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We recently maintained a Neutral recommendation on Brazilian electric utility, Companhia Energetica de Minas Gerais (CIG - Analyst Report), also known as CEMIG.

Why the Downgrade?

Cemig is a well-recognized and fifth largest integrated electric utility in Brazil. The company derives roughly 97% of its electricity from hydroelectric sources.

Revival from lows experienced post the 2008 global crisis has spurred economic activities around the world. Growth in 2013 is predicted to be 3.3% in 2013 and roughly 4.0% in 2014, according to the International Monetary Fund (IMF). Brazil, one of the prospering emerging nations, is expected to grow 3.0% in 2013 and 4.0% in 2014.

Long-term growth prospects of the Brazilian electricity industry are very bright; especially because of the soaring electricity demand in Brazil, as the country prepares to host two major sporting events in the coming years. The national agency has predicted a consumption hike of about 4.5% in the 2011-2021 timeframe. Government spending has been geared up to improve the infrastructure in the electric industry. Roughly R$1.1 trillion has been allocated for the electric industry under the Second Accelerated Growth Program (PAC 2).

For Cemig, new projects, strategic acquisitions and investments all bode well for the future. The company is in a constant pursuit to attain the comfortable position, which would allow it to benefit from the expected growth in electriciy demand in Brazil.

Despite these positives, it’s the near-term concerns that restrict our view on Cemig and keep us on the sidelines. Rising operating expenses, governmental interference and dependence on hydro sources for electricity pose serious threat to growth.

If we steal a look into the first quarter 2013 financial results, we find expenses in the quarter grew 7% and offset partially the revenue increase, thus impacting margins. Electricity sold also registered a slight decline.

The Zacks Consensus Estimate for Cemig is US$1.41 per ADR for year 2013 and US$1.46 per ADR for year 2014, representing a 42.5% decline and growth of 3.8%, respectively.

Others Stocks to Consider

Cemig currently has a $9.3 billion market capitalization. Other stocks to watch out for in the industry are Companhia Paranaense de Energia (ELP - Analyst Report) and CPFL Energia S.A. (CPL - Snapshot Report), each with a Zacks Rank #1 (Strong Buy) while ALLETE, Inc. (ALE - Snapshot Report) has a Zacks Rank #2 (Buy).

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