Equatorial Energia SA

BOVESPA:EQTL3

Earnings Call Analysis

Strong Performance Amidst Challenges and Opportunities

Equatorial Energia Group reported substantial performance in Q3, with a 6.8% year-over-year growth in distributed energy and adjusted EBITDA rising by 33% to BRL 2.5 billion, credited largely to an impressive distribution sector performance and incorporation of Equatorial Goias. Despite weather adversities like cyclones and heatwaves, the company's strategic loss reduction resulted in an 18.6% consolidated reduction and managed to reduce the net debt-to-EBITDA ratio by 0.2x to 3.6x. Moreover, the company advances in renewables with solar plant projects set to begin next year. Looking ahead, Equatorial anticipates continuous improvements in quality and loss reduction, with a keen eye on evaluating valuable capital allocation opportunities and maintaining a disciplined financial approach.

Resilience Amidst Natural Disasters and Economic Shifts

Equatorial Energia has demonstrated solid operational and economic performance in Q3 despite facing extraordinary weather events such as massive cyclones in Rio Grande do Sul and intense heat waves. These challenging conditions strained the grid but did not prevent the company from making progress in its debt reduction process. More broadly, a favorable macroeconomic shift with lower interest rates since July has reduced debt costs, offering opportunities for more attractive liability management.

Expanding Market Presence and Reducing Losses

With a focus on its strategy of loss reduction and growth in distributed energy, Equatorial Energia saw a significant annual increase of 6.8% in energy distribution. The company's aggressive loss reduction strategies have brought down the consolidated level of losses to 18.6%, a 0.9 percentage point improvement from the prior year. This has been a major factor in driving Equatorial Energia’s strong financial results, including a 33% jump in adjusted EBITDA to BRL 2.5 billion, partially fueled by the integration of Equatorial Goias.

Expensing and Investment Diligence

The discipline displayed in managing operating expenses has been commendable, with costs growing just 5.5% excluding Goias, which is aligned with inflation rates. On the investment front, caution is exercised with a 13% reduction in expenditures for distribution, excluding Goias, to conform to the state of tariff review processes. In renewables, two significant solar parks are being developed with an accumulated investment of BRL 2 billion to date.

Debt Management and Grid Performance

Despite the heavy investment in growth and development, successful earnings before interest, taxes, depreciation, and amortization (EBITDA) have enabled Equatorial Energia to lower its leverage, achieving a net debt-to-EBITDA ratio of 3.6x. The reduction of grid losses and a continued commitment to expense management have been pivotal in achieving this improved debt profile.

Renewed Focus on Energy Distribution and Operational Efficiency

The consolidation of Equatorial Goias has been significant, with distributed energy growth standing at 6.8%, driven by high temperatures and advanced loss reduction efforts. Operational efficiency was also improved with significant reductions in states like Amapa and Rio Grande do Sul, as well as a 5.6% growth in adjusted OpEx.

Leveraging Transmission Asset Performance

Equatorial Energia maintained a steady performance in their transmission segment, with a marginal 0.6% year-on-year increase in EBITDA for this segment. Highlighted was the sale of Intesa, expected to aid in the company's deleveraging strategy. The divestment reflects a strategic decision to focus on reducing debt levels but does not indicate departure from the transmission business.

Renewables and Infrastructure Expansion

Constraints in national operations led to a 17% decrease in energy volume and a 10.9% decrease in EBITDA for the renewable segment. Nonetheless, Equatorial Energia has made strides with the solar project pipeline, reaching important milestones, notably securing significant financing and customer base growth. Notably, a solar park in Ribeiro Gonçalves secured BRL 200 million financing, indicating the company's strength in advancing major renewable projects.

Outlook and Strategic Priorities

Looking forward, Equatorial Energia has set clear priorities including improving service quality, reducing losses, especially in Goiás, and organic deleverage. The successful tariff review in Goiás, which recognized a BRL 9.4 billion net asset base, is vital for sustained investment and growth in the region. With these systematic efforts, the company positions itself competitively for future value creation opportunities.

Earnings Call Transcript 2023-Q3

[Operator]

Ladies and gentlemen, thank you for waiting. Welcome to Equatorial Energia's Q3 2023 Earnings Call. Today, we have Mr. Augusto Miranda, CEO; Mr. Leonardo Lucas, CFO; and Mr. Cristiano Logrado, Director of Regulations; Mr. Tinn Freire Amado, CEO of Echoenergia; Mr. Liu Aquino, Operations Director of Echoenergia; and Ms. Tatiana Vasques, Superintendent of Investor Relations. This is being recorded. [Operator Instructions]. This is also being broadcast via webcast at http://www.equatorialenergia.com.br/ where you can also find the presentation for download. You have control over the slide selection. This recording will be available shortly after its conclusion. Webcast participants can submit questions via the website. They will be replied shortly after the call.

Before we continue, we would like to inform that any statements made during this call regarding the company's business prospects, projections, operational and financial goals are based on beliefs and assumptions of the company's management. Future considerations do not guarantee performance. They involve risks, uncertainties and assumptions as they relate to future events, and therefore, depend on circumstances that may or may not occur. Investors, analysts should understand it general condition, industry and operational factors can affect future results and may lead to outcomes that substantially differ from those expressed in such forward-looking statements.

I would like to turn the floor over to Mr. Augusto Miranda. You may proceed now, sir.

[Augusto da Paz Júnior, executive]

Good morning. Thank you for attending. I would be showing Q3 results of Equatorial Energia's Group. As far as the operational environment, Q3 was marked by strong operational and economic financial performance despite extraordinary weather events in Rio Grande do Sul with massive cyclones and [indiscernible] with intense heat waves that's strained the grid. In addition to the progress of group's [indiscernible] process and the regulatory environment, we do have positive prospects regarding renewable concessions based on the technical note issued by the ministry, which outlined a positive framework for the renewal process.

In the macroeconomic scenario, the start of the smaller interest rates started in July to contribute to a reduction of the cost of our debt, providing an opportunity to advance managing our liabilities at more attractive costs.

Let me start with Slide 3. Let me start with the operation highlights. I would like to find out the growth of distributed energy in a consolidated view, showed a 6.8% increase on an annual comparison basis. This growth is adjusted taking into account the pro forma data from Q3 of '22 with Equatorial Goias coming from a strong temperature quarter in most region we operate and driven by the results we have achieved in implementing our loss reduction strategy, which recorded a consolidated level of 18.6%, a 0.9 percentage point reduction on an annual basis influenced by significant reductions in both Amapa and Rio Grande do Sul.

We achieved BRL 2.5 billion of adjusted EBITDA in the quarter, a 33% higher performance than previous quarter led by the remarkable performance of the distribution sector in addition to consolidation of Equatorial Goias. This view already excludes the noncash effects of them, VNR, IFRS and MTM, invested about BRL 3 billion in the quarter.

The highlight is in renewables with 2 solar plants that are scheduled to start operations next year. We ended the quarter with a 0.2x reduction in the net debt-to-EBITDA ratio, compared to the previous quarter, totaling 3.6x in the covenant view. This is the third consecutive quarter of reductions in the consolidation of Equatorial Goiás, which confirms our focus on leverage management.

To that extent, with the highlights the asset recycling movement announced just last week with the signing of a purchase and sale contract of 100% of Intesa Capital, one of our transmission assets, just yet another initiative to accelerate to deleverage, which is expected to impact the next quarter.

Finally, I would like to highlight the conclusion of the tariff reviews of the 2 largest distributor in the group, Equatorial Pará in August and more recently, Equatorial Goiás back in October. With the recognition of [indiscernible] with BRL 9.4 billion, this will be crucial to keep on advancing in the investments that are necessary to the quality of [indiscernible] region.

I'll turn over to Leo on Slide 5. We'll start with our consolidated view with the economic and financial performance of the group. Over to you, Leo.

[Leonardo da Silva Lucas Tavares de Lima, executive]

Thank you, Augusto. Good morning, everyone. I'll briefly talk about the group's economic and financial performance. This is the consolidated view. These numbers are adjusted by nonrecurring and noncash effects, such as, VNR in distributors and IFRS in transmission and MTM in marketing. Our consolidated group margin grew by 39.9%, compared to Q3 of last year. This growth is primarily linked to the strong performance of the distribution sector, driven by the growth in the tariff market mix, alongside with loss reduction on top of the consolidation effect of Equatorial Goiás, which added BRL 662 million to the margin in the quarter.

Within the same concept, the adjusted OpEx in the distribution sector, excluding Goiás grew by 5.5% in line with inflation rates, consolidated grew by 11% when we quarterly compared, primarily due to the Equatorial Services growth with the inclusion of Equatorial Goiás.

The reported EBITDA for the quarter reached BRL 2.8 billion, 69% higher year-on-year. Adjusting for nonrecurring noncash effects, EBITDA reached BRL 2.5 billion, 33% higher than Q3 2022. The group is mostly driven by distribution assets, which in the next Goiás view, grew by 16% when compared to the same period of last year. Thus reflecting a strong market increase and the evolution and loss reduction strategies.

Moving on to Slide 6 now. These are investments and debt information. We had a significant volume of investments in the quarter, totaling BRL 3 billion. This amount is driven by the peak of CapEx for the execution of Echoenergia pipeline, which in the quarter reached about BRL 1.1 billion. In the development of 2 solar parks in both Bahia and Piaui.

As far as distribution is concerned, excluding Goiás, the 13% reduction demonstrate the appropriateness of investments considering the current stage of tariff review processes. Furthermore, regarding the renewable segment, it's worth mentioning that back in October, we completed the financial agreement for the Ribeiro Gonçalves solo part up BRL 200 million. There's a 24 years with 15 months of interest and principal grace period at a cost of IPCA plus 5.34 per annum.

On the right, you can see the company's debt profile. We ended the quarter with a consolidated net debt of BRL 37 billion. Despite the significant investments, the substantial EBITDA growth has contributed to a leverage reduction. We are at 3.6x, a 0.2x reduction when compared to the previous quarter. This is the third consecutive quarter of reductions against the consolidation of Equatorial Goiás, once again, restating our strong deleveraging capacity in addition to our robust cash position of approximately BRL 10 billion.

Moving on to Slide 8 on to distribution now. We now show an overview of operational and commercial performances of our distributors. For comparison purposes, operational data are presented with the Q3 '22 vision adjusted with the Equatorial Goiás data. I would like to draw your attention on this slide to the strong market performance, a distributed energy growth of 6.8%, driven by high temperatures during the period and advancements in the loss reduction. We closed the quarter with a consolidated loss level of 18.6%, only 0.2 percentage points from the consolidated regulatory limit.

When compared to the same period of last year, we recorded significant reductions in Amapa, 6.9 percentage points and Rio Grande do Sul minus 3.6 percentage points. However, I would like to point out Equatorial Pará. For the first time, it's now operating within the regulatory tariff coverage for loss levels.

As to the commercial performance now, we keep on delivering good performance in both PECLD and revenue collection. In terms of quality, I would like to highlight the significant reduction in [ Maranhão ], 12.9 hours when compared to the previous year. On top of Alagoas with a 6.1 hour reduction when compared to Q3 of last year. In the adjusted OpEx, a 5.6% growth in an ex Goiás view. Once again, that points out our ability to manage and control costs within Equatorial.

When we compare adjusted EBITDA, we show a strong growth of 25% influenced by improved gross margins driven by market growth, loss reductions on top of cost discipline.

On to Slide 9 now. Here, we show our recent tariff processes very quickly. In the quarter, we had a tariff revision for Equatorial Pará in August. And more recently, we had the approval of the revision of the new cycle for Equatorial Goiás now back in October. I would like to draw your attention to 2 important points: losses in Pará and the approved asset base in Goiás. As a result of efforts [indiscernible] losses in recent years to the outcome of tariff review, real losses in Pará reached the regulatory level. Despite the trajectory of regulatory losses, we see significant potential for value generation throughout the tariff cycle that is beginning.

In Goias, the confirmation of the net asset-based RAB of BRL 9.4 billion surpassing market expectations is the primary trigger, because we are properly positioned so that we can be more adherent to the required investment volume for this important concession. The following quarters will still be marked by tariff reviews for group assets. In Q4 of 2023, we will have reviews of both Piauí and Amapa and Q2 '24 for Alagoas.

Moving on to the next slide, please, Slide 11. We quickly demonstrate the transmission performance. In the quarter, the regulatory EBITDA for this segment had a 0.6% variation, reaching BRL 307 million, compared to BRL 305 million in Q3 of last year, with the impact of scheduled 50% reduction in the RAP original of Intesa and offset by the adjustment of our RAPs for both '23 and '24.

As you can see, transmission operation recorded a consolidated EBITDA margin of 91.1%. On top of that, we have recently announced actually this last week, the divestment of Intesa, which will help us in the company's deleveraging process. The operation is up to BRL 714 million, laid-up of an equity value of up to BRL 396 million as of December 31 of 2023. The rest corresponded to the asset net debt as of June 30. We expect to finalize the operation later this year, but I would like to point out that this move does not represent the group's exit from the transmission segment.

Slide 13. Let us now look at our renewables energy operation of Echoenergia. This quarter, records the impact of restrictions of the national operating, which implemented operational changes the way we operate after the event that occurred on August 15, results in the partial ship down of the National Interconnected System. These restrictions known as constrained off significantly impacted generation during the period. As a result, the volume of energy decreased by 17% in the quarter when compared to last year.

Additionally, to that effect the maintenance of 2 wind turbines in the Echo 2 park contributed to the reduction affecting technical availability. Excluding the impact of Echo 2, the adjusted tech availability of the portfolio reached 97% for the period. In the quarter, EBITDA showed a decrease of 10.9%, reaching BRL 200 million for the period, affected by the above-mentioned events.

Moving on to the next slide, on Slide 4, I'd like to give you more details about our solar project pipeline development. As you can see, we have moved along the development of Ribeiro Gonçalves and Barreiras 1 park in Piauí and Bahia, respectively. They're expected to start operations in 2024. We keep on advancing according to the construction schedule. For this development, the total CapEx for the quarter was BRL 1.1 billion and accrued investment of BRL 2 billion. I highlight the contracts signed in October for line of BRL 200 million for the Ribeiro Gonçalves park with very attractive conditions. With this slide, the company should not draw on sub-creditor B with the Brazilian National Development Bank.

Finally, I would like to draw your attention to the progress of marketing energy from these projects. 900 customers in the quarter, a 45% growth when compared to Q2. Continuing through the end of October, we have already reached the milestone of 1,000 customers. Another way to illustrate this progress. We just showed the positive results from market energy contracts to market, which had a net impact of our results of BRL 24 million. This result was driven by sales to final customers [indiscernible] following the market methodology or through the operations.

On to Slide 16 now. In CSA, we have concluded 1 year of operations in July. And for the first time, we can make an annual comparison. We concluded Q3 with about 83,000 build water supply connections. Improvements in the water coverage rates from 35% to 42% and losses from 70% to 59%. I think it's worth noting that this asset is a long-term investment with a longer average duration. So we still have a long way to go. And this project, which resembles the ring fear project as shown by universalization time line.

The lessons learned in CSA will be extremely important to evaluate new investment opportunities that are expected to come to market next year. This is a significant avenue growth for the group.

I'll turn the floor over to Augusto for his closing remarks.

[Augusto da Paz Júnior, executive]

Thank you, Leo. I would like to conclude by summarizing the key messages of our call and once again reinstating our recent achievements. Overall, the main highlight is the strong performance with a significant increase in gross margin, which grew by 41%, compared to the previous year. It was made possible by the performance of the distribution segment, including the consolidation of Equatorial Goiás, combined with efficient management of operating expenses as we saw in the expense growth in line with inflation, leading to a 33% growth in adjusted EBITDA.

We continue to make progress in the construction of solo project, adding approximately 600 megawatts of installed capacity and in October, we completed the financing agreement with BNB. I would also like to point out the tariff review processes, we have undergoing at especially in Equatorial Goiás back in October, recognition of BRL 9.4 billion in net cash base is key to enable the necessary investments in the concession.

As to the outlook for the year, we continue to focus on improving the quality and reducing losses in our distribution company, with special attention to the turnaround in Goiás. As RS capital structure is concerned, we see organic deleverage through every reprocesses and progress in turnaround processes, which will allow us to be more competitive in evaluating potential future capital allocation and opportunities to create value.

I'll hand over the floor to the operator so that we can start our Q&A session.

[Operator]

[Operator Instructions] First question comes from Guilherme Lima from Santander. You may proceed sir.

[Guilherme Lima, analyst]

We have seen pressure in the legislative or tariff reduction. Can you elaborate on your strategy about the actions to reduce that pressure from tariffs?

Can you talk about the [indiscernible] Block 2, I think it has been approved in the state of Minas Gerais, allowing the use of [ NCR ] resources to offset expenses by 2025. Could you elaborate on your take on this new approval?

[Augusto da Paz Júnior, executive]

Thank you, Guilherme, for the question. I'll turn it over to Cristiano to answer part of that question. [indiscernible] we have been working with other companies and other CEOs and even with the Congress, it has to do with the regulation. So I'll turn it over to Cristiano.

[Cristiano de Lima Logrado, executive]

Let me address the issue to mitigate tariff pressures. These issues have been discussed in several forum. Most often, they deal with subsidies of resources allocation, especially in installment adjustments. We keep on monitoring them to make sure that whenever they are approved, they are balanced, so that they don't generate any distortions that may put even more pressure in these issues that we know are present in the industry.

As to the recent bill of law that has been approved, I've been keeping track of those discussions, but there are still many details pending. So still have to wait to see how these negotiations evolve.

[Operator]

Daniel Travitzky from Banco Safra asks the next question.

[Daniel Travitzky, analyst]

Let me piggyback on the previous question actually. The concession renewal process. We would like to get some updates, if you may. We don't have a decree that has been defining renewals. This is a topic that has been discussed quite extensively in recent months. So what's your take? What's your expectation of those negotiations? If you please, could you provide us with more color as to the operational problems switches the ones we've seen in Sao Paulo, the relationship between ANEEL and the government, how can that impact the renewal of concession? I've heard news about it. So I would like to hear your take on this type of event.

[Augusto da Paz Júnior, executive]

Thank you, Daniel, for your questions. This is something that's been on our radar for quite some time. But even the ministry, they clarify a couple of questions. So we remain positive about it. We have been closely monitoring it. And these 2, the accounts revenue that sent back to both regulatory agencies and the ministry. Every now and then there are a couple of questions and we clarify them on an as-needed basis. But the ministry has been very clear about it.

The process is very normal the way they see it. That's our take from our conversations with the ministry. That's the way we see it. The topic is a hot topic, we know and the problems we've seen in Sao Paulo will generate discussions. But it's a very political bias. People that are more privatization prone, others are like the opposite. Whenever there's an adverse event, that topic is discussed once again.

But privatization has been positive, that's undeniable. There are problems here and there. Of course, if it's a state-owned company population, it's more "patient". So one day it's privatized, they are more demanding, but it's only natural that this discussion will occur. But the benefits of privatization, take energy, water treatment. Of course, facts are very evident there. Cristiano, Leo, Tati, if you want to contribute, if you want to jump in, feel free to do so.

[Unknown Executive]

Let me comment on the problems in Sao Paulo. The discussion is heated, of course, based on the perception, not only for what happened to Enno, Sao Paulo, but other companies in the region. Both [indiscernible] will be more objectively assessing the situation before they come up with a conclusion. Of course, you're not going to take this occasion or problem to determine a concession renewal that is for 30 years. Let me just say that what we've done so far we already had a renewal session every new interaction, the topic becomes more and more mature, more consolidated, hasn't been finalized, yes. But as it matures, as it evolves, there's room for adjustments, but they are going to be diminishing as time goes by.

[Operator]

Luiza Candiota from Itau BBA asks the next question.

[Luiza Candiota, analyst]

My question is more specific to OpEx. We had a relevant growth, especially in distribution. But that is driven by the construction effort in Maranhão. We've seen reductions. You have been focusing on improving quality. I would like to better understand your take on costs looking forward. Do you believe that these numbers can get back to normal values?

[Augusto da Paz Júnior, executive]

Luiza, thank you for your question. We have been focusing on cost, and we look at it on a daily basis. This is embedded across the Board in the company. We had that event back in Maranhão during the pandemic, we had problems with some service providers, [ 5, 4, Chapter 11 ] that impacted some services. But let me point out, Luiza, we have worked hard as there were some pent-up demand for some of those services. But we have been reducing that by 12.9 hours. This is a record. Some services had some pent-up demand, of course. But when you look at the track record of back of [indiscernible], numbers on a consolidated basis are below inflation. Leo can give you further details about it.

[Leonardo da Silva Lucas Tavares de Lima, executive]

Yes. That's right. That's a very good question. The quality reduction in Maranhão is substantial. It has to do with that plan, and that has been thought out very carefully. And there's some ramp-up going on for their more robust growth to take place. But this is going to happen in the timely fashion when you improve quality, resources are being properly allocated. So results are showing. And as the plan evolves, we'll be able to see smaller growth rates. There will be CapEx impact to fight their quality issue, especially as frequency is concerned.

We're now close to a tariff review, which is 2 years. We'll keep on investing more CapEx there. And after year during the budget discussion, we're always challenging those numbers so that we have everything in place. And at this point in time, that reinforcement and costs is affecting our positive, our otherwise very positive results.

[Operator]

[Operator Instructions]. We have a question from the webcast. This is [ Luciano Acosta ] from TC Investments. Can you explain the opportunities of water treatment for 2024? Are you looking at specific assets even if you can't announce what they are, are you considering any opportunities in this industry?

[Augusto da Paz Júnior, executive]

Thank you, Luciano, for your question. We have been looking at water treatment with the PSA in Amapá as the testing ground. We have been looking at opportunities. We've seen the new video of framework. I'll turn over to Leo to talk about these new business opportunities. Leo?

[Leonardo da Silva Lucas Tavares de Lima, executive]

Thank you, Augusto. Well, we have learned our lessons in this industry. So the opportunities are huge. The investments gap to make that service universal is huge. We need private capital. We were discussing as potential changes. But for next year, we see a very busy pipeline. So we are present in industry. Of course, we are considering business opportunities, and we are considering opportunities to participate in that segment.

Maybe individual or separate deals or auctions we've seen something happening in [indiscernible] Paraíba, Rondônia, something in to Piauí are maybe further down the road, in Minas, Espírito Santo, we are considering some possibilities. So this pipeline is again on the move, which is very interesting, and we would like to position ourselves in that segment, aiming at an expansion in this industry, always maintaining our capital allocation discipline generate value, but it's a very attractive pipeline undoubtedly.

[Operator]

Well, since there are no other questions, I will turn the floor over to Mr. Augusto Miranda for his closing remarks. Mr. Miranda, you may proceed.

[Augusto da Paz Júnior, executive]

Thank you. I would like to once again emphasize our commitment to the continuous value generation agenda that we look for our investors by delivering consistent results in the various segments in which we operate, always maintaining financial discipline. Our IR team is available to answer any questions you may have. Once again, thank you for taking part in our earnings call. Have a great afternoon. Thank you.

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