sure, with a higher share price, it may be easier to trade SRF and SRV. But that’s not likely the reason for the split. Although neither was at the point where you’d worry about a delisting, both were at the point where investors could reasonably be scared off by the low price. So the reverse split makes both SRF and SRV appear a bit more respectable. The problem is that both have made material use of return of capital in recent years. In fact, SRF has supported its distribution with nothing but return of capital since its initial public offering in early 2011. The net asset value, or NAV, fell from roughly $23 a share at the IPO to $5.60 at the end of May. By the time of the split, the NAV had fallen even further, falling into the $3.80 a share range. That’s brutal, particularly for a fund that’s only provided return of capital to its shareholders. The fund’s goal , by the way, is to seek a high total return with an emphasis on current income. I’m hard pressed to see how it’s lived up to that objective. SRV has done a little better, with its NAV falling to the $3.75 a share range before the reverse split from around $5.75 or so in late 2009. However, the high in the period was an NAV of around $8. So for many investors the NAV drop has been pretty harsh. And return of capital has been a big part of the distribution, representing roughly 60% of the disbursement between December of 2009 and May of 2015. That’s not a good number, but, to be fair, not nearly as bad SRF’s 100%. No dividend cuts, yet… At this point, neither fund has enacted a distribution cut. But with SRF offering a yield of over 15% and so much return of capital, I wouldn’t expect the payment to hold up. And if it does, then the split was cosmetic in that it helps to hide the fact that the fund has basically been self-liquidating since the day it came public. Based on the numbers, I just find it really hard to buy into the “ease of trading” logic the fund is using to justify the reverse stock split. SRV’s reverse split doesn’t look quite as bad, since the CEF yields around half as much as SRF. That could actually be sustainable, but only if the oil and gas sector on which the fund focuses turns around. If that doesn’t happen soon, the note in the split announcement highlighting that the September distribution was expected to be all return of capital is a not-so-subtle problem. And it could just get worse if low oil and gas prices force more dividend and distribution cuts in the oil and gas sector from which SRV generates its income. So SRV will be “easier to trade” too. But bumping up the share price via a reverse stock split still looks more like an attempt to paper over the trouble brewing with the distribution and NAV. Not where you want to be SRF and SRV are focused on a rough area of the market. If you are a contrarian that might interest you. But the high levels of return of capital for funds that have seen their NAVs fall dramatically should be a big concern. And the reverse stock split does nothing to change that dynamic – unless potentially large distribution cuts are made. The reverse split will probably make it easier to trade SRF and SRV, as the CEFs suggest. However, the splits look more like an attempt to cover deeper problems to me. I would avoid this pair. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) 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.