CESP Companhia Energetica de São Paulo : Transcript Conference Call 2Q21

Local Conference Call

CESP - Companhia Energética de São Paulo

Second Quarter 2021 Results

Operator: Good morning, ladies and gentlemen, and thank you for standing by and for your audience. Welcome to the 2Q21 earnings conference call for Companhia Energética de São Paulo, CESP. We would like to inform you that this event is being recorded. After the Company's remarks, there will be a question and answers session for analysts and investors.

If you need assistance during the conference call, please press *0 to reach an operator. The link to access the webcast with the respective audio track and slides is available on CESP's investor relations website at www.ri.cesp.com.br. The slide deck is also available for download on the website.

All the information presented below is BRLs, Brazilian Reais, in accordance with the Brazilian Corporate Law and also accounting practices adopted in Brazil and also in accordance with international accounting standards, IFRS, except when otherwise indicated.

Before moving on, we would like to mention that forward-looking statements made during this conference call regarding CESP's business perspectives, operating and financial projections and goals are based on beliefs and assumptions on the part of the Company's management, as well as on information currently available. Forward-looking statements are no guarantee of performance, they involve risks, uncertainties and assumptions, as they refer to future events and therefore depend on circumstances that may or may not materialize.

Investors should have in mind that general economic conditions, industry conditions and other operating factors may affect the company's future performance and thus lead to results that will differ considerably from those expressed in these forward-looking statements.

The presentation will be conducted by Mario Bertoncini, CEO and IRO and Mr. Marcelo de Jesus, the Company's CFO. I would like now to hand the floor over to Mr. Mario Bertoncini, who will start the presentation.

Mr. Mario Bertoncini: Thank you all for participating in our earnings call, where we'll discuss results relative to 2Q21. In this first bit of the presentation, we will be addressing the highlights for 2Q21. After that we'll review the contingent liabilities around Três Irmãos, then we'll address the energy market and about our commercial strategy in this quarter, in

particular, where we have the hydro crisis. After that, Marcelo de Jesus, our CFO, will be talking about our financial performance. I'll be back at the end to comment on our ESG agenda and also make my final comments for this first part of the call. After that, we'll have a Q&A session.

Going now to page number 4, where we have the highlights for 2Q21, we closed the quarter with a generation of 768 megawatt average in the quarter and that level of generation has been impacted by the water crisis, it is 20% below the generation posted in 2Q20, last year, but, as several of you know, that does not mean a major impact on the revenue or on the cash generation of CESP.

Obviously we have received, we have used our physical guarantee and there is no major impact, as I said, coming from that lower dispatch by the ONS in this quarter. On top of that and also linked to the water crisis in 2Q21, we conducted tests to reduce the flow rate at Porto Primavera hydro plant, in compliance with legal requests from the Ministry of Mines and Energy and then, also, following a request from the Chamber of Exceptional Rules, which is that chamber which works across different ministries.

We have been conducting those tests and they are following along as expected and as defined by an action plan proposed by IBAMA, the plan has been totally met and all potential environmental impacts have been mitigated by a team on the field. In addition to that, in this quarter we have maintained our availability level at a very high level for both plants, an average of 95.9%. That availability index remains above reference levels set forth by ANEEL and has been so for some time on a consistent basis.

In terms of the financial performance in the quarter, we closed with an adjusted EBITDA at 222 million BRLs, with a cash generation of 274 million, so a generation 123% above the EBITDA and that is driven mainly by non-cash effects on the EBITDA, which will be detailed by Marcelo in a moment.

In addition, in the quarter we have moved forward in reducing our contingent liabilities with a gross reduction before monetary adjustments, I'll be talking about it in a moment as well, we had a drop of 636 million BRLs in this quarter when compared to the balance on March 31.

As for our commercial strategy, we had a worsening in the GSF throughout the quarter, that burden that affects the hydroelectric sector whenever we have thermal dispatchers to offset a lower hydro generation and that basically made us go to market and to zero an additional energy balance because of this increment in GSF. We did it and you'll see that in details moving forward, but it's totally been addressed for 2021 at an average price, right now, of 239 BRLs per megawatt hour.

Moreover, we also progressed in the contracted sales for the mid to the long run, especially because of the water crisis. But because of long term potential risks coming from the hydro crisis, but also because we have a perspective of economic growth, so the mid to the long run energy prices have gone up significantly, but we were able to conduct an additional contracting of energy.

As for the contingent liabilities on the left hand side of slide number 6, we had, as I said, an evolution of 636 million gross and that has to do basically with favorable decisions in the quarter, favorable to CESP and also the entering of judicial agreements to reach that level and it also has to do with smaller adjustments made in the period.

In the second quarter, once again, we have also evolved in IGPM very strongly, IGPM Increased by 6% in the quarter. Approximately 2/3 of our contingent liabilities is corrected by IGP-M on top of interest rates, of course, and therefore that explains that significant adjustments, 752 million BRLs. We have closed the quarter in a pro forma character for June, in compliance with legal decisions in July we closed the quarter and you can see that on the slide on the right hand side column, on the left side, 10.3 billion, the total contingent liabilities for CESP, with a provisioned amount, the probable amount of 1.6 billion.

On the right hand side of the page, we have the evolution of our contingent assets for Três Irmãos. What is new on that front? Well, you have been following up on that. After the news that the expert had died earlier in the year, also in April our request for injunction was not acknowledged, was not upheld. On April 27 we filed an injunction for the immediate payments, but that request was not upheld. From then on there were news in the lower court in Brasilia.

The judge presiding over the case requested a manifestation from both parties, from the Union and from CESP about a potential closing of the period. The evidentiary period means the end of the experts' works around the amount to be reimbursed. Both the Union, as ourselves, complying with the deadlines we've provided our statements, CESP stated that the mistakes had been addressed by the original expert, the one who died, and so we would favor an immediate ruling in the lower court. The union, as expected, maintained their line of conduct, that they had maintained before and they requested that we rectify the expert's report, they wanted a new report, a new expert's report to estimate the amounts due.

So now, in terms of the legal process, the next step is to wait for the judge to make a decision whether or not he agrees with the evidentiary period and then we would move on to the trial phase in the lower courts or whether the judge will appoint a new expert to continue where the other one left off or conduct a new assessment, a new expert assessment. We will keep the market informed as usual, as soon as we have news on that front as well.

Moving on, on page number 8 we will talk about the energy market for the quarter that has now just ended. What we can see on both bar charts on page number 8 is the size, the magnitude of the water crisis we're going through right now and in special in the South and Southeast regions of the country. On the left hand side, we see an evolution. We have isolated 3 years: 2021 in dark blue and then 2001, where we have the energy rationing in Brazil and also the year of 2014, which was a very critical year from the point of the water management and the energy matrix management in Brazil.

On the chart on the left, we can see that we do have inflows, natural inflows, as a percentage of average in the long run we can see that and specially starting in April this year the water crisis worsens and we have natural levels at the tune of 62%, 62% of the long-term average, considerably below what we had In other periods, when compared to 2001 and 2014 with this year

The same severity also goes for the stored energy on the right hand side, those are reservoir levels converted into potential megawatts and you can observe here that, for the months of June and July, we have reservoir levels in the Midwest and Southern Brazil at 27%, the same levels we had in 2001, but below the levels we had in 2014. So that's something we are following closely and that is the main driver for the testing and for dropping the flow rate at Porto Primavera, given the fact that the basins here, Parnaíba, Rio Grande and Paraná, those are the basins that have been the most impacted by the hydro crisis.

Moving on, on page number 9, still speaking about the energy market, we have the evolution of loads, the consumption of energy throughout the period, when we compare 2021 with previous years. Below, the 2021, the forecast, the projected plus the remaining of the year, projected by the ONS, the Federal Regulator. We expect a load 3.1% above that of 2019, when you compare both years, 2021 and 2019 and, when we compare this year, 2021, with last year, something around 4.6% above that load has been revisited in the last three days by the ONS and it already reflects a projection based on a response by retail industry and a slow recovery of confidence levels by the Brazilian consumer.

As for the energy matrix, there are positive aspects in that. Today, 2021, our matrix is a lot more diversified than it used to be 10 or 20 years ago. Currently we have the hydro sector prevailing at 62% of the matrix, but we can already see a significant participation from solar and wind energy at 12% and thermal at 26%, which is evolving for the better, as we see an expectation of renewable energy, which will be increasingly relevant for the country in the coming years and that will help mitigate potential risks as this crisis tends to worsen. That remains to be seen, of course.

On the next page, page number 10, we have our energy balance. Once again, this is a standard structure we have been presenting quarter after quarter on the chart number 3, on the right hand side. On the top we have our energy matrix totally addressed for 2021, we have purchased all the energy that is necessary to zero our short position at CESP, already considering a GSF which will be worsened, which was just published by the CCE at 72.9% for this year. Based on that, we have zeroed our energy balance so, from the net standpoint can be seen on the chart number 4 at a cost of 239 BRLs per megawatt hour, as I had mentioned before.

It's important also to mention that for the past few days we have purchased additional energy, because we do have a balance which has been addressed, but we have used also more conservative GSF amounts or values. As for 2022, in practice we have already addressed, we have already purchased 97% of all short exposure in energy for 2022, with conservative assumptions as well, in terms of GSF, for next years as well, so that position has been addressed as well for next year.

Moving on, page 11, we have some features of our commercial strategy. We moved on with our strategy to expand and diversify our client base and in particular by selling energy in the long run. Right now, for the 3-year period, which is from 2024 to 2026, which is an important period for us, we have seized good opportunities, with good clients, we have diversified in terms of industries, we have expanded our client base on that respect.

What we have today in this chart, on the right hand side of slide 11, is how we have evolved from the contract standpoint in average megawatts. For today's prices, for 2024 through 2026, energy at an average price at 165 BRLs per megawatt hour, prices which are still on the up trends. I'd like now to turn the conference over to Marcelo de Jesus, our CFO, who'll be talking about the group's financial performance in the quarter.

Mr. Marcelo de Jesus: Thank you, good morning everyone, we now continue with the presentation, our earnings call, talking about our financial performance, on slide number 13 now. The adjusted EBITDA for second quarter reached 222 million BRLs, a drop of 23% when compared to the same period of last year, that driven by the water crisis, as Mario has just mentioned, and also by recurring events, which were positive in the second quarter of the past year, which did not repeat in this quarter and that led to a negative margin, to a drop of 24 million when compared to the previous year.

Another important impact came from the mark to market effects, a variation which was negative at 31 million also, driven by a hike in prices that we saw and lastly we have a variation, negative, of 10 million in costs and expenses and it's important to mention that there is not an increase in cost, but positive effects that we had in the second quarter in the previous year, which did not repeat this year. For example, a provision to reverse the RGR in the amount of 6 million BRLs in addition to maintenance events for our power plants, which were delayed from last year for this year because of the Covid pandemic.

Moving on, on slide number 14 we are going to be talking about our cash flow in this quarter, the operating cash flow after the service set at 274 BRLs, equivalent of 123% of the EBITDA of the period, that is a strong cash generation level. That amount above 100% was driven by the benefit of our working capital, but most of that benefit came from the negative mark to market, which impacted EBITDA, but it's not a cash outflow and also coming from the receival from outstanding debt from CCE around this GSF.

That strong cash generation, we also had a drop in EBITDA because of the water crisis, but that cash generation allows us to have a very comfortable leverage, below 2 times in the second quarter. We stand at 1.6 times net debt EBIDA and with an average duration of 7.3, which provides us some reassurance to continue with our operations and to go through this water crisis on top of course our efficient energy balance management, as Mario has already mentioned as well.

And lastly, I'd like to reaffirm that because of that robust capital structure and the strength of our operations, we also had S&P and Fitch reaffirming our rating for CESP for 2021. I'd like to turn the word back over to Mario, to talk about our ESG agenda and also to provide his final comments. Thank you, Mario, over to you now.