CESP Companhia Energetica de São Paulo : Transcript Conference Call 3Q20

Conference Call

CESP - Companhia Energética de São Paulo

3Q20 Results

October 29, 2020

Operator:

Good morning, ladies and gentlemen, and thank you for attending the call. Welcome to the earnings conference call of the 3Q20 of CESP, Companhia Energética de São Paulo.

I would like to inform that this event is being recorded. After the presentation by CESP, there will be a Q&A session for analysts and investors. Should you need any assistance during the call, please press *0 to speak to the operator.

We will also have a live webcast with audio and slides that can be accessed at the Investor Relations website of CESP at www.ri.ces.com.br. Presentation will also be available for download at the website. Information is available in BRLs according to the Brazilian corporate law and the accounting practices adopted in Brazil, BR GAAP, already in compliance with IFRS, except when noted otherwise.

Before proceeding, I would like to clarify that statements that may be made during this call regarding the business prospects of CESP, projections and operating and financial goals are based on beliefs and assumptions of the Company's management as well as on information currently available. Considerations about the future are not guarantee of performance because they involve risks, uncertainties and assumptions as they refer to future events and depend on circumstances which may or may not occur. Investors should understand that general economic conditions, industry conditions and other operating factors may affect the future performance of the Company and lead to results that differ materially from those expressed in such considerations.

Here with us, we have Mr. Mario Bertoncini, CEO and Investor Relations Officer, and Marcelo de Jesus, CFO.

I would like to hand the floor over to Mr. Mario Bertoncini, who will start the presentation.

Mario Bertoncini:

Thank you all very much for attending the call. Marcelo de Jesus, CFO of CESP, and I will make the presentation for the results of this 3Q20, and then we will open for the Q&A session.

Moving on to page four, we have the highlights for this quarter. With regards to COVID, we continue to work from home. 82% of our staff is working from home, both from plants and management. The three plants have adopted a special operations regime due to COVID with the energy production at regular normal levels.

The generation in this 3Q amounted to 1.04 average GW, 10% above the physical guarantee. And this dispatch has been determined by ONS. The availability index in the period was 95% consistently as well in the last quarters above a new reference values.

With regard to our financial performance, which will be detailed by Marcelo, in the 3Q, we had a growth of net operating revenue of 14% when compared to the 3Q of last year. The adjusted EBITDA in this quarter amounted to R$236 million with an EBITDA margin of 50%. In this quarter, we had a

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reduction in contingent liability of R$123 million before monetary collection, of which R$34 million refer to the write-off of probable liability before adjustment for inflation.

The operating cash generation of CESP in the quarter amounted to R$150 million after debt service before payment, principal or interest, with a cash conversion of 64%. So this operating cash generation amounts for 64% of EBITDA in the period.

We also completed the infrastructure bond issue amounting to R$1.5 billion, and with an average term of 9 years at the rate of IPCA plus 4.3% per annum. Also, in October, we completed the second payment of dividends at R$0.60 per share, and such dividend was resolved in March of this year. This was the second and last installment of dividend payment.

In terms of energy sales, as you will see shortly, our energy balance for 2020 is virtually equalized. We have purchased 90% of the energy necessary to cover the deficit of 2021. And we could also advance in our policy and plan to sell energy for the long run, especially for 2023 to 2025.

Moving on to slide six, you can see the GSF updated related to the new agreement on hydrology risk. As you may know and recall, Bill 3975 passed and became Law 14052 that sets forth the general guidelines for the new agreement at hydrology risk. It was published on September 9 and has to do with the extension of grant terms for plants that participate in the regulated energy market. ANEEL has published already within the public consultation for the regulation of this law.

It already published some preliminary calculations for compensation purposes, based on the assumption use, which was of a total period of 102 months from March 2012 to August 2020. With an IPCA plus 0 adjustment for inflation, the values that already published for Porto Primavera, account for an extended period of seven years, which is the maximum limit provided in law, and the concession ends in 2049. So it is seven years after that.

And for Paraibuna plant, it is an extension of nine months approximately, based on these assumptions, which are preliminary, and the preliminary calculations made by ANEEL. It is also important to highlight that CESP is not part or party to these lawsuits.

So there is nothing for CESP to pay due to this new agreement on hydrology risk. On the contrary, we are creditors of that because of this dispute regarding GSF. So there is no cash disbursement. On the contrary, there is cash release as soon as the guidelines of the law are implemented.

Regarding the schedule, which is basically based on Law 14052, it sets forth that the deadline for resolutions of standardizations, et cetera, is 90 days after the publication. So it is December 9. So that is the deadline for regulation. So we would have until May 9, 2021, as the maximum date, the deadline for adoption by agents. It is likely that this schedule is advanced because CCEE has made some announcements confirming this possibility of advance in the schedule. But that is still to be confirmed.

Moving on to page eight, we have details about the contingent liability. As you may recall, in the second quarter 2020, we closed with a total contingency of R$10.95 billion contingent liability. That is the left bar chart. During this 3Q, IGP-M had a strong impact, especially due to the currency depreciation, among other factors.

And in the 3Q, the variation was 9.3%. This caused an increase in contingent liability monetary correction, and therefore amounted to R$499 million in this 3Q. In parallel, due to court decisions and some negotiations, there was a write-off of R$123 million of the total contingent liability, and we

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closed the 3Q with R$11.32 billion. Out of these R$11.32 billion, as you may see in the middle of the page chart, we have a probable liability of R$1.85 billion that is fully provisioned for.

On the pie chart on the right of the page, we see the updated breakdown of the contingent liability. And so from this R$11.32 billion total liability, 42% refer to civil lawsuits of potters, ceramists of the region; 26% are civil lawsuits of fishermen; followed by 16% miscellaneous lawsuits, especially expropriation and some other lawsuits, what are general civil lawsuits not related to potters or fishermen.

And completing the chart, 9% of total contingents is environmental lawsuits; 5% tax lawsuits; and 2% labor claims. In this quarter, although the reduction was small, R$123 million, it was a quarter with many final favorable decisions for CESP. And we were able to write-off 216 lawsuits. And also, we advanced on the negotiation of several lawsuits that we expect to conclude in the following months.

Continuing on page nine, we have the lawsuits of Três Irmãos. There is nothing new in July in the beginning of the 3Q. The judge of the lower court made a resolution on July 10, which is to complete a small number of documents that still were to be digitalized in this process. And he informed that as soon as the digitalization process of the document is completed, there will be 15 working days for the impartial expert to provide his report, the expert report.

This 15 working days period has not started yet. We are waiting for the digitalization of the documents to be finished by the courthouse. And we hope it ends soon. And then we filed a new petition in this process with some additional comments and additional analysis about the expert report.

In parallel, as you may know, we are still waiting for the decision on the injunction by the Superior Court of Justice in Brazil. Nothing new here in terms of that decision.

Now continuing on page 11, we have an update of some indicators from the energy market in this quarter. Let us start with the chart on the left. It shows, on the green curve, the information about the reservoir levels; and in gray, you can see the ANE Affluent Natural Energy information. We closed the quarter with the reservoir levels at 40%, so 5% above the 35% of the same period last year.

Although in October, we had a very dry month, very low rainfall, which caused us to probably end October with reservoir levels around 29%, slightly below 30%, which is slightly above the levels of the same periods last year, but still low anyway with the ANE, around 41% for the end of October, which is a very low level, considering the historical measurement data.

On the chart on the right, has to do with demand for energy. We see the high volatility of prices in the energy prices in these last weeks. We see, in the green curve, the monthly consumption from last year all over the country, demand in average gigawatts; and in yellow, the consumption from this year. And you have the updated estimate for October 9 and November and December by ONS.

We see a peak of consumption in Brazil in October that has to do with very high temperatures that we had, which in Brazil, at this time of the year, boosts consumption of energy for air conditioning; and as well as some activities resuming after the deceleration of the pandemic. The combination of these two factors has brought volatility in prices.

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So if the projections of ONS are confirmed for 2020, the demand in the year for the 12 months would have dropped 1.4% this year when compared to last year, and the consumption of energy of the last quarter of the year would have increased 2.9% when compared to the last quarter of 2019.

Also, there was an upward review of GSF, that according to CCEE, the projections were 80%. And it was revised to 81%. So decreasing the burden on energy plants, such as CESP. This will cause for a slight energy deficit according to the dispatch.

On the following page, we talk about the energy balance for 2020. I would refer to the last chart at the lower right hand, chart number four, which shows the net position of the energy balance. It is virtually equalized for 2020. We have some very light deficit positions in October to December. And according to the review of GSF, they could be even offset. As the GSF improves, there is energy release to CESP, which is enough to offset this small, short position that remains.

And I would like to reaffirm the information I provided earlier that in parallel to the equalization of the energy balance for 2020, we have also equalized around 90% of the needs of our short position exposure for 2021 and have advanced as well in order to reduce our short position for 2022.

Now I would like to hand the floor over to Marcelo de Jesus, our CFO, who will talk about the financial performance of CESP in this quarter.

Marcelo de Jesus:

Good morning. Continuing with our results, let us talk about the financial data. As we presented in previous quarters, in the 3Q20, we continued to have a consistent reduction in costs and expenses. This is the result of the transformation initiatives implemented by CESP throughout 2019, and the reduction of the volume of energy purchased was 53% higher than the volume purchased in the same period of last year due to our strategy of seasonalization.

But it is important to highlight that the average purchase price of this energy volume was 8% lower when compared to the price paid in the same period of 2019, which is the result of our strategy for the energy balance.

We seek the best opportunity windows to purchase energy and meet our contract needs. In terms of personnel management expenditures, the reduction in the quarter was 22%. And year-to-date, it was a 33% reduction.

This reduction in total expenditures results from the high addition to voluntary dismissal programs in 2009 and which amounted to a reduction in the number of employees. As to third-party services, materials and rents, the reduction in the quarter was 37%, and year-to-date 44% reduction. This is the result of the renegotiation of some contracts, both for vendors, as well as an improvement in internal processes of the Company.

Now going to slide 15, we continue to talk about the financial performance of the Company. On the left upper corner, we see the net revenue growth of 14% or R$57 million, basically due to trade activities that started in January this year.

On the right corner, we show the EBITDA, which in the 3Q20 is in line with the 3Q19. Because the growth in revenue was offset by higher energy purchases, as we signed in previous slide. As for this first 9 months of the year, the EBITDA grew by 74% or R$364 million. As a result of a reduction of costs and expenses, better management of energy balance and trade activities.

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At the lower part of the slide, we see the operating cash flow after paying debt service of R$150 million. This cash flow represents the conversion rate of 64%. It's important to highlight that this conversion rate, considered that this first quarter, we paid R$14 million in PIS/COFINS taxes referring to periods of previous semesters that were postponed due to ordinances of the Finance Ministry due to the COVID-19 pandemic.

If we do not consider these amounts paid in this 3Q, which referred to previous periods, the conversion rate would be 70%, which is strong cash generation, which allowed us to reach the end of the quarter with R$873 million in cash. On the next slide, we see the capital structure.

And the highlight is the 12th issue of infrastructure bonds, R$1.5 billion IPCA, plus 4.3% with a term of ten years. This issue was very important because it increased our previous average term from 4 years to 9 years. So it almost doubled or more than doubled. And the funds raised with the issue of debentures were used for partial payment of the 11th issue. And therefore, we have a residual balance of the 11th issue amounting to R$300 million.

It is important to highlight that due to this prepayment, we also renegotiated the conditions of the 11th issue. And the payment term and the cost of debt were maintained, but we were able to exclude all the financial covenants as well as trade receivable guarantees requirements.

I now hand the floor over back to Mario, because he will talk about the other initiatives of the Company. Mario?

Mario Bertoncini:

Thank you, Marcelo. Now moving on to page 18 of our presentation. Since December 2018 and throughout last year and this year, we have noticed a known agenda of management of the lawsuits of CESP with the derisking and reduction of costs and expenses.

You have seen there our agenda of gains in productivity and people management. In this quarter, for the second year, we were awarded the seal of GPTW, Great Place to Work. And we are one of the best companies to work for in Brazil. In addition to all these initiatives that you all know, we have listed 3 other initiatives that we are more focused on. The first one is the agenda of sustainability.

And I highlight three aspects. The first is the agenda of initiatives in occupational health and safety. We are moving fast to place us at a benchmark position in terms of occupational health and safety in the energy industry in Brazil.

In addition, in this last month, we have deeply reviewed our social environmental guidelines in the ESG agenda. We have an ambitious initiatives for this next quarters because we have the UN Sustainable Development Goals, and we have established some priorities, and based on that, an action plan with the targets in order to deliver on this action plan on the next quarters.

And also on the environmental agenda, in this 3Q, we advanced on the publication and commercialization of certified energy with IRAC certificates that attest for the clean energy produced by CESP. So we can now sell the energy with a sustainable energy certificate, I-REC. We have worked hard so that in the beginning of 2021, referring to 2020, we will be able to have our first integrated report, including sustainability as well, financial, economic and sustainability data.

We are very focused on the modernization and simplification of our technological architecture, focusing on modernization, agile processes and systems, focusing on automation and data analytics.

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We are advancing very well to be a very lean and agile company that is able to quickly reply and act on the challenges that appear. We also have CESP Energy Trading. In the beginning of 2020, we started CESP Comercializadora. And since then, we are able to advance a lot in the position of energy sold. And this regarding '20 until 2022, this is a position that has been very well resolved that was made by the traders of CESP Comercializadora, CESP Trading.

We also advanced in our trading operation this year, following a policy of establishing risks with very clear goals, and we had very promising results so far. And finally, we have started to develop, based on a very detailed plan, to sell energy in the long term. In this first quarter, we resumed this planned sale of long-term energy, and particularly for the three years from 2023 to 2025.

And now we are preparing to diversify our client base of end customers, developing new customers, new markets for CESP and continuing to add value more and more in the energy sales in the long run. I would like to thank you all for your attention.

This completes the first part of our virtual meeting, and now we open for the Q&A session.

Fernando Zorzi, Itaú:

Good morning. Thank you for the call. I have a question about contingent liabilities. The 3Q was marked with higher monetary correction. And so what is the outlook for the fourth quarter with this scenario post pandemic? And do you see discussions evolving regarding contingents in this next quarter?

And then I have a second question about leverage. We see that the Company is quite leveraged with a strong cash generation quarter-on-quarter. And you said that the first cash inflow would go for the contingencies that are being negotiated. And then after that, you will discuss dividend payment, growth, et cetera. So what are your thoughts on that? Has that changed? Or would that be postponed for next year?

Mario Bertoncini:

Thank you for your question, Fernando. Talking about contingency. Well, actually, this 3Q, we are able to lower the contingent liability by R$123, which is quite low when compared to the recent write- offs. But it was a promising quarter due to two factors mainly: first, the favorable decisions were many and continue to create good precedent for CESP.

We had some individual smaller case, but for example, the fisherman case, but we consider to establish a good jurisprudence on our behalf, and as well as some smaller cases that entered under a statute of limitations, which can help us a lot in the short run.

Another aspect is the negotiations. We have advanced a lot in this quarter in negotiating the liabilities for lawsuits, and we expect to complete the negotiations. And after some pending issues are solved, we can be able to give you a full report. We are very excited at the Company with the development of the negotiations.

And Fernando, we expect to be able to disclose the results of that soon. As for leverage, now answering your second question, in fact, the generation of cash is quite robust. In this quarter, along with the R$150 million, we brought leverage to 1%, one time the activity again. That is a good level. We now await the following aspects: first, the advancement on our negotiations on contingent

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liabilities for lawsuits that will need an additional cash disbursement as well as the GSF and the transfer of the hydrological risk, according to Law 14052.

We expect the recognition of that. This is an open discussion in the marketplace because that could leverage the accounting results of CESP and, according to our dividend policies, it could have an important impact on future dividends. So we have been very careful in managing cash and liquidity.

As for the future, you commented on growth. We have been able to consistently deliver what we have said to the market. So we are doing our homework, and even a bit ahead of our plans. I refer to solving costs and expenses, management of contingent liabilities, as well as the CESP Comercializadora management and people management.

So we are still not focused on growth projects. This is not the time yet, but we are getting closer to that moment each day.

Fernando Zorzi:

Okay, that is very clear. Thank you.

Pedro Manfredini, Goldman Sachs:

Good morning. Thank you for the opportunity. I would like to go back to slide 12 on the energy balance. You had the need to purchase energy in this quarter, the strategy of Comercializadora. The percentage of purchase was a bit above the spot of the period, right? So the strategy is to anticipate the future needs in the market. And then you incur in fixed prices, but could vary according to the spot price. Am I reading it correctly? Or in any month you decide to purchase at CCEE incurring the risk of spot. How do you anticipate the purchase needs? And how do you balance your exposure at CCEE? And what do you plan to buy anticipatedly in the market at a fixed price?

Mario Bertoncini:

Thank you for your question, Manfredini. If we see slide 12, especially chart #4, the energy balance after energy purchase. In gray, it is a short exposure; green bars are long exposure, so energy surplus. I refer to the past deficit, September backwards. So this is actually what is taken through CCEE.

This deficit position that you see from April to July are very well managed, and they have not represented a price exposure of CESP. But they are basically calculated so that we can release funds with CCEE.

Unfortunately, with this systemic default that the law of 14000 tries to solve, we have an important trade receivables at CCEE due to our size. One way to monetize that is to send them a short position. So these are very careful calculations, and I can affirm you, they have not involved any price risk from CESP.

The long position from August to September refer to a recalculation of GSF. August and September were periods of slightly above market expectations in terms of demand. And this increase in demand favors us in a favorable GSF.

And when we do this, there is a release of energy. And combined with the good prices, this is convenient to us to take it to CCEE to settle that, because that accounted for higher financial gains rather than working on the lateral market. Now from October to December, it is a very small loss.

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And it takes into account some volatility, some variation band for GSF. So it is maintained there to solve any possible variation in GSF.

With regard to price, which was the second part of your question, we can disclose to you the effective price of all purchases made, everything that is on the green bars of chart number three. And since we have been managing this deficit position since December 2018, so we have been purchasing and getting to zero the deficit position. Last year, we ended up purchasing energy, and for this year, at a price that was higher to the spot price of this year, or some of it happened before COVID, at the prices before COVID and then important price after COVID. So the average is R$213.

Pedro Manfredini:

I understood, Mario. So except for the systemic default at CCEE that you mentioned, CESP could have higher exposure at CCEE, or the strategy to maintain the exposure to 2021 is probably a fixed price, right? Would that change in any way once this systemic default ends? Or the strategy of the Group would have to lock a good portion of the price?

Mario Bertoncini:

Let me answer you in two parts. If it were not for the strategy of releasing funds at CCEE, we would not have this long position from April to July. So much so that if you get the material from our energy balances from the beginning of the year, for example, the material in the first quarter of 2020, this long position was not there. It was only created for CCEE.

This is not our strategy to have short-term balances so exposed. We try to work with the value to risk, very contained values, to manage the energy balance, which is different from our trade balance, which could have a short-term position according to VAR established there. But our strategy here is to have a very tight equation apart from what is here.

Pedro Manfredini:

Thank you very much, Mario.

Antonio Junqueira, Citibank:

I think the audio is much better now. If you cannot hear me, let me know, please. So in the beginning, or in your earnings release, you said that you have signed an energy agreement from 2023 to '25. So my question is, what could you share with us in terms of perception in terms of price liquidity of longer-term contracts, considering the economic impact of COVID? We would like to hear from you about that. You did not disclose the price of the contract. If you could, that is wonderful, otherwise, all right. But we would like to understand more about what you expect for the market.

Mario Bertoncini:

Much better. We could hear you loud and clearly, Antonio. Thank you for your question. Well, the way we disclose information in the earnings release, if you compare this quarter to the previous quarter. In this quarter of 2020, we showed something very close to 95 MW of energy of 2023 and 50 average MW for 2024 and 2025.

This, Antonio, is basically related to our policy for long-term sales of energy. And when we started the 2H20, the market liquidity improved with the prices started to improve in the long run as well with the smaller impact of COVID.

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The long-term market did not suffer from COVID so much, but even so, we have not disclosed prices of long term sales. This is a strategy of CESP. But I can assure you, since it is a very gradual strategy, the average market price for the period is very close to what we show.

So this average price for the three years for 2023 to 2025 has varied between 150 to 170 MW. So this is the average price, not our trade price, but it is a good proxy for you.

Antonio Junqueira:

Okay. Perfect. If I could ask a second question along with the question from Itaú that asked about potential growth. Of course, the Company is correctly focusing on this cleaning up of this legacy that was inherited. But I would like to ask you, if you turn the key tomorrow to start investing and seeking opportunities, either M&A or construction projects, do you feel that the Company already has the right team to perform that? Or would you have to bring new talents onboard to prepare for future growth in capacity?

Mario Bertoncini:

Antonio, I would say that we are training our people for many of our core areas. For any company that decides to grow, we have an in-house team. We have, for example, a very good trade area with a higher capacity than the current needs.

We have a planning team that is very good for budgeting and planning. It is very mature in discussions. We also have capital structure management that's well-formed, engineering team that is very well-trained and very capable, in terms of planning operations, maintenance, legal team also.

So we do have a very good team and capable. But depending on the growth scenario, when we have turned the key, using your expression, of course, here and there, you will need additional capabilities. But these are not people you need to have all the time. You would reassess and acquire those talents as they are needed. So we are a Company that is getting ready quarter-on-quarter for a new scenario. It has not arrived yet. It is not yet our focus, but we have been preparing ourselves consistently for that.

Antonio Junqueira:

That is a very clear answer. Thank you.

Daniel Travitzky, Safra:

Good morning. Thank you for the question. Looking at the cost reduction that you have shown in the last quarters, I would like to understand your point of view regarding the future. How much is there to be done still to reach a more normalized expenditure standard? We have seen many companies in the industry accelerating their digitalization strategies. I would like to understand how much these initiatives are related to cost reduction.

Marcelo de Jesus:

Thank you for your question. Well, as you have said, we have implemented cost reduction initiatives since the beginning of 2019. I can say that we have reached a level of what would be a good proxy for the future. Of course, we still have improvements opportunities for the future.

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You mentioned digitalization. We continue to invest, but we have made some investment this year already. And as Mario mentioned in the initiatives, it remains a priority for 2021. Of course, there is still opportunity to reduce cost, but it is not going to be at the same levels that we saw during 2020. It will be lower. But there is opportunity coming from digital transformation, as well as the continuity of the process improvement.

Daniel Travitzky:

Perfect. Thank you.

Pedro Rodrigues, Bogari Capital (via webcast):

Mario, could you comment on the cost and expense structure of CESP? Is there room for further reduction of costs and expenses?

Marcelo de Jesus:

As I just answered to Daniel, we have already implemented most of our cost reduction initiatives as we presented in this call. But there is still additional opportunity for cost reduction, of course, not at the same levels we have seen in 2020. But there is an opportunity resulting from the continuity of improvement in the process of the companies as well as digitalization strategy, as Mario mentioned, for next year.

Fernando Antônio, Santander (via webcast):

is there any chance of making a settlement on payment of Três Irmãos lawsuit without going to court for that. In general, why does the GSF lines at the hearing please the Company the way they are?

Mario Bertoncini:

Thank you for your question. Regarding Três Irmãos, our main focus is on the decision of the lower court level. We discussed in July. That means that once this decision of the lower court level is probably closed, then we need to know whether the judge will open for the parties to make their final considerations. But we are very focused on this first decision.

After that, we reassess our position. We constantly do that. We always think that the solution is not to wait for the final decision of the lawsuit that could take many and many years. But at some point in time, it is favorable for CESP to restart the conversations with the Ministry of Energy about this lawsuit. But right now, we are focusing on the decision of the lower court level, first instance.

With regard to your second question about GSF, I think it is a good solution. I understand you refer to the Law 14052. Yes, it was a good solution from the Ministry of Energy, ANEEL, CCEE. There are very serious people working on that. We understand that this is a solution.

We are still in the public hearing phase for the law to be regulated because the law was sanctioned and published. And ANEEL has 90 days to regulate the law. And they have opened the public hearing for that.

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It has been a very diligent process by ANEEL, and we believe that it is very likely that this will be a solution for the industry. We and the entire market through our associations, we have made suggestions trying to improve the legal framework, but we believe this will be the final solution for this dispute. It is about time to solve that. I mean, this subject has been in discussion since 2013. So it is about time we solve that.

Operator:

With that, we conclude our Q&A session. Now I would like to hand the floor over to Mr. Mario Bertoncini for his final remarks. Mr. Bertoncini, you may continue.

Mario Bertoncini:

I think it has been a very good call. It will help clarify other points. And I would like to thank you all very much for your participation, and we remain available and we are working hard to deliver our results. Thank you very much for your participation. Have a good day.

Operator:

The conference call for the earnings of CESP has been finished. We thank you all for your participation. Have a good day. You may disconnect your phones now. Thank you.

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