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Should You Start Buying Argentinean Utilities?

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Sep 19, 2013
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For over 10 years, Argentina's government has held inconsistent energy policies in place. Residential and industrial electric and gas prices were well below marginal costs. As a result, companies such as Edenor (EDN, Financial) and its parent, the diversified energy holding Pampa Energia (PAM, Financial), lost millions. Low tariffs were simply not high enough to cover total operational costs.

But the outlook seems to be changing. After losing primary parliamentary elections about a month ago, the party that has been the major political force in Argentina since 2003 is preparing itself to leave the government as soon as 2015, when presidential elections are to be held. Moreover, the presidential candidates with real chances for 2015 are far more market-friendly than the current administration. Hence, energy policies should turn for the best, and companies such as Edenor, Pampa and even Transportadora de Gas del Sur (TGS, Financial), which is still making money despite low tariffs, should soar.

The question is: Should you go long now?

The Ultimate Argentinean Electricity Holding

Pampa Energia owns 51.5% of Edenor, the largest distributor of electricity in Argentina, with more than 2.7 million customers. Pampa also participates in the electricity generation business (with assets such as Central Loma de la Lata) and controls the transmission business in the country through its controlling stake in Transener, which transports 95% of electricity in Argentina.

Under current conditions, Pampa's results have been consistently poor. Second quarter results are a good example of this. With revenues at around $300 million for the six months ended in June (taking into account the blue chip swap exchange rate), the company produced negative EBITDA results of about $30 million. Even with the stock up by 26% year-to-date, the company trades at 37% its book value. Some investment houses such as Ruane Cunniff have already seen value in the stock and hold it in their portfolio.

Edenor, which is held by Renaissance Technologies, is my favorite play among Argentinean electricity assets. The reason is simple: I always rather own pure plays to diversified holdings such as Pampa Energia. During the second quarter, the company could slightly re-negotiate electricity tariffs with the federal government in order to increase its top line by as much as 15%. That said, Edenor still suffered an operating loss for the quarter of $45 million. Nevertheless, the government has been partially recognizing the losses the company has been suffering through periodical transfers of funds. This is the reason to explain Edenor's highly positive net income figure for the second quarter – Edenor reported a net income gain of $194 million. Edenor, which is up by 48% ytd, trades at 39% of its book value and should soar in price as soon as sustainable energy policies come back to Argentina.

Bottom Line

Clearly, the situation in Argentinean utilities is unsustainable over time. Utility companies should always produce predictable earnings in order to incentivize necessary infrastructure investments. When the current government came into power in 2003, Argentina, a resource-rich country, was self-sufficient in oil, gas and electricity. As a result of poor policies, the country is today a net importer of oil, gas and electricity. Naturally, at the currently negative rates of return, no company is ready to invest as much as necessary to bring the country back to self-sufficiency. My bet is that a new administration will make the necessary changes in order to produce the much-needed investments.

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