Empresa Distribuidora y Comercializadora Norte S.A.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Empresa Distribuidora y Comercializadora Norte S.A. (EDENOR S.A.) is Argentina’s largest electricity distribution company, serving the northern part of the greater Buenos Aires metropolitan area.

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.

EDN’s core operations revolve around electricity distribution, a regulated utility service. This means the company doesn’t generate power but rather manages the electricity grid and deliver electricity to a diverse range of customers.

Let’s dive deeper into EDN’s operations and financials:

Business Overview

  • Revenue Distribution: EDN’s revenue is primarily driven by electricity sales to various customer segments: residential, commercial, and industrial. The company’s primary revenue is the regulated tariffs charged for electricity transmission and distribution. The amount of electricity demanded varies based on the weather and the economy in general, meaning it is slightly cyclical.
    • To understand this better, let’s see Exhibit 72 which outlines the annual electricity demand within the concession area which can help us determine fluctuations during the seasons.
    • Let’s also look at Exhibit 73 which highlights the different pricing models that exist within EDENOR’s business. The different price structures exist for a variety of electricity consumers, which are segmented to different types of categories. This chart is useful when it comes to understanding the different revenue that EDENOR earns from electricity sales.
  • Industry Trends: The electricity distribution industry is typically characterized by large infrastructure investments and heavy regulation. This sector also has a limited amount of competition, though technological changes like renewable energy integration, electric vehicles and smart grids are now pushing the boundaries of the industry, requiring utilities to adapt.
  • Margins: EDN’s EBITDA margins have shown some variability, and while revenue growth is generally quite stable (due to its essential service nature), this isn’t always translated into consistent profit margins. Inflation has been a significant factor in eroding some of the margins, so they have implemented adjustments and have been looking to reduce costs.
  • Competitive Landscape: Being a regulated electricity distributor within a concession area means that EDN does not have direct competition. However, the company’s operations are heavily regulated, which impacts profitability. The risk comes from the regulatory agencies potentially changing the amount of revenues that EDN is able to collect for providing electricity services, this is an essential risk to monitor for an investor.
  • What Makes EDN Different?
    • EDN has a very large electricity distribution network throughout Greater Buenos Aires, making them the go-to provider in the area.
    • A high degree of infrastructure investments have helped establish a stable and wide distribution throughout the Argentine Republic.
    • There are a number of long-term agreements in place with the Argentinian government, and these dictate the prices it can charge for the use of the infrastructure. This also establishes a high barrier to entry that is difficult for other providers to enter.
    • EDN is focused on integrating renewable technology into their energy grid. This focus helps with long term profitability and future demand growth.

Financial Analysis

  • Income Statement:
    • Let’s start with the revenue. The company had 930,000 million pesos in sales in the most recent fiscal year.
    • Going down the income statement, we find the cost of sales is 698,000 million which leads to 232,000 in gross profit, a decent margin.
    • Then, selling and administrative expenses were 129,000, leaving 103,000 in operating profit
    • The company recorded 26,000 in other operational income and (154,000) million in finance costs, resulting in 24,000 million in net income.

Given the heavy amounts of debt the company has taken to expand their operations, this high finance expense is not surprising. In the future, we would like to see this number reduce as their operations become more profitable.

  • Balance Sheet:
    • On the asset side, we see that they hold a sizeable amount of Property, plant and equipment of 1,272,000 million (with a lot of accumulated depreciation), along with other financial assets.
    • We also find they carry around 460,000 million in Current Assets, primarily in cash/equivalents.
    • On the liability side, Trade payables of 320,000 and total liabilities of 1,500,000 million. Equity is around 125,000 million.

The significant size of liabilities indicates a high degree of leverage, which is worth keeping in mind.

  • Cash Flows:
    • The most recent Cash flow statement shows operating activities generating $132 million.
    • Investing activities lead to cash outflow of $151 million.
    • Financing activities provided a net $20 million in cash flow.
    • The net change in Cash and equivalents is a loss of $3 million.

    These numbers reflect a company in a transitional phase, heavily leveraging debt to invest for growth.

Moat Analysis

  • Moat Rating: 2/5
    • While EDN enjoys a geographical and regulatory advantage, its competitive advantage isn’t that strong. Its economic moat relies primarily on its regulatory concessions and large infrastructure investments, creating barriers to entry in electricity distribution. However, this moat is very vulnerable to regulatory changes. The government sets tariffs, and they can decide what they will pay the business for its infrastructure. Hence, the sustainability of this moat is questionable.
    • A major portion of this rating depends on the strength of the long-term agreement with the Argentinian government. Any change to the structure of that agreement, or the terms, may affect EDN.
    • Finally, as a business, EDN doesn’t command a very large ROIC, and thus, even though it operates a critical infrastructure, its margins are too close to its costs for it to be deemed high quality.

Risks Affecting the Moat and Business Resilience

  • Regulatory Risk: As a regulated utility, EDN’s profitability is heavily dependent on decisions made by regulatory bodies that can change tariffs, investment levels, or financing.
  • Any change in the energy transition policies could also alter their operating profits and strategies.
  • Economic Risk: Argentina’s economy is known for fluctuating and high inflation which could affect currency valuation and cost structure.
  • Any future financial crises will almost certainly hurt the ability of the company to continue to make capital expenditure investments.
  • This is an important point since most of the contracts are priced in Argentinan pesos, and therefore EDN is highly exposed to the Argentinan economy, even though their assets are valued in USD.
  • A further decline in the Argentine peso, or hyperinflation, could significantly impair financial performance.
  • Macroeconomic Instability: The financial instability in Argentina could impact both revenues and cost, given it’s a domestic player in that market. This means a significant slowdown in GDP, or hyperinflation could easily harm profits and revenues.
  • Management Risk: Some of the acquisitions seem to have been overpriced based on their low profitability, thus, further investments and operational changes need to be seen from the company to maintain its profitability.
  • Technological Disruption: While EDN has plans for renewable integration, it’s possible that other sources of electricity generation might come along and disrupt the current power grid system.
  • The shift to localized and micro-grids is also worth noting, as the traditional business model might become less efficient if more businesses decide to operate their own energy grids.

Recent Controversies and Management’s Response

  • EDN is currently involved in a number of legal proceedings with some authorities, which is worth monitoring. Any negative impact from those proceedings could lead to uncertainty about their financial stability and agreements with the government. For context, one such claim is with CAAVSA, but the company believes they have abided by the agreement and have submitted the relevant evidence.
  • The company has highlighted a reduction in energy consumption from consumers, although it isn’t clear how exactly it is going to be affected, as the demand for electricity is difficult to predict.
  • Management notes that they are looking into alternative forms of revenue diversification to combat the cyclical nature of their main business (electricity distribution) and for opportunities to increase earnings.

Understandability Rating

  • 3/5
  • EDN is in a business that is easy to understand: It delivers electricity to the people of Argentina, and then charges for that. However, the way it creates value, specifically how the government negotiates pricing and long-term agreements, makes it slightly less easy to understand.
  • Further analysis of the financials and operational structure reveals more of a complex business than one might initially think.
  • Finally, the number of external factors that could influence the operations of EDN, ranging from government regulations to technological changes, makes it a slightly complex business to understand.

Balance Sheet Health Rating

  • 3/5
    • The balance sheet shows the company has substantial assets, but those are financed with high debts. The company does have adequate assets to offset the debt, but they are in no way excessive. This leads to a lower rating, as we prefer companies with strong financial strength and cash balances.
    • There is also a slight concern with the amount of goodwill and intangibles they carry relative to the net tangible assets.
    • Despite the high debt, the fact they are a utility business in a regulated environment means their revenues are reliable. Hence, the ability for them to pay off debts in time is higher, lowering their chances of defaulting on obligations.