Neoenergia: Brazilian Utility Leaving Rehab?
B3: NEOE3
Today we are going to talk about the largest private electricity distribution company in Brazil: Neoenergia (B3: NEOE3).
If you don't have an account in Brazil, you can buy shares in B3 using Interactive Brokers or ask your brokerage house to open a custody account in Brazil for you.
Who will I be a partner with?
Listed on B3 since June 2019, the company only has common shares: NEOE3.
Shareholder composition of Neoenergia:
53.5%: Iberdrola (Controlling shareholder)
30.3%: Previ (Banco do Brasil's Pension Fund)
16.2%: Free Float
Who is Iberdrola?
Founded in 1992 through the merger of Hidroeléctrica Española (founded in 1907) with Iberduero (founded in 1944), Iberdrola is a multinational company based in Spain, operating in the generation, transmission and distribution of electrical energy and the distribution of natural gas .
Main subsidiaries:
Iberdrola España - 42% of 2022 revenue
Scottish Power (United Kingdom) - 18% of revenue 2022
Neoenergia (Brazil) - 16% of revenue 2022
Avangrid (United States) - 15% of revenue 2022
Iberdrola Mexico - 7% of revenue 2022
Iberdrola Internacional - 2% of revenue 2022
Iberdrola has a strong focus on generating renewable energy in the world, especially wind and hydroelectric power, being the largest generator of wind energy in the world.
Listed on the Madrid Stock Exchange, its main shareholders are:
8.7%: Qatar Investment Authority (Qatar sovereign wealth fund)
3.6% Norges Bank (Norway Central Bank)
3.3% The Vanguard Group (largest investment manager in the world)
What is Neoenergia?
Founded in 1997 with the privatization of the electricity distributors Coelba and Cosern, Neoenergia is currently the largest private electricity distribution company in Brazil in terms of number of customers, with more than 15 million consumer units and more than 37 million people served by its distributors:
Neoenergia Coelba
Neoenergia Cosern
Neoenergia Pernambuco
Neoenergia Elektro
Neoenergia Brasília
Additionally, Neoenergia has energy transmission lines in partnership with GIC (Singapore's sovereign wealth fund), some generators (hydroelectric, wind, solar, thermoelectric) and a trading company.
Unlike Iberdrola's profile, Neoenergia is mainly an electricity distribution company, as ~80% of its EBITDA comes from this segment.
My Point of View:
The company carries some stigmas to this day that make the share remain down:
Poor capital allocation:
2018: Neoenergia made an offer to buy Eletropaulo distribution company for an astronomical value. Thank God that the Italians at Enel had had more drinks in this auction and made an even higher offer, taking the asset. But this alone has left Neoenergia with a reputation as a terrible capital allocator.
2018: very aggressive bids led the company to acquire some transmission lines at irrational prices. Despite this, with the closing of the interest curve, the returns ended up being worth it. But the bad reputation still remains.
2020: this time, Neoenergia may have been drinking all bottles in the distribution auction, winning CEB (Brasília distribution company), currently Neoenergia Brasília, for 69% more than its opponent Equatorial, known for being an excellent capital allocator. R$1 billion thrown in the trash. Managers and analysts are horrified and classified the company as a value trap.
Unreliable controller (using a very strong euphemism):
2021: the company announces that it will start paying royalties to Iberdrola for the use of the brand. Around R$160 million annually. It's the so-called synthetic dividend where only the controller receives... Mercado loved it and nostalgically recalled other companies that did something similar, such as Klabin and Gerdau.
Low Free Float:
2022: with just 16.2% free float, shares on the ground, royalties and a reputation for being a bad capital allocator, rumors of a takeover bid begin.
We are at rock bottom, when a new CEO arrives in mid-2022. Here it seems that the game is starting to change…
At the end of 2022, he shows what he came for. He promises the market that he will address the issue of high leverage by selling some assets, such as the Termopernambuco thermal plant and in 2024 the 10% stake in the Belo Monte Plant, which rumor has it is an atomic bomb. Therefore, the idea is to focus on hydroelectric plants where it has controlling interest. But everyone talks, right?
Finally, in April 2023, some concrete good news. The company sells 50% of the operational transmission lines to the GIC (Singapore's sovereign wealth fund), grants it the Right of First Offer for the lines under construction and plans to participate with it in future auctions. In addition to selling the asset with a fat profit and making more than R$1.1 billion go into cash, alleviating the heavy leverage, bringing in a partner who has capital allocation discipline gives an image that the times of empire building (growth at any cost) are over.
In June 2023, there was a transmission auction and Neoenergia made sensible offers, behaved like that teetotal nerd friend of yours who does the math in his head.
Even so, there were so many years of crazy life at auctions, among other adventures, that the market continues to price the company like a teenager who fries his family's savings in online games, in addition to taking money from his father's wallet without him knowing.
Little by little these bad stigmas are disappearing and a reputation for responsibility is being built.
The issue of royalties should remain as it is, but who still remembers and has mortal hatred for Klabin and Gerdau? People end up forgetting... And, even though it is an obviously uncomfortable situation for the minority shareholder, it is around 10% of the amount paid in dividends in the last 12 months. Let's be pragmatic.
Although revenue is practically stagnant now, the company has shown growth in recent years. It grows in steps. With the Selic rate continuing to fall, the energy distribution business benefits from the increase in economic activity and there should be new growth in revenue and, ceteris paribus, profit.
Furthermore, net debt is large, representing 3.11x EBITDA. But being 50% indexed to the CDI / Selic, with the fall in the Selic, financial expenses drop significantly.
Thus, net profit grows by increasing operating profit and also by reducing financial expenses.
Most of Neoenergia's problems must be resolved with the ongoing fall of the Selic, in addition to the management of this more judicious CEO, but...
Is it time to buy?
Is it cheap?
After all, is it to buy this stock or not?
What is the price to buy and sell NEOE3 after all?
I'll show you all the rationale, in detail.
Let's go.