This week, we focus on a monopolistic company providing an essential service within its captive market. Edenor is the largest electricity distribution company in Argentina, providing service to a large majority of Argentina’s largest city, Buenos Aires. After many years of government imposed tariff rates, recent legislation has not only provided additional revenues, but has laid the groundwork for a long-overdue increase in the rates Edenor can charge to its customers. These additional revenues have had an extremely positive effect on Edenor’s financials, with the company registering over 200% increase in its profit from continuing operations for the first six months (ended June 30) of 2015, as compared to the same time period in 2014. With Argentina’s national elections next month, the international business community is anticipating the positive economic reforms that may come from a new ruling government, including long-overdue tariff increases for electricity distributors and generators. These slightly longer seven-year bonds, couponed at 9.75% and currently indicated a yield of about 12.5% when discounted to about 87.5, offer very high cash flow and represent an excellent opportunity for savvy investors to participate in the renaissance of the Argentine economy. Therefore, we are targeting them as a strong addition to our FX1 and FX2 income portfolios.
Argentine Yankee Bonds
Three years ago, we began finding great opportunities in many of Argentina’s nicely discounted dollar-denominated short-term bonds. While the high yields that were indicated turned away many of the typically more conservative fixed investors, the previously recommended Argentina bonds, as a group, have continued to remain on track towards producing remarkably high yields that are over 8% (and some upwards of 14%). As a group, the Yankee bonds from Argentina have significantly outperformed all other segments of our global high-yield portfolios.
About the Issuer
Empresa Distribuidora y Comercializadora Norte S.A. (Edenor) is the largest electricity distribution company in Argentina in terms of number of customers and electricity sold. Through a concession, Edenor distributes electricity exclusively to the northwestern zone of the greater Buenos Aires metropolitan area and the northern part of the city of Buenos Aires, which has a population of approximately 7 million people. Edenor’s ultimate parent company is Pampa Energia, the largest, fully integrated, electricity company in Argentina. Pampa is involved in all aspects of electricity, including generation, transmission and distribution.
Edenor has a geographic monopoly in the area where it provides electricity service. In Argentina, each distributor supplies electricity to consumers and operates the related distribution network in a specified geographic area pursuant to a concession granted by the Argentine government. Only one concession is granted in each area.
Increasing Tariff Rates
After over a decade of frozen tariff rates, the Argentine government is finally conceding to the need for increased rates in the electricity sector. In March of this year, Argentina’s Secretary of Energy passed legislation that will pave the way for Edenor and other distributors in the country to raise tariff rates for the first time since 2007. Until those rates are officially increased later this year, the government will transfer funds to the company to cover the difference between current rates and actual distribution costs. The big picture of this legislation for Edenor in 2015 is an estimated US $455 million in additional revenues. In fact,Edenor had already received an additional $262.8 million as of June 30, 2015.
This legislation (known as Resolution 32/15) has been well-received by the financial markets, with Edenor stock rising to its highest point in March 2015 since the company’s stock began trading in 2007. Currently, Edenor stock is up 47% from the beginning of 2015. Edenor has also been anticipating the long-awaited rate increases, and is in the process of drafting a new 10-year investment plan to update and upgrade its distribution network.
Argentina’s much anticipated elections will take place on October 25, 2015. Due to term limits, current Argentine President Kirchner will not seek reelection. Many Argentine citizens, as well as many in the financial world, are anticipating that the next ruling government will enact changes long overdue under President Kirchner’s watch. These changes include lifting trade barriers, amending price controls and reducing subsidies. The heavily subsidized electricity industry, which currently experiences outages during peak demand times, will likely be one of the first areas the new government will address. With the recently enacted legislation, industry experts predict the first order of business will be to raise tariff rates to a level more reflective of the actual costs for energy distribution. These higher rates will definitely favor Edenor, increasing the company’s cash flow, bolstering its operating margins and improving its credit rating.
Edenor’s financials have shown marked improvement with the addition of the revenue tied to the March 2015 legislation. For the six months ended June 30, 2015, the company had a profit of AR$724.7 million from continuing operations as compared to a AR$722.8 million loss for the first six months of 2014.
Q2 2015 also showed an impressive year-over-year increase in adjusted EBITDA. Edenor registered an adjusted EBITDA of AR$310.0 million as compared to a loss of AR$479.3 million for Q2 2014.
As one might expect, Edenor has significant asset value in its property, plant and equipment. As of June 30, 2015, the company recorded $807.5 million (in US dollars) in asset value for its property, plant and equipment. This value well exceeds the company’s dollar-denominated debt of $191.2 million.
The default risk is Edenor’s ability to perform. After over a decade of artificially low tariff rates, it is encouraging that the Argentine government is finally acknowledging the need to adjust rates to more accurately reflect the actual cost of electricity distribution. Edenor’s cash flow and operating margins have improved significantly since legislation was passed earlier this year to direct additional revenues to the company to more closely match actual operating expenses.
Given Argentina’s history of government regulation in the private sector, there is certainly some geopolitical risks involved for bondholders of Edenor. With national elections only a month away, the international consensus is that whatever new government comes to power will need to contend with remedying the many areas of Argentina’s economy that have suffered under the current ruling party, including the aging electricity infrastructure. This will most certainly involve reducing subsidies (to shore up Argentina’s reserves), as well as raising electricity rates, which will translate to increased income for Edenor. Also, as electricity is an absolute essential need for any modern society, the government will do whatever is required to ensure Edenor’s viability.
Edenor’s current dollar denominated debt totals $191.2 million (in US dollars). A decline in the Argentine peso would increase Edenor’s interest payments on this debt as their revenues are recognized in Argentine pesos. Even if a devaluation of the Argentine peso occurs after the upcoming election (as many are predicting), the expected increase in tariff rates for Edenor will help to balance peso volatility.
Summary and Conclusion
Edenor provides an essential service to the citizens of Argentina’s largest city, Buenos Aries. Although the company has had challenges in trying to match revenue with costs due to the long-standing tariff freeze, the tide has turned, as evidenced by the recent rally in Edenor stock, with the Argentine government moving towards allowing rate increases by the end of this year. Any such increase will have a positive effect for Edenor – increasing operating margins and allowing the company to update its aging systems. For bondholders, Argentina represents an excellent diversification opportunity into a country poised to make significant economic progress with the advent of a new ruling government. These 9.75% couponed bonds have a slightly longer duration than many of the bonds recommended here on BondYields.com, but we like the monopolistic position of Edenor along with the essential service it provides to the city and country where it operates. Consequently, we believe the high 12.5% yields indicated with these bonds will make an excellent addition to our Fixed-Income1.com and Fixed-Income2.com global high yield fixed income portfolios.
Issuer: Empresa Distribuidora y Comercializadora Norte S.A. (Edenor)
Yield to Maturity: ~12.5%
Disclosure: Some Durig Capital clients may currently own Edenor’s 2022 bonds.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
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