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Companhia Paranaense de Energia (ADR) (ELP), CPFL Energia S.A. (ADR) (CPL), Companhia Energetica Minas Gerais (ADR) (CIG): Three Electricity Picks From Brazil

The resumption of economic growth and industrial development in Brazil is increasing demand for electricity. Forecasts predict that electricity consumption in the country will grow 5% annually through 2019, which is a 40% increase from 2012. This higher demand will prove advantageous for Brazilian electric energy operators, backed by an approved government 10-year plan to build 167 gigawatts.

Companhia Energetica Minas Gerais (ADR) (NYSE:CIG)

But not all the companies will equally benefit from this outlook. Here, I will analyze three big electricity producers and distributors to identify which is better positioned to enjoy higher profits.

Good performance despite some risks ahead

Companhia Paranaense de Energia (ADR) (NYSE:ELP), also known as COPEL, produces, transforms, transmits, distributes, and sells electrical energy exclusively in the state of Paraná, Brazil.

The company posted a 25% increase in net earnings in local currency for its first quarter, driven by an 18% increase in net operating revenue. EPS was $0.73, $0.07 higher than the year-ago quarter. Final customer demand for electricity grew 27% while sales to distributors increased 27%.

Companhia Paranaense de Energia (ADR) (NYSE:ELP) plans to invest $1.9 billion this year to improve its internal generation capacity and distribution network. Management plans to expand outside Paraná state, and become operational in new areas by mid-2014.

However, 58.6% of Companhia Paranaense de Energia (ADR) (NYSE:ELP)’s outstanding common shares are held by the government of the state of Paraná, giving it a great amount of power to direct the company’s future in terms of activities and expenses. The state controls the election of the majority of the company’s Board of Directors, allowing high regulation. This meddling has already caused delays in execution of regular operations of the company, so I would not be surprised to see more issues of this kind.

One last factor to consider is Companhia Paranaense de Energia (ADR) (NYSE:ELP)’s dependency on rainwater to source 99% of its hydroelectricity as unpredictable weather may affect the company’s energy supply.

Cash flow is key

CPFL Energia S.A. (ADR) (NYSE:CPL) generates electricity through hydroelectric plants, small hydropower plants, and thermoelectric power stations, which it then distributes and sells.

The company posted a 4% increase in energy sales in its concession area for its first quarter of 2013. The conclusion of a tariff review for CPFL Paulista subsidiary re-positioned tariffs 5.48% up, which improved results.

CPFL Energia S.A. (ADR) (NYSE:CPL) enjoys a scale and distribution monopoly that gives it a sustainable competitive advantage. Brazil’s fairly young regulatory system gives CPFL Energia S.A. (ADR) (NYSE:CPL) three-fourths of its operating income, as it derives from regulated electricity sales. This provides a steady cash flow for the company.

Within CPFL Energia S.A. (ADR) (NYSE:CPL)’s regulated customer base, about 25% of customers could migrate to other suppliers when their contracts finalize. But since the company offers competitive rates, I expect that only a small fraction will eventually switch. Plus, the company’s commercial department makes strong efforts to retain customers, recapture the ones that opted out, and recruit new clients that are outside the company’s regulated areas.