Long-Term Concession Renewal And Loss Reduction Will Transform Earnings Stability

Catalysts

About Light

Light is an integrated Brazilian electricity company focused on power distribution, generation and commercialization in Rio de Janeiro and surrounding regions.

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

• The expected 30 year renewal of the distribution concession, with rebalanced contract terms for risk areas, should lock in a more predictable and favorable regulatory framework and support structurally higher and more resilient revenue over time.
• Acceleration of network modernization and quality investments, already reflected in record low DEC and FEC levels and sharply faster emergency response, positions Light to reduce service penalties and operating disruptions and to improve net margins and long term earnings power.
• The combination of a court approved debt reprofiling, lower interest costs and the planned capital increase of up to BRL 1.5 billion is set to materially deleverage the balance sheet, reduce financial expenses and enhance future net income growth.
• Systematic reduction of nontechnical losses through advanced metering, data intelligence and field actions on a dense urban grid should steadily recover previously lost energy volumes and directly boost billable consumption and distribution EBITDA.
• Growing investment in the generation and commercialization businesses, together with participation in upcoming capacity reserve auctions and hedging of foreign currency debt, is expected to diversify cash flows and stabilize earnings and to support higher consolidated profitability.

Assumptions

This narrative explores a more optimistic perspective on Light 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 Light's revenue will grow by 6.4% annually over the next 3 years.
• The bullish analysts assume that profit margins will shrink from 15.4% today to 6.3% in 3 years time.
• The bullish analysts expect earnings to reach R$1.1 billion (and earnings per share of R$2.36) by about December 2028, down from R$2.3 billion today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as R$998.4 million.
• 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 4.0x on those 2028 earnings, up from 0.8x today. This future PE is lower than the current PE for the BR Electric Utilities industry at 8.3x.
• 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 25.61%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The company remains heavily exposed to structurally high nontechnical losses in a dense and complex urban grid, and the current reduction to 22.8 percent on wire load is modest. If theft and fraud remain entrenched despite technology and field actions, recovered volumes may fall short of expectations and cap revenue and distribution EBITDA over the long term.
• Light is committing to a broad, multi year network modernization and quality investment plan that already lifted distribution capex more than 70 percent year on year and pushed PMSO higher. If anticipated efficiency gains and cost savings take longer to materialize, rising operating expenses could compress net margins and delay sustainable earnings growth.
• The business is still emerging from a court mandated reorganization with reprofiled debt and a planned capital increase of up to BRL 1.5 billion plus debt to equity conversion. If macro or market conditions weaken and constrain access to capital or increase funding costs, deleveraging could stall and higher financial expenses could weigh on net income.
• Electricity demand in the concession area is vulnerable to long term economic softness and climate variability, evidenced by the recent 5.3 percent decline in the energy market due to a harsh winter and weaker industrial demand. If regional growth underperforms or weather patterns structurally dampen consumption, lower volumes could limit revenue expansion and EBIT generation.

Valuation

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

• The assumed bullish price target for Light is R$6.2, which represents up to two standard deviations above the consensus price target of R$5.1. This valuation is based on what can be assumed as the expectations of Light'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$6.2, and the most bearish reporting a price target of just R$4.0.
  
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2028, revenues will be R$18.0 billion, earnings will come to R$1.1 billion, and it would be trading on a PE ratio of 4.0x, assuming you use a discount rate of 25.6%.
  
• Given the current share price of R$5.08, the analyst price target of R$6.2 is 18.1% higher. Despite analysts expecting the underlying business to decline, they seem to believe it's more valuable than what the market thinks.
  
• 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.