Edited Transcript of CESP6.SA earnings conference call or presentation 30-Jul-20 2:00pm GMT

Moving on to Slide #6 of the slide deck, we have the highlights for the second quarter of 2020. We had once again, and that’s a tendency you’ve seen for the past quarters, we had a generation, which is slightly above our physical guarantee, 2% in this case above our physical guarantee because of the ONS dispatch. And the main driver was or has been, so far, this very dry season in the south of Brazil, in Southeastern, in particular. And we have to transfer energy to the south, and that led our reference power plants to dispatch slightly above the physical guarantee.

Our availability index remains at a very good level at 94.5% in the quarter, slightly above that of the first quarter of this year and high — consistently above expected levels expected by ANEEL regulating agency.

The dispatches are normalized. Our contingency plans are light as it were, both for Porto Primavera and Paraibuna, and also for the transitory operation Jaguari. So we’re operating with normal dispatches across the board.

As for the financial performance, we closed the quarter with revenues of BRL 435 million (sic) [BRL 486 million] in the quarter. It’s 32% above the same quarter of last year. The increase in revenue is due to 3 factors, mainly: the trading contributes to the consolidated revenue of the company. On top of that, indexing of contracts when compare that with last year, of course. And besides the fact that in this quarter, we had a reduction of dispatches of contracts, which was lower compared to the second quarter of 2019 because of energy balance management. In the second quarter of last year, we chose to negotiate some reductions for those contracts back then.

The adjusted EBITDA for the second quarter came out at BRL 287 million with an adjusted margin of 59%, and it is also 31% higher than last year’s period. Very good result. I’ll comment on it in more detail, but we continue in this quarter to reduce the lability contingency. So I’ll go into that in a moment.

And something else which was confirmed, it was a strong cash generation. After the debt service and before 2 events, we pay out the dividends and the disbursement to cover liabilities. We closed the quarter with BRL 263 million in terms of operating cash flow generation, a very important cash conversion ratio, which will be detailed by Marcelo in a moment.

As for energy trading in the quarter, we have reached a very good energy balance for the second half, and we will see that in detail once again in a moment. We also benefited from the drop in prices in the short run, which impacted prices for 2021. We [sped up] the zeroing of our energy balance for 2021, and we have already working with an eye at 2023.

Right now for 2020, in terms of energy balance, we have covered 83% of our short exposure, something close in terms of megawatt goals for 2022.

We are working layer-by-layer, and we started selling energy in the long run, so starting 2023. Still at moderate levels with a lot of caution, but…

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Operator [3]

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Ladies and gentlemen, please stand by as we reconnect the line.

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Operator [4]

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(Operator Instructions) You may carry on now, sir.

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Mario Antonio Bertoncini, CESP – Companhia Energética de São Paulo – CEO, IR Officer & Member of Management Board [5]

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I apologize for the technical glitch, but we are back. This is Mario, once again. I was completing Page #6. And I was saying that concerning the trading results, we closed the second quarter with a positive MTM of BRL 22 million. Those BRL 22 million, for comparison, effects with the first quarter of 2020, which sat at BRL 25 million will be appropriated in the second quarter. So BRL 22 million of MTM plus BRL 9 million, which are appropriated, lead to BRL 31 million, which are then compared to the BRL 25 million filed in the first quarter.

Moving on, on Page 8, we have details about our contingent liability. We had closed the first quarter of 2020 at BRL 11.7 billion in total liability. In the second quarter of 2020, we had interest and monetary adjustments of BRL 250 million and a [net] breakdown of $1 billion, which led us to close the second quarter with a total liability level of BRL 10.9 million (sic) [BRL 10.9 billion]. And the probable variation on the right-hand side, we closed the period at BRL 1.8 billion in probable variation in terms of liability, which we made provision for with a write-down of BRL 154 million. The reason for those write-downs are mainly due to 2 main factors. The first one, favorable rulings coming from the judiciary committee in favor of CESP, and also a review of amounts because of process evolution, some process, some losses evolved favorable — favorably to CESP. They have not been sentenced yet, but that led us to a very comfortable position in that respect. So still, we have a reduction in the amounts when we compare quarter-on-quarter.

Now on Page #9, we touched upon the lawsuit relative to Três Irmãos. It’s an active lawsuit. That’s again, as I said, referring to Três Irmãos. There is news concerning that lawsuit in July. On July 10, the judge made important statements. They requested a few corrections in the digitalization of the processing. You will remember that the process was digitized late last year. So they requested a review of that. So as soon as these adjustments in digitalization are made, this should be happening in a few days, a couple of weeks, at the most.

The judge will define a deadline for the experts to analyze the fact. He will give the expert 15 days. This has not started yet. It depends, as I said, on those adjustments we are making, and we’ll keep the market informed as this lawsuit evolves. As for the injunction, which is the second part, and which is in parallel, no news as of the second quarter of 2020.

Moving on, on Slide #11, we have a few numbers for the energy market. Basically on the left-hand side of the slide, we have the ANE evolution on the storage level. That’s the green curve on the left-hand side. That’s the storage level of our reservoirs nationwide. And then we reached the end of July with a storage level of 60%, 7% higher than June last year, and that has to do basically with the drop in load because of the COVID-19 situation.

First and foremost, in terms of hydrology, we have lower levels, 81% when compared to 101% for the same period of last year. But the drop in load due to the COVID situation led us — that even with a lower ANE, we have a higher storage level.

As for market and projections from ONS and EPE for the market for this year, that’s on the right-hand side of the slide. Basically based on the current prediction, we should close the year with a load across the nation 3% below what we had last year, around 3%. That’s a reasonable recovery when compared to the first productions we had early on in the pandemic. That assumes drops of 1% in the third quarter 2020 and up 3% in the fourth quarter of this year, in 2020. That’s good news for the market as a whole.

On top of that, because of this load variation, the CCEE, the Chamber, has updated its GSF projections for 80% — to 80%. That’s a level that we here converge with, with our predictions, and it’s slightly higher than the level we have been working with, actually, which is also positive. The higher the GSF, of course, the lower the burden for CESP.

On the next page, Page 12, we have the energy balance for 2020. Basically, most of you are familiar with those charts in the slide. So I’ll briefly go over it. What we have on chart 1 is our seasonality curve, the black curve and — which has been adjusted for GSF, which is the dotted green line. On chart #2, we compare the availability of the net physical guarantee with our energy sold, which is the red curve. So originally, we saw a deficit of 300 megawatts average for the year 2020. The way we manage those events are reflected on chart #3, where we have the energy deficit, the same from chart 2 of — and our purchases, which are in green, the green columns. So we bought at an average price of BRL 213 megawatt — per megawatt for the year, and the monthly average prices are on the top of the chart #3.

And lastly, the net effect can be seen on chart #4, it’s energy balance, already equalized for the second half of the year. And we have the three — the third and fourth quarters ahead of us.

So that’s the position that we have right now. And when we see that difference in the second quarter we just closed, most of that — 2/3 of that, again that short position, has to do with some of the positions that we took to CCEE to be able to release resources where they withheld because of that pandemic default with our creditors in that respect.

So when we do that, we release resources, which were withheld at CCEE, as I said. So — and we managed to do that, to free up resources in the second quarter of 2020.

I’ll give the floor now back over to Marcelo, who will continue with our financial performance. Marcelo, please, you have the floor.

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Marcelo Antonio de Jesus, CESP – Companhia Energética de São Paulo – CFO & Member of Management Board [6]

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Thank you, Mario. Good morning, everyone. Moving on with the presentation on Slide 14, where we’ll be talking about costs and expenses. I’ll start with personnel, administration and third-party materials. The second quarter still reflects the transformations, which were implemented throughout 2019, positioning CESP in a place where we have more discipline in terms of financial management.

As for personnel and administration, in the second half, we had a drop of 26%. And in the quarter — the first half, a total of 39%, a result of a reduction in the number of — the headcount and the success of our volunteer resignation program. As for third-party services, materials and rents, the drop in the quarter set at 42%, and it was 46% year-to-date for this first half driven by contract renegotiations and cost review, which enabled us to capture efficiencies.

Now talking about expenses with energy purchases, we saw an increase in energy purchases of BRL 61 million, totaling BRL 137 million. It’s important to highlight that this increase refers to a higher volume of energy purchased in the quarter. This quarter, we acquired 225 megawatt average, 44% above because of our seasonality strategy with a lower allocation of physical guarantee and a higher need to purchase. But most importantly is to emphasize that the average price in the second quarter was 8% below when compared to the second half — second quarter of last year. We had a BRL 69 million increase in volume. In price, we saw a drop of BRL 8 million. So a BRL 61 million in net gain.

Now moving on to Slide #15. On the left-hand side, we have the growth of our net revenue at BRL 118 million or 32%, mainly driven by the revenue from the CESP trading and also driven by the sale that we made to monetize, and also a lower reduction of negotiated contracts last year, as Mario mentioned early on. So that implied in a higher balance of sales.

On the right-hand side — on the top right-hand side of the slide, we have the growth of our EBITDA in the quarter, a growth of BRL 68 million or 31%. And in the first half, a growth of 140% when compared to the previous year. The EBITDA figure converted in a strong cash generation in the first half. The operating cash generation [before] debt service reached [BRL 263 million], a 92% conversion ratio. 90% takes into account an improvement in working capital basically due to 2 items: number one, the delay of the payment of some taxes in the first half following government instructions; and, two, the monetization of our credit balance at CCEE. We have not considered those 2 items. If we had, the conversion rate would be around 68%, still very robust.

Moving now to Slide 16. We have the company’s capital structure. We have reached in the second quarter a net debt of BRL 1.2 billion, a growth when compared to the first quarter because of the dividend payout at BRL 400 million in April, offset by the cash generation in the second quarter. As we just saw, the net debt accounts for 1.1x net debt-over-EBITDA ratio.

Another highlight, yesterday, CESP received a new rating from Fitch and the same rating we have from Standard & Poor’s. And we are now AAA — local, AAA. And internationally, we are capped by the sovereign. So it’s a different rating.

On the right-hand side, we have our gross debt. We have maintained the same level, no major news. That sits at BRL 1.8 billion, an average debt term of 4 years. And our amortization only happens by 2022. So we have a comfortable period going forward to be able to manage our capital structure.

I now give the floor back over to Mario, who will be talking about the company’s key initiatives for 2020. Mario, please?

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Mario Antonio Bertoncini, CESP – Companhia Energética de São Paulo – CEO, IR Officer & Member of Management Board [7]

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Thank you, Marcelo. Moving on to Page 18 of the deck, I’d like to highlight a few items. Number one, in the second quarter, we have continued, and this should prevail throughout 2021, is, today, well-disciplined of cost and expenses management. We started a process this year, a process which is stronger, more widespread to automate our processes. And this will lead to gains in the mid — to the short run in terms of productivity, in terms of management costs, in terms of precision of information, on top of advancing in our [SG&A] agenda.

As for our occupational, health and environmental agenda, we work with the (inaudible) institute from [Holland], we received a [GRA] certification, one of the first big, large hydro power companies to receive that in Brazil, and that’s an acknowledgment of the good job we’ve been doing in that respect. So starting this month, we can trade our energy along with environmental certification, which is quite important to many of our consumers, as you know.

In terms of contingency, we continue to work on it. We’ll give you a timely report of that when the time comes. And all efforts are being directed to address that. And we’ll keep the market informed about the Três Irmãos lawsuit.

As for energy trading, once we have the energy balance for 2020 done, we will maintain our focus on managing for 2021, 2022. Because of the current situation in the market, it is a moment that lends itself for us to speed up our — addressing our short positions, and we’ll start implementing our commercial strategy for the long run with a lot of caution and gradually starting selling energy in the long run, as I mentioned.

In summary, to close this first part of the call, we are consistent. We are coherent. This has been, once again, another quarter where we had to practice what we preach, right, in terms of results and positioning CESP as one of the companies which have proven to be very resilient through this very difficult moment the world and Brazil are going through.

Once again, I apologize for the technical glitch, which interrupted our video streaming, so we had to adopt the plan B. Sorry about that. But we are now ready for our Q&A session. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Carolina Carneiro from Crédit Suisse.

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Carolina Carneiro, Crédit Suisse AG, Research Division – Sector Head [2]

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Actually, two questions concerning energy trading. Number one, you have [showed] some volumes of energy this quarter. You highlighted that in the presentation, 30 megawatts for 2023 and some more gigawatts for ’24, ’25. I’d like you to comment on the expectations that you have in terms of placing your available energy for the coming years. Can we expect you to follow on that strategy of reallocating the energy into the market after some time? If you could comment on that.

Also about price levels. We saw that in some platforms, prices have reacted and recovered conventional energy prices for some contracts at the level of BRL 160, BRL 150 per megawatt hour. Some other contracts with a more attractive price level, BRL 170, BRL 180. So if you could comment on that, I’d appreciate.

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Mario Antonio Bertoncini, CESP – Companhia Energética de São Paulo – CEO, IR Officer & Member of Management Board [3]

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This is Mario. Thank you for your questions. I’ll address the first one. As for long-term trading, we have a strategy in place for the long run, which assumes an execution by layer, by phases, according to prices and volumes metrics. When we do that — so we’re not looking at specific moments where there are concentrations. We’re looking in the long run. And also, we do not want to take volumes to markets, which would not be favorable to us in terms of pricing. And as you said, when you compare different positions, there are market prices which vary. For 2023, they are slightly above what we mentioned actually, and they’re basically market prices. So even though the long-term prices have not been much affected by the COVID situation, they did have some effect in the [for May]. But as you’ve noticed, those numbers recovered, reacted in the past weeks, in particular, the past month, which led us to go to market.

We’re not going to announce our overall guidance because that would be against our [interest], as you would imagine. But we did that in a very cautious way, very well those volumes. We don’t want to stress the market. We want to service our clients with market prices, with some (inaudible) we’ll then try to gauge prices at slightly above the average.

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Carolina Carneiro, Crédit Suisse AG, Research Division – Sector Head [4]

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Okay. So if I could ask the second question concerning the expert that you mentioned and [termination] for Três Irmãos, so that we can understand the meaning of that. What is that expert going to present after those 2 weeks of deadline? And after you made your adjustment in digitization of the process, what is the expert going to do? And once it — one has to do, what will happen? Do we have a final sentence right after that? Do we have some time, another phase of the process? Maybe you mentioned that, but I got disconnected at the very end of your speech. But I’m just trying to understand the status of the process, what happens moving forward.

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Mario Antonio Bertoncini, CESP – Companhia Energética de São Paulo – CEO, IR Officer & Member of Management Board [5]

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Okay. No, if you will remember, if you might go throughout last year, there was room for CESP and the government, the federal government to place an (inaudible) about the expert opinion. Those are public manifestations, and so I’m free to talk about that. And that’s the federal government made more forceful criticism against the opinion. But we do see a technical merit in the expert’s opinion [on this matter] in line with the goal, the prerequisites. So what — [the judge have] some rule, is that he will give 15 days for the expert to answer to the criticisms made by the government. So as soon as the [judge] allows, the expert will rebut or refine the criticisms made by the government to his expert opinion. From then on, there are a few possibilities. The judge is sovereign. He might listen to the expert and then issue a sentence. There’s no impediment to that.

The second possibility would be the judge set another deadline for a final hearing or final says — or a final say from both parties. He could do that and then issue the sentence after that. And it’s a possibility, he might — the judge might understand that we should find another expert. That’s up to the judge to decide. He is the sovereign. And the conclusion of the process will be either one of those 3 possibilities, and we’ll keep the market informed about that.

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Operator [6]

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Next question…

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We are negotiating again. They are very restrictive. But we are still negotiating. And I’d say that there is no understanding as of now that we will enter into other agreements. That’s water under the bridge, the most critical moment for the COVID is, as I said. As for dividend payout, I’ll start with the last part of your second question. We still work on a very hard work, doing our internal homework, as we call it. We are not in a moment where we are looking to opportunities to grow. We understand there is still a lot of value in terms of derisking, in terms of productivity gains, in cost management as for energy balance in our trading strategy. Given that we are a very strong cash generator, it wouldn’t make sense to pile up cash. If we do not have a specified cash allocation right now, so I don’t want to anticipate any movement, but it would be reasonable to imagine that CESP will continue to be a good dividend pay down company until a second moment of our evolution.

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Operator [7]

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(Operator Instructions)

We have a question from the webcast from [Bernardo] from [SDK]. And this question is about, what was the problem that we had as we were digitizing the process for Três Irmãos?

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Mario Antonio Bertoncini, CESP – Companhia Energética de São Paulo – CEO, IR Officer & Member of Management Board [8]

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Thank you, [Bernardo]. It’s not exactly a problem. But the judge understood that parts of the suits — accessory parts for the lawsuit should be included, should also be digitized. And this will be done by the judiciary branch, not by us. We ask the

Judiciary branch to gather all the documents and digitize everything and all the accessory parts who wants it to complement the whole thing. So that’s something that shouldn’t take too long. I wouldn’t expect that to take too long. But we’re waiting for that to be concluded. I’d say a few days, and then the judge will define the 15-day period for the expert to take a look at it.

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Operator [9]

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(Operator Instructions) The next question comes from Carolina Carneiro from Crédit Suisse.

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Carolina Carneiro, Crédit Suisse AG, Research Division – Sector Head [10]

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It’s me again. And since nobody asked, I’ll take the opportunity. You had mentioned in your earnings release a high amount of tax credits that could be activated in the future as it were — if you could give us some more color on the process you have to go through in order to activate and be able to use those credits.

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Marcelo Antonio de Jesus, CESP – Companhia Energética de São Paulo – CFO & Member of Management Board [11]

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Carol, thank you for the question. This is Marcelo de Jesus. We have 2 different measures for those tax credits. The first and foremost is the credit — tax credit coming from our physical loss, tax loss. In one way, you have to recognize those credits throughout the time. And once again, this is more an accounting issue. There’s some rules that we have to follow. So we have to recognize credits in 10 years. So as the company moves on and will show more stability, more profitability as we have, we have a chance to complement the realization of those credits because others are being consumed. We are generating tax profit. We are offsetting losses. So we use part of it to consume, convert all [that] and that opens, makes room for us to use new credit. So they’ll come as we consume credits, as I said, and it also comes as we evolve in terms of profitability. That’s the nature of those credit, and that’s an accounting issue, as I said.

And we also can recover taxes. We analyze the situation, and we saw that we’re surplus payments based on opinion from our counsel. There is a possibility for us to recover those tax credits, which were paid in surplus. Part of those credits have been recovered. We recovered that this year, especially from INSS. And there is another portion, which will be addressed and recovered in the second half. We do not give a guidance in terms of the amount in case, but the company is quite focused on it and disciplined on recovering those amounts because those are important numbers, and it means cash for us.

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Operator [12]

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(Operator Instructions) Since there are no more questions, I’ll give the floor back over to Mr. Bertoncini for his final remarks.

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Mario Antonio Bertoncini, CESP – Companhia Energética de São Paulo – CEO, IR Officer & Member of Management Board [13]

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I’d like to thank you all for participating, for attending. Once again, sorry for the connection glitches with the operator we had today. And we remain available to all of you to go into more detail about any information we have. Thank you again, and have a nice day, everyone.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]