Centrais Elétricas Brasileiras S.A. - ELETROBRÁS

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 3/5

Brazilian Electric Power Company (ELETROBRÁS) is a state-controlled electric utility company in Brazil, primarily engaged in power generation and transmission.

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.

Eletrobras, as a state-controlled company, is navigating a complex regulatory landscape, which introduces unique risks and opportunities.

Business Overview

ELETROBRÁS is a major player in the Brazilian energy sector, focusing on electricity generation, transmission, and distribution. Here’s a breakdown of its business:

  • Generation: ELETROBRÁS is a major generator of electricity, primarily through hydroelectric plants, with some thermal and nuclear power assets. This segment is a big contributor to the company’s revenues and is significantly impacted by the hydrology of the river systems used by its dams and climate.
  • Transmission: The company operates a nationwide transmission network, which carries high-voltage power from generating stations to distribution companies, connecting Brazil’s disparate regions. ELETROBRÁS is responsible for much of the Brazilian high-voltage transmission system.
  • Distribution: ELETROBRÁS is a partner with several distribution companies in brazil and has the control over the management of some of them, however, most of the distribution is decentralized and done by private companies and local government entities.

The Brazilian government’s energy policy is very much linked with the company’s financials as well as its future.

The Brazilian electricity sector is undergoing significant transformation. Here are some key trends:

  • Growth in Demand: Electricity consumption in Brazil is expected to increase, driven by economic growth and a rising population.
  • Shift to Renewables: Brazil is increasingly focusing on renewable energy to reduce reliance on traditional sources, as part of its environmental commitments.
  • Increased Private Participation: The government is also increasingly allowing the participation of private entities in power generation and distribution, in an effort to increase efficiency and access to capital.
  • Regulatory Changes: The sector is heavily regulated, with frequent changes in rules, tariffs, and legislation. This regulatory uncertainty presents a degree of unpredictability.

Competitive Landscape

ELETROBRÁS operates in a competitive landscape alongside private companies. These companies may operate in generation, distribution, and/or transmission. Some key aspects of the competition include:

  • Diverse Player Base: The competition in Brazil’s energy market ranges from large state-controlled companies to private national and international energy producers.
  • Consolidation: Despite the diversity of players, the sector is seeing increased consolidations in all areas, for example, the recent buy-out of large private companies like CELG by a single player. This may reduce competition.
  • Price Competition: Competition occurs in prices (especially in generation and distribution), in the process, and in the quality of service (especially transmission).

What Makes ELETROBRÁS Different

ELETROBRÁS is a state-controlled company with significant financial assets and liabilities and is the biggest electricity generator in the nation. These features set it apart in the following ways:

  • Scale and Scope: As the largest electrical utility company in Brazil, ELETROBRÁS has a large and far-reaching national infrastructure and a dominant market presence.
  • State Control: As a majority state-controlled company, ELETROBRÁS’s strategies are often driven by the national interests of Brazil, in addition to the financial interests of the investors.
  • Emphasis on Hydroelectric Power: The company heavily relies on hydroelectric power for its generation capacity, making it sensitive to the effects of weather patterns and rainfall levels.

Financials

The company has presented its financials until December 31, 2022. A few key points are:

  • Revenue Growth ELETROBRÁS’s revenue has grown in 2022 compared to 2021 from 60B to 70B BRL. The increase in electricity consumption is expected to drive the future growth.
  • Net Income: Net Income also increased in 2022 compared to 2021 but in a lower rate compared to revenues, from 6B to 6.3B BRL.
  • Expenses: A big portion of the expenses are related to operation and maintenance as well as with fuels used by the thermoelectric plants and nuclear plant, these expenses are quite sensible to the inflation and energy prices, the company had a 12.7B BRL expense with fuel and an overall operations and maintenance expense of 15.2B BRL.
  • Investments: ELETROBRÁS invests heavily in property, plant, and equipment (PP&E). In 2022 they invested more than 10B BRL in PP&E, most of which was related to investments in other companies as part of the privatization effort.
  • Liabilities The company has a lot of long-term debt (more than 20B BRL) and financial liabilities (more than 30B BRL). They also carry a considerable amount of provisions (more than 20B BRL).

The company’s financial results in 2022 were greatly affected by the company’s privatization which also included a considerable amount of assets being sold and written off.

Moat Analysis

Based on the given resources, ELETROBRÁS appears to have:

  • Limited Intangible Assets: The company does not possess a great level of intangible assets, other than its brand. However, unlike Coke and Pepsi, it is not particularly a brand-oriented company, since its market (electricity distribution) is more of a commodity.
  • Low Switching Costs: ELETROBRÁS has, directly, no customers and no switching costs since consumers don’t choose the power provider, rather they choose their electricity distribution company. However, as a power provider, contracts are hard to change and the current market conditions do not favor the switching costs of such contracts.
  • Weak Network Effect: ELETROBRÁS’s transmission network does provide a network effect in its sector, however, the connections are not exclusive and other competitors may still be able to form other networks and connect to them.
  • Limited Cost Advantages: There is no evidence that ELETROBRÁS consistently operates with a lower cost than its competitors, but since it is state-controlled, the company may have access to government subsidies which would provide a cost advantage.

Based on these factors the moat is deemed narrow. It is not enough to give it a strong advantage but enough for it to be somewhat profitable. So it is a 2/5.

Risks

Here are the risks that could impact the company’s performance:

  • Political and Regulatory Risk: The biggest risk factor for the company is the strong influence of the Brazilian government in the company’s operations and financials. The price controls can significantly affect the company’s profitability and the sector can have an unfavorable shift from the government if it stops subsidizing the company. The government also sets the terms for the concession contracts which can negatively impact the company’s ability to generate profit.
  • Hydrological Risk: Given its strong reliance on hydroelectric power, changes in rainfall patterns can directly impact its production levels.
  • Debt Exposure High debt levels, especially in foreign currency, may expose ELETROBRÁS to financial risks.
  • Competition: Competitors may start gaining a competitive advantage. With increased privatization, local and international players might compete more actively and reduce profitability, as it may be hard to match cost reductions and innovative strategies.
  • Currency Risk: Since the company has loans in other currencies and also assets abroad, exchange rates may significantly affect the company and its financials.

Business Resilience

ELETROBRÁS’s core business in an essential industry provides some resilience, as electricity is essential for industrial and personal use. Also, its operations are partially insulated by its contracts and the national interest. But the level of volatility and the complex landscape could cause significant issues for the company.

Understandability: 4 / 5

ELETROBRÁS’s core business of electricity generation and distribution is relatively easy to understand. However, its structure as a public-private partnership with complex regulations and contracts complicates the assessment. The nuances of power production, regulations, and the impact of macroeconomic factors on the financial statements also make the company difficult to follow.

Balance Sheet Health: 3 / 5

ELETROBRÁS’s balance sheet is considered mixed, and a 3/5 rating is warranted. The company has a large amount of debt and liabilities, particularly after the privatization, which does create risk. However, it also has solid assets that create a strong base for its business. The financial situation is complicated and must be closely monitored, but not in any way critical.

Recent Concerns and Management Stance

  • Privatization: ELETROBRÁS underwent a major privatization process where the government sold parts of its ownership to private entities, this created a new scenario in the financial conditions of the company and it also introduced several risks that management must navigate. This seems like the main focus of the company, to stabilize after the privatization.
  • Debt Burden: Despite the privatization effort, the company is still carrying a lot of debt, particularly in USD, which represents a major concern given potential adverse movements in forex rates. Management is looking to reduce the debt and its interest rates.
  • Regulatory Uncertainty: Changes in regulations are likely to continue impacting the sector and ELETROBRÁS in the coming years. This requires management to be adaptable and forward-thinking.