Brazilian electric utility, Companhia Energetica de Minas Gerais ( CIG - Analyst Report ) , also known as CEMIG, was recently downgraded by us from Outperform to a Neutral recommendation.

Cemig, the fifth largest electricity generator in Brazil, generates approximately 97% of electricity from hydroelectric sources. Demand for electricity seems to be on the rise as Brazil prepares to host two major sporting events in the coming years. The Government is also keen to invest heavily in infrastructure and power generation capabilities.

The Brazilian government intends to improvise the electricity industry through its Second Accelerated Growth Program (PAC 2). Approximately R$1.1 trillion has been allocated for the electricity industry under the PAC 2. In Cemig’s area of operation—according to the national Energy Research Institute, EPE—average consumption growth is expected to be 4.5% from 2011 to 2021.

Moreover, Cemig’s management, over the long term (2011-2015), expects total energy distribution to reach a range of 48.8-53.8 TWh by 2015. Energy generation in 2015 is estimated to be roughly 36.1 TWh while EBITDA for 2015 would be within the R$5.3-6.1 billion range by 2015.

In the recently announced second quarter 2012 results, Cemig reported a net income increase of 15% in local currency and a 16% revenue growth. Earnings came in at R$0.82 per share or US$0.42 per ADR.

Despite the company’s bright long-term prospects, we have downgraded Cemig from Outperform to a Neutral recommendation. The company’s rising operating expenses seem to be the major hurdle for growth. Expenses in the last reported quarter increased roughly 16% year over year.

Furthermore, near-total dependence on natural water resources and interference from the state government tend to be detrimental to growth. Cemig also faces competitive pressures in the Brazilian market from its rivals like Companhia Paranaense de Energia ( ELP - Analyst Report ) .

The current Zacks Consensus Estimates for 2012 and 2013 are US$2.04 and US$1.33 per ADR, reflecting annual growth of 7.4% and decline of 34.8%, respectively.

The stock currently bears a Zacks #3 Rank, translating into a short-term Hold rating.