Central Puerto S.A.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Central Puerto S.A. is Argentina’s largest private-sector power generation company, operating thermal, hydro, wind, and solar power plants across the country.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Central Puerto S.A. (CEPU), the largest private power generation company in Argentina, primarily operates in the generation of electricity, providing energy to the Argentinean wholesale electricity market. The company’s power generation mix includes thermal, hydro, wind, and solar plants.

The company also participates in commercial operations and may enter into contracts for the direct sale of energy.

  • Revenue Distribution: CEPU’s revenue streams are primarily derived from:
    • Generation: The sale of electricity from the company’s power plants to CAMMESA, the Argentine wholesale electricity market.
    • Power Purchase Agreements (PPAs): long-term contracts with distribution companies where energy price is contracted
    • Auxiliary and other services: The revenue from the sale of power-related services and other products

  • In 3Q24, approximately 60% of power sold was through “Priority” and “Base” contracts at regulated prices while approximately 40% was sold on the spot market, where prices fluctuate with market conditions. However, given the high inflation regime in Argentina, even regulated prices are usually adjusted frequently.

  • Industry Trends: The Argentinean energy market is undergoing changes as the government seeks to promote renewable energy, increase energy efficiency, and ensure energy security. However, the energy sector in Argentina has also faced economic hurdles, with frequent price freezes and regulatory uncertainties impacting profitability.

  • The current trends are towards more renewable energy, and more flexible contracts. The country is also trying to fix the energy transmission and infrastructure problems.

  • CAMMESA (the wholesale electricity market operator), has become more strict regarding quality and payment procedures. Also, they are increasingly incentivising production on renewable assets.

  • Margins: CEPU’s profitability depends largely on its operating costs, particularly fuel costs for its thermal plants (which fluctuate with commodity prices). While the company tries to use a combination of fuel-source strategy to try to avoid large price increases, and reduce costs, it’s operating profitability is affected by macro conditions.

  • CEPU has struggled with a volatile financial performance in the past, driven by lower hydro generation and a general slowdown in consumption.
  • Competitive Landscape: CEPU operates in a competitive market with other power generators, both public and private, in Argentina. They have been actively acquiring new assets, mostly from companies they perceive have had poor financial performance. This means they will be competing with companies with better capital structure.

Moat Analysis

CEPU’s moat is rated as 2 out of 5 based on the following assessment:

  • Barriers to Entry: The power generation market has some barriers to entry.
  • Existing facilities (especially the large ones) are subject to regulatory procedures to be built, requiring high levels of experience, and usually several permits. However, after some projects have already secured their permit, the government tends to auction them and other investors can buy these.
    • Large energy infrastructure projects require high investment costs and sophisticated technological expertise, potentially reducing the number of new entrants.
  • Switching Costs: While CEPU has a wide client portfolio of power distribution companies, it may not benefit directly from high switching costs. These power distribution companies may not have a contractual obligation to purchase power directly with CEPU, as the Argentinian market is a wholesale market.
  • Intangible Assets: CEPU controls its own fleet of power plants, and they have some goodwill. Some wind and hydro projects have a higher value and are hard to replicate. Some of their properties are also close to high areas of energy consumption (like Buenos Aires), making them strategically located.
  • Cost Advantage: By controlling its own fleet of power plants, and by having some hydro or wind capacity that have low operational costs, CEPU can have certain cost advantages over its competitors.

Risks to the Moat

The risks to CEPU’s moat and business include:

  • Regulatory Changes: The Argentinean government frequently changes the regulatory framework in the energy industry, potentially affecting CEPU’s profitability and returns.
  • Economic Instability: Argentina’s economy is highly volatile, with high rates of inflation and currency devaluation that can reduce the real profitability of a company and increases investor risks.
  • The high currency devaluation makes debt denominated in US dollars (a large portion of the company’s debt) to rise in value in peso terms.
  • The high inflation means that many costs must increase to preserve real value, yet the rates the energy is sold at are highly regulated and can be harder to increase.
  • Industry Trends: There are global and local pushes toward cleaner energy sources, which may hinder CEPU’s growth in its traditional thermal and hydro assets.
  • Competition: CEPU competes with other large companies for market share, including more efficient and sustainable ones.

  • Weather Conditions: The hydro plants are highly dependent on rain, which has been scarce lately, reducing their capacity and profitability. This affects revenues and profitability. Also, drought conditions can make operations difficult to conduct and may disrupt operations.

  • Business Resilience: CEPU has shown some resilience in the past when faced with adverse market conditions. Despite having suffered high revenue losses in the past, the company still managed to generate profits, which speaks to the durability of the business model. However, if all other conditions are met, the company may struggle to perform its activities properly.
  • Given that a large portion of the company is related to state energy policy, the company can be considered to be a quasi-governmental organization and this may make it less susceptible to failure.

Financial Analysis

CEPU’s financials are complex due to high inflation and foreign currency volatility, but some key observations from the latest 3Q24 earnings include:

  • Revenues:
    • Revenues increased to ARS 198,553 million in Q3, up 14% compared to the same period in 2023, and reached USD 523 million. However, the increase is primarily due to increased spot-market revenue.
    • While regulated revenues are stable, market price fluctuations create volatility in reported revenue and net income.
  • Costs: Operating costs, excluding depreciation and amortization, increased 20% to ARS 61 billion, and SG&A expenses also increased. This was mainly due to a non-cash impact of currency devaluation (and inflation).
  • Profitability: Despite revenue growth, the company reported a loss, with a consolidated adjusted EBITDA at ARS 158 billion (approximately USD 193 million). However, if we consider that there was a net financial gain of ARS 16 billion, the combined adjusted EBITDA and financial gain will be ARS 174 billion (USD 198 million), which shows that operations alone don’t produce good value. Net losses were at ARS 20 billion.
  • This shows that the company is dependent on financial maneuvers (such as tax credits), which are generally unsustainable in the long term, for overall profitability.
  • Debt: The company’s debt profile is a mix of US-dollar-denominated and Argentine-Peso denominated instruments.
  • Total gross financial debt was at ARS 548,901 million (USD 765 million), and a significant portion of debt is denominated in US dollars. This makes the company vulnerable to currency fluctuations.
  • The company has been using US dollar debt for a hedge against inflation and devaluation in ARS, however, it does add additional risks to the company.
  • Cash flow: The company reported a net decrease in cash position of approximately ARS 12 million (USD 12 million) during the quarter.
  • Key Metrics: The current ratio is at 1.6 and current liabilities are close to short-term assets, indicating some possible financial constraints in the future.

The company is a profitable business but it also is highly dependent on a volatile economy and regulatory decisions, making the financial statements difficult to forecast or even understand.

Understandability

The business is rated as 3 out of 5 for understandability due to the following reasons:

  • The basic aspects of power generation are not extremely complicated.
  • The complexity arises when considering the regulatory and financial hurdles faced in Argentina, making understanding the financials complex.

Balance Sheet Health

CEPU’s balance sheet is rated as 3 out of 5:

  • The company has more debt than it usually should, driven by its need to keep raising capital due to large investment projects.
  • The liquidity may be strained in the future, as its current assets aren’t way higher than its current liabilities. This leaves little room for maneuvering or unexpected changes in the market.
  • The company has significant exposure to exchange rate risk.

Recent Concerns

  • The company has been facing scrutiny for allegedly violating PPA terms. As a consequence, some distribution companies have reduced the payments to Central Puerto. If this trend continues, it may impact the company’s overall revenues and profitability, as a considerable amount of contracts are based on these types of agreements.
    • The management addressed these points by saying that they are exploring different ways to sell energy while having a more diversified portfolio of clients. *The Argentinian economy still shows volatile conditions, with inflation rates rising. The Central Bank of Argentina has been increasing the interest rates, making debt more expensive for everyone.
  • CEPU has a large expansion plan based on both organic and inorganic (acquisitions) growth. This might make the company more vulnerable to errors in acquisitions or other project-related costs in the future.
  • Management mentioned they believe their current stock is undervalued, but they haven’t yet announced a buy-back program.

Management also stated in the last earnings call that they are committed to: “increasing operational efficiency in all our facilities”, “continuing the commercialization of available energy” and “diversifying our customer base”.

Summary

CEPU’s potential is directly tied to the Argentinean economy and regulations. While the company does have some clear strengths, the regulatory and economic landscape in the country create a lot of uncertainties. The company does not have a large moat, due to its many threats and competitors, and the balance sheet is somewhat fragile, making it a relatively risky stock.