Grid Expansion And ESG Momentum Will Drive Stronger Long Term Earnings Visibility

Catalysts

About CPFL Energia

CPFL Energia is a leading Brazilian integrated utility engaged in electricity distribution, transmission, generation and energy services.

What are the underlying business or industry changes driving this perspective?

• Acceleration of Brazil's grid expansion agenda, evidenced by CPFL winning the largest lot in the latest transmission auction with assets adjacent to its existing network in Rio Grande do Sul, should boost long term regulated revenue growth and enhance returns through operating synergies and scale.
• Regulatory advances around curtailment relief through MP 1304 and the upcoming renewal of distribution concessions are set to reduce earnings volatility and improve visibility, supporting higher and more stable EBITDA and net income over the next cycle.
• Growing global and domestic focus on decarbonization and ESG, highlighted by CPFL's active role at COP30 and multiple sector awards, positions the company to capture premium pricing, preferential access to capital and incremental investment opportunities, supporting margin resilience and earnings growth.
• Strengthened credit profile with investment grade ratings above Brazil's sovereign level and comfortable leverage around 2.2 times, combined with long dated funding already secured through 2026, should lower financial costs and support higher free cash flow and earnings.
• Consistently rising and front loaded CapEx in distribution and transmission, with plans to invest more than BRL 6 billion in 2025 and additional growth from new projects like Lot 3, is expected to expand the regulated asset base and drive sustained growth in tariff revenues and EBITDA.

Assumptions

This narrative explores a more optimistic perspective on CPFL Energia compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts. How have these above catalysts been quantified?

• The bullish analysts are assuming CPFL Energia's revenue will grow by 5.0% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 12.3% today to 13.9% in 3 years time.
• The bullish analysts expect earnings to reach R$7.1 billion (and earnings per share of R$6.21) by about December 2028, up from R$5.5 billion today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as R$4.6 billion.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 14.6x on those 2028 earnings, up from 10.3x today. This future PE is greater than the current PE for the US Electric Utilities industry at 8.4x.
• The bullish analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 18.16%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Persistently flat or declining electricity demand in key distribution markets due to milder temperatures, continued growth of distributed generation and weak performance in industrial segments such as chemicals and vehicles could structurally cap volume growth, limiting future tariff revenue and EBITDA expansion.
• Ongoing challenges in network losses, which remain above regulatory limits despite gradual improvement, may force CPFL to sustain high levels of inspections and grid investment, pressuring operating costs and constraining net margins and earnings growth over time.
• Rising curtailment of wind generation, which has already driven a double digit drop in net generation and a sharp increase in lost revenue, could remain a structural issue in Brazil's grid and continue to weigh on the profitability of the generation segment and group level earnings.
• Exposure to hydrological risk, evidenced by less favorable hydrology and higher spot prices, may persist as a long term feature of Brazil's power system, creating volatility in generation results and potentially compressing EBITDA and net income in weak hydrology years.
• Ambitious and rising CapEx commitments in distribution and transmission, including large new projects with long construction timelines, increase execution risk and financing needs. If returns are lower than planned or tariffs do not fully compensate, this could dilute returns on invested capital and restrain future earnings growth.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bullish price target for CPFL Energia is R$54.59, which represents up to two standard deviations above the consensus price target of R$43.28. This valuation is based on what can be assumed as the expectations of CPFL Energia's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of R$59.0, and the most bearish reporting a price target of just R$35.63.
  
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2028, revenues will be R$51.4 billion, earnings will come to R$7.1 billion, and it would be trading on a PE ratio of 14.6x, assuming you use a discount rate of 18.2%.
  
• Given the current share price of R$48.8, the analyst price target of R$54.59 is 10.6% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.