Stock of the Month: CIG

Companhia Energetica de Minas Gerais (CIG), better known as CEMIG, is the second-largest power company in Brazil, feeding electricity to more than 7 million households and businesses across 774 cities and towns. Minas Gerais is the dynamic economic heartland of the country, with nearly 20 million inhabitants living and working between the inland capital of Brasilia and metropolitan Sao Paulo and Rio de Janeiro along the coast. While CIG has been a direct beneficiary of its eponymous district’s evolution from sleepy rural hinterland to middle-class sprawl, the company is also active across Brazil and has offices in Chile, as well.

And while the Brazilian utility sector is changing, it is important to remember that CIG and its counterparts are still utility companies, which is an extremely stable business. Once households and workplaces turn the lights on, they rarely go off the grid, so subscriber numbers continue to go up, not down. In areas like Minas Gerais, where the population is growing and consuming more power per capita, the overall revenue opportunity rises as well. Over the last three years alone, CIG has boosted its annual output by 9.9% and its per-kilowatt-hour rates climbed a lot faster than that.

With Brazil tracking to use 50% more electricity in 2020 than it does today, the utilities have their growth markets cut out for them. Although the 2016 Rio de Janiero Olympics is not a catalyst for the company like so many other Brazilian stocks, its home stadium in Belo Horizonte will be one of the main venues in next year’s FIFA World Cup, so we should see usage rates start spiking as the final construction ends and the tourists start arriving.

Our Opportunity

Unlike many of the world’s more mature utilities, CIG is considered a growth stock. The population of Minas Gerais expands at roughly the same rate of the United States – about 11% since 2000 – but the appetite for electricity among its relatively affluent households has ramped up twice as fast. Over the last five years alone, CIG has boosted its revenue an average of 14.3% a year and expanded its EPS by 19.1% a year over the same period, which is a lot better than the 1%-4% top or bottom line improvement investors can find in the U.S. utility sector.

The long-term growth curve hit a bump last quarter, but it wasn’t because Brazilians turned out the lights. CIG reported on August 14 that its cash flow almost doubled year over year, but declining income from transmission tariffs and construction fees left overall revenue down 1%. Even so, while costs swelled in line with 6% Brazilian inflation, voluntary layoffs supported EBITDA margins, giving net earnings room to improve 2% over the second quarter of 2012.

CIG shares were already deeply depressed before the earnings release due in part to the general flight from Brazilian stocks, so the 8% drop that followed the release could have been worse. The stock had been trading at its lowest levels since March 2009, but with operating cash flow spiking the way it is and Brazilians rapidly electrifying their lives, I don’t think CIG’s growth days are over.

In fact, shares have already regained their lost ground, telling me this was truly an overreaction by investors and that this company is getting back on track.

Management is already ahead of the game when it comes to sourcing cheap power without having to deal with Brasilia. The company is in the process of winning a Supreme Court fight to maintain its existing revenue split on one 400-megawatt hydro plant without surrendering its licenses, but part of its aggressive M&A in recent months has gone toward wind power, which it can source and sell even more cheaply than government hydro.

Whether these initiatives can extend CIG’s 19%-a-year growth curve remains to be seen, but the company has shown it has significant potential to keep its numbers going in the right direction. Buy CIG below $9.25.