Enel Americas (OTC:ENIAY) is one of several publicly traded subsidiaries of Enel (OTCPK:ENLAY) that investors can choose from to deconglomerate their utility exposure to Enel. The company operates in most South American countries except for Chile, while Enel Chile (ENIC) exists. As a major regulated utility with exposure to Brazil, they benefit from key elements of regulated remuneration as interest rates rise. In addition, the generation business is performing well as projects come online and Colombia’s hydrology recovers. Although the dividend based on FCF is not particularly attractive and investors should also be aware that the ADRs will be phased out as the shares are now only available on the Santiago Stock Exchange, the company is performing well.
Q1 results are highlighted below, bearing in mind that much of the EBITDA growth was due to the consolidation of Enel Green Power’s (“EGP”) South American assets from Enel’s parent company.
The remainder of the growth can be attributed to operational improvements in generation and favorable tariff indexation on the grids. Generation results benefited from new projects being commissioned, but also from higher electricity prices and significantly improved performance from hydroelectric power plants, mainly concentrated in Colombia as the hydrological situation recovers.
Even taking into account the EGP consolidation, EBITDA has progressively improved against ENIAY’s original assets in generation, and all this despite a fairly significant depreciation of local currencies against a raging dollar.
Focus on networks
Regulated utilities operate by being compensated according to a scheme agreed upon in negotiations with government agencies on the regulation of utilities. In the UK it is Ofgem, in Spain CNMC and in Brazil for example ANEEL. Regulated utilities were somewhat exposed in an inflationary environment. In most systems, in order to increase network revenues, the regulated asset base, ie the base of assets developed by the regulated utility after approval by the utility authorities, must grow and remuneration rates are paid on this basis. The remuneration rates and the regulated WACC are interest-indexed. In countries like Brazil and other emerging markets, where interest rates are generally higher due to in-country risk premiums due to exchange rate effects, WACCs are generally higher, usually in the double digits. With rate hikes in Brazil, the key grid concession for Enel Americas, coming into effect shortly after the Fed’s rate hike, the agreement was set aside for further improvement on top of CPI indexing, which took place throughout the first quarter. This means that we should expect further improvement in network results in Q2. Similar effects were observed in Colombia.
Networks make up the majority of the company’s EBITDA, which moves the needle, and the EBITDA waterfall shows the important network contribution that even withstands the consolidation effects of EGP in generation.
The other news is that the company has delisted its ADRs and this just went into effect on June 20th. Shareholders had the option to cancel their ADRs or swap shares which are still happily trading on the Santiago Stock Exchange or OTC using the ENIAY ticker with ample liquidity. There really is no financial impact here.
While networks will continue to benefit from tariff revisions linked to interest rates and to some extent CPI, they will also be demand leveraged to some extent, with higher demand for the system meaning higher remuneration for the operators of the distribution or transmission facilities. A recession could pose a problem for demand, so rate increases due to rate increases could be moderated somewhat. Also note that Peru, while fairly low in network exposure, will have introduced a new tariff system by November. Normally we don’t like new bargaining, especially when recessions are looming, because the government is championing consumers and trying to make things more affordable and less profitable for the operator. Nevertheless, the impact of interest rate indexation will certainly remain. Finally, risks associated with forex should not be ignored. The dollar is shooting up right now and this is adversely affecting ENIAY’s cash flow where they are paid in local markets and accounted for in dollars. However, at least the depreciation of local currencies means that the credit environment is generally comparatively benign and the tightening is not happening anytime soon. You’ll find that the real doesn’t fare badly at all in Brazil, which is conducting similar rate hikes.
Overall, the dividend remains weak on an FCF basis, as we discussed in our last article, and perhaps shouldn’t be relied on. But other than that, ENIAY is robust and we continue to take a positive view of it, although we are in no rush to buy it.