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We have downgraded our recommendation on Brazilian electric utility, Companhia Energetica de Minas Gerais (CIG - Analyst Report), also known as CEMIG from Outperform to Neutral.

Why the Downgrade?

We find the long-term growth prospects for this Brazilian electricity utility very bright. It ranks fifth among the electricity generators in the country and derives roughly 97% of electricity from hydroelectric sources. The company is in a constant pursuit to attain the position to benefit from the expected growth in electricity demand in Brazil which is gearing up to host two major sporting events in the coming years.

The Brazilian government, in a bid to improvise the electricity industry through its Second Accelerated Growth Program (PAC 2), has allocated approximately R$1.1 trillion. 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.

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.  

Despite these positives, it’s the near-term concerns that restrict our view on the stock and keep us on the sidelines. Rising operating expenses, governmental interference and dependence on hydro sources for electricity pose serious threat to growth. In its last quarterly results, the company reported 26.8% year-over-year increase in operational costs and expenses, primarily due to rises in personnel costs, material costs, electricity bought for resale, infrastructure construction costs and gas bought for resale, among others.

Other Stocks to Consider

Other stocks to watch out for in the industry are Brookfield Infrastructure Partners L.P. (BIP - Snapshot Report), Huaneng Power International, Inc. (HNP - Snapshot Report) and Otter Tail Corporation (OTTR - Snapshot Report), each with a Zacks Rank #1 (Strong Buy).
 

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