Brazilian energy stock yielding 8.5% may be a bright purchase

Published February 15, 2023

Here is a stock that has had the energy sapped from it. Companhia Energetica de Minas Gerais (CIG-N) changes hands at around US$2, way down from more than US$8 where it traded just over a decade ago. The dividend is not exactly consistent, and being based in Brazil means that the taxation level for Canadians is higher than with our stocks. Revenues have been pretty consistent over the past decade but have not gained upward traction, and the debt load is not light, although it has been dropping. While Benj finds this outfit attractive and ponied up to buy a whack at US$1.97, you might just want to think, “Not a very bright purchase by a Contra Guy.”

So, let us look at the positives, shall we? After all, our goal is not to buy into stocks that will simply lose us money. We might be contrarians, but that does not make us stupid. Or so we hope.

What does this company do that has been around since 1952? Electricity is the key. The enterprise has 70 hydroelectric, solar and wind plants, including approximately 545,000 kilometres of distribution lines and about 2,300 kilometres of transmission lines. Besides electricity, it transports and distributes natural gas, and runs a host of related enterprises, with IT infrastructure and management front and centre.

There have been at least two dividends every year since 2009 (with six last year), and one or more for the past 25 years, but the tally is much lower than it used to be. The current yield of about 8.5 per cent is high, albeit the payout ratio of 47 per cent is reasonable. Often too-generous disbursements indicate that a cut could be in the cards. To be fair, however, the fact the company makes money year after year does offer a sense of comfort. And the profits remain remarkably steady – no big ups or downs.

One wild card the company must deal with is Brazilian politics. Currently, President for the second time is Luiz Inacio Lula da Silva, who regained power in October. When he defeated Jair Bolsonaro, the latter’s supporters attacked federal government buildings, attempting to overthrow the government. Calm has since been restored, but it is difficult to gauge what might happen next given the unstable situation. To pacify some of the populace, could nationalization of enterprises such as CIG take place? Certainly, it is not out of the question and investors in Brazil should remain wary that this nation is not stable.

An additional potential trouble spot for investors is currency risk. The Brazilian real is worth about one-third of what it was relative to the U.S. dollar a dozen years ago. The chart seems to indicate that it might be around the bottom, but of course, that is not certain. However, from this angle, it seems more likely the real will increase in value, rather than decrease.

As mentioned, the stock traded north of US$8 about a decade ago, but since 2015, it has particularly struggled. Perhaps our initial sell target of US$5.24 is a big ask and if the stock ever gets to that level, it will likely take many years. Meanwhile the fat dividend, even with the tax ramifications of being in a foreign country, will help to buoy the return.

Lots of investors dismiss stocks like Companhia Energética de Minas Gerais out of hand. No question, it is not everyone’s cup of tea. Nor should it be and we understand why many investors prefer to stay closer to home with Canadian banks and utilities. But companies like this are a major reason that the President’s Portfolio at Contra the Heard Investment Letter had a 19.1-per-cent 10-year annualized return. But hey, as you likely know, past returns are not necessarily indicative of future returns.

Benj Gallander and Ben Stadelmann are co-editors of Contra the Heard Investment Letter