Empresa Distribuidora y Comercializadora Norte SA

NYSE:EDN

Earnings Call Transcript 2018-Q3

[Operator]

Good morning, ladies and gentlemen, and thank you for waiting. At this time, we would like to welcome everyone to Edenor's Third Quarter 2018 Results Conference Call. We would like to inform you that this event is being recorded and all participants will be in a listen-only mode during the presentation. After the remarks are completed there will be a question and answer session. At that time further instructions will be given. [Operator Instructions]

Before proceeding, let me mention that forward-looking statements are based on the beliefs and assumptions of Edenor's management and on information currently available. They involve risks, uncertainties and assumptions because they relate to future events and, therefore, depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of Edenor and could cause results to differ materially from those expressed in such forward-looking statements.

Now I’ll turn the conference over to Mr. Leandro Montero, CFO of Edenor. Mr. Montero, you may begin your conference.

[Leandro Montero, Chief Finanical Officer]

Thank you very much. Good morning everyone and thanks for joining our third quarter 2018 earnings conference call. First, we will focus on the main events that recently took place and then briefly review the results of quarter. As you know, you can always call any member of our team for more details on the results of the period for any doubts you might have. In first place, aiming to replace our headquarters, concentrating centralized functions and reducing rental cost, in 2015, we acquired to Ribera Desarrollos, a renowned developer in Argentina, a real estate asset to be constructed for the amount of $46 million, equivalent to ARS 439 million at the exchange rate in effect at the time of acquisition.

To guarantee the payment of the indemnity contractually agreed upon in the event of termination due to the seller's breach, the company received a surety bond for up to $46 million plus interest with a Badlar interest rate in dollars plus 2%. On June 1, this year, the term for the delivery of the rental real estate asset terminated, being the milestone broken by the developer. Therefore, the company served the seller the notice of default, notifying the situation to the insurance company issuing the surety bond and collecting the fines accrued during the term of the purchase agreement and duly deposited in escrow by the seller due to its lack of compliance with the construction milestone foreseen in the contract.

Later, upon the expiration of the legal terms stipulated in the agreement, on August 27, we notified the seller of its termination, demanding payment of the contractually agreed compensation. Likewise, on September 3, the company filed the corresponding claim with the insurance company and subsequently delivered the additional information and documentation that was required by the insurance company. As of September 30 this year, the recorded receivables' fair value amounts to, ARS 2,069 million,which does not exceed its recoverable value. Thus, income generated by this transaction amounts to ARS 1,629 million before tax. As of the issuance of this earnings release, we are undertaking the necessary judicial and extrajudicial actions to collect the above-mentioned receivable.

Moving to other matter. International Accounting Standard 29, concerning financial reporting in hyperinflationary economies, requires the financial statements of an entity with a functional currency of a high-inflation economy to be restated in terms of the measuring unit current at the end of the reporting period. As Argentina is, under this standard a hyperinflationary economy, the defined restatement criteria should apply for periods ending on or after July 1, 2018.

Furthermore, on July 24, the Argentine Federation of Professional Councils in Economic Sciences issued a communication confirming the previous requirement. However, taking into consideration that as of the date hereof, Executive Decree 664 of 2003, which prohibits the presentation of restated financial statements to the National Securities Commission, is still in force, the company's management has not applied GAAP 29 in the preparation of its financial statements as of September 30, 2018.

Regarding pending obligations arising during the transition period, on September 16 this year, the Secretariat of Electric Energy extended the term to regularize outstanding liabilities it had announced it would start to resolve last July 31. Likewise, on September 29 [indiscernible] processionfor the mentioned liability, being complied by Edenor on date.

To date, although what part people working on the matter, all the proceedings are still pending. Regarding the seasonal price of electricity programming, on October 26 this year, the Undersecretariat of Electric Energy approved through Disposition No 97 the Wholesale Electricity Market Seasonal Program elevated by CAMMESA, corresponding to the period from November 1, 2018, to April 30, 2018.

By doing this, power capacity, energy and transport prices previously established by Disposition No 75, which should be clear, were extended for the following quarter. And this means that in – at November 1, there's no increase for the seasonal price applied to our customers. Additionally, the criteria regarding subsidies to users under the social tariff category and discounts for savings remains effective.

Moreover, on September 3 this year, the Standard & Poor's Global Ratings issued a report, modifying this – modifying Argentina company's global debt ratings. The downgrading is accounted for by the higher sovereign risk, resulting from the weakening of the peso and the rising inflation. Edenor's global rating changed from B with a positive outlook to B with a stable outlook. Furthermore, on September 4, Edenor's local rating was also modified from local A+ with a positive outlook to local A with a stable outlook. This change is mainly explained by the national economic downturn and the imbalance between Edenor's peso inflows and its dollar-denominated debt.

Finally, regarding our controlling company's merger process, as of August 24 this year, Pampa Energia became Edenor's direct controlling company. Pursuant to this process, EASA, former Edenor's controlling company, and IEASA, former EASA's controlling company, were absorbed into Central Termica Loma de la Lata, and the latter was lastly absorbed by Pampa as the absorbing and continuing company.

Now taking into consideration our result in the third quarter of 2018, net sales increased by 108% to ARS 13.5 billion against ARS 6.5 billion in the same period last year. In addition to the new generation cost passed through to tariff when the new – that we will explain on the energy purchases slide, this increase is mainly due to the entry into effect of all VAD updates provided by the ENRE Resolution No. 53, resulting from the Comprehensive Tariff Review process, together with the bi-annual adjustments corresponding to Own Distribution Costs increases. Between the comparison periods, two 80% are VAD updates were applied, the last one being effective as from February 1 this year, thus completing the total update stipulated under the Comprehensive Tariff Review and granted in three stages.

Regarding distribution cost adjustments corresponding to last year's cost increases, December 2017 and February and August 2018 update, corresponding to the first three semester adjustments to the distribution fee, were applied totalizing in a combinative increase of around 35%. The last adjustment estimated at 16%, effective from August 3 this year, was granted in two stages, 50% as from that date and the remaining 50% as from February 2018.

The difference in revenues generated during the August 2018 to January 2018 period will be recoverable through six installments as from February 2018 and updated according to the adjustment in the distribution cost increases. Hereon, if the full increase in distribution cost had been recorded, sales in this quarter would have increased by an additional ARS308 million.

Moreover, under the deferred income recoverable in 28 installments and accrued during the February 2017, January 2018 period, ARS540 million were accounted for in the third quarter this year. The increase in revenue from sales was accompanied, although to a lesser extent, by a slight 0.7% increase in the volume of energy sales, which reached 5.66 gigawatt hours in the third quarter this year, against 5.65 – 5.59, sorry, gigawatt hours for the same period in 2017.

This rise was mainly due to an increase of 2.5% for residential users and of 31% for shantytowns, which was partially offset by decreases of 3.4% for large users, industrial and wheeling system users and 0.9% for medium and small commercial users. The residential demand increased as a result of the lower temperatures recorded in July and August this year compared to the same period of the previous year, partially offset in September as a result of the higher temperatures compared to the previous year and the impact of tariff increases. In the case of shantytowns, lower temperatures added to the zero impact of the tariff increases on account of the total tax being granted by the national government, resulting in a strong increase in consumption.

Furthermore, small and medium and medium commercial users were adversely affected by the lower commercial activity and large users by the lower industrial activity, which is reflected in the fall in the industrial production index. Furthermore, Edenor's customers base increased by 2.9%, mainly explained by the increase in residential customers due to the regularization resolution resulting from the market discipline actions implemented.

The electricity power purchases increased 133% to ARS 8 billion in the third quarter of this year compared to ARS 3.4 billion for the same period last year, mainly due to an approximate 122% increase in the average purchase price, resulting from the entry enforced in December 2017 and February and August 2018 of the new seasonal prices for electricity set forth by Resolution No. 1,081 and Disposition No. 75 of the Secretariat of Electric Energy and considering the effects of the application of the social tariff to 21.4% of our residential customers.

However, it is important to note that the reference seasonal price is still subsidized, particularly for residential customers, where price subsidy reached approximately 50% of the system's average generation cost after considering the impact of devaluation of the peso on the seasonal price.

Additionally, the energy loss rate increased from 18.4% in the third quarter last year to 20.4% in the same period this year. It was mainly generated by an increase in the demand by residential customers, which is the segment with the highest rate of delinquency and irregular connections as a result of the colder winter with average temperatures up to 2.4 Celsius degrees lower this year and the impact of tariff increases. In turn, cost associated with these losses increased by 147%, mainly as a result of the application of the new seasonal price for its determination.

Meanwhile, operating expenses increased by 80%, which increased ARS 0.6 billion in the third quarter this year, against ARS 2 billion in the same period 2017. This is mainly accounted for five reasons: first, by a ARS 586 million increase in penalties, mainly as a result of changes in the calculation methodology introduced by the ENRE in 2017, which means certain adjustments last year and the application of new penalties set by the regulator as Resolution No. 170, which set a fine for deviating from the 2017 Annual Investment Plan in relation to that presented in the Comprehensive Tariff Review for a total amount of ARS 105 million.

Second, by a ARS 280 million increase in fees for third-party services, mainly explained by a higher number of market discipline works associated with the losses reduction plan; higher expenses in pruning, changes of posts, street safety works and the repair of sidewalks as well as higher expenses associated with the distribution of bills, physical surveillance costs and new hired IT services related to new applications implemented at the workforce management project and success factors.

Third, by a ARS 233 million increase in the allowance for the impairment of trade and other receivables due to a change in accounting standards resulting from the application of IFRS 9 and higher bad debt; fourth, by a ARS 204 million increase in payroll and social security charges on account of salary increases totaling 29% quarter-over-quarter; fifth and lastly, by a ARS 191 million increase in taxes and charges.

Regarding our financial results, we experienced a 7% decrease mixed loss due to a ARS 350 million loss in the third quarter this year against a ARS 340 million loss for the same period last year. The positive effects were mainly the update in the value of the receivable associated to the real estate asset in the amount of ARS 1.6 billion exiting the relevant debt, the increase in the fair value of financial assets for ARS 120 million and in higher commercial and financial interest for ARS 83 million.

These effects were partially offset by an acceleration in the peso depreciation rate against our U.S. dollar net position, which caused a total negative impact in the amount of ARS 1.3 billion on account of foreign exchange rate variations. Other factors affecting this loss were higher interest from the installed debt with CAMMESA in the amount of ARS 803 million due to higher applicable interest rate and ARS 190 million increase in interest also as a result of the increase in the exchange rate.

Finally, net results showing the ARS 556 million increase, reporting profits for ARS 847 million in the third quarter this year against profits for ARS 653 million for the same period last year. This is mainly accounted for by an improvement in gross margin as a result of the tariff increases established in the Comprehensive Tariff Review, which were partially offset by the previously described higher operation – operating expenses.

Regarding the financial results, they have not suffered any significant changes as losses resulting from a higher devaluation of the peso were offset by the revaluation of the receivable associated to the real estate asset. Talking about Edenor’s adjusted EBITDA, it reached to a gain of ARS 1.9 billion in the third quarter of 2018, ARS 1 billion higher than the same period last year. This 120% increase reflects the reconstruction of economic and financial equation of the utility under concession. Adjustments made to EBITDA corresponds to the retroactive effect of penalties for deviating from the investment plan and commercial interest.

Moreover, it is important to note that the deferred income from the August 2018 CPD adjustments, which is not included in the EBITDA, amount to ARS 308 million for the third quarter of this year. As well, it is important to highlight that the current quarter includes ARS 540 million from the 2017 deferred income to be recovered in 48 installments. Regarding Edenor’s capital expenditures. During this quarter, our investment totalized ARS 2.1 billion compared to ARS 1.3 billion in the same quarter last year, from which a 59% corresponds to network infrastructure and expansion, and the remaining 41% to network maintenance.

The increase in investments results from the ambitious plan devised by Edenor for the 2017-2021 period, which focuses on investments optimizing service quality levels in accordance with the quality curves required in the Comprehensive Tariff Review by the regulatory agency. Taking into account our energy losses, they showed an increase, reaching 20.4% in the third quarter of 2018 in comparison with 18.4% for the same period last year.

This mainly explained by tariff increases for 2017 and 2018, which generate a greater incentive to fraud by certain customers. In addition, this effect, alongside with the impact of lower average temperatures in July and August this year, generated a 187 gigawatt increase in the level of losses in physical units.

Likewise, the rise in the average energy purchase price increases the value in pesos of these losses.

Furthermore, in the third quarter of 2018, we continued taking actions to reduce energy losses on two fronts. On the one hand, market discipline actions were intensified, aiming to detect and normalize irregular connections and electricity theft and frauds. And on the other hand, there was an increase in the installation of Inclusion Meters to foster consumption self-management and the integration of users having a non-regular income, at the same time encouraging the reduction and prevention of irregular connections. We expect to intensify these actions until reaching expected levels with the purpose of meeting the outlined loss reduction goals.

Finally, as far as financial debt is concerned, the outstanding principal of our dollar-denominated financial debt amounts to $226 million, while net debt amounts to $27 million. Financial debt consists of $176 million from our senior notes 2022 and $50 million from the bank loan taken out with the Industrial and Commercial Bank of China Dubai Branch for a term of 36 months and a six month LIBOR rate plus spread of 2.75% semi-annual incremental.

Currently, at a level of 325 basis points until April 2018. Subsequent to the end of the quarter, we purchased in different market operations corporate bonds for a total face value of about $3 million. On April 01 this year, the company entered into a hedge transaction with Citibank London with the purpose of fixing the financial cost of the loan granted by ICBC, which is subject to a variable rate during the October 2018 October 2020 interest payment period. Thus, all the company’s financial liabilities are disclosed at a fixed rate.

So this concludes my review on Edenor. Now we are open for questions.

[Operator]

Thank you. And the first question comes from Gustavo Fingeret of Bradesco.

[Gustavo Fingeret, Bradesco]

Hi, good morning, guys. Thank you for the call. I have one question, which is pretty similar to what I did in the previous quarter regarding losses and CapEx. When you see losses, they continue to pick up. You were not able to reduce them from one side. And from the other side, although it’s hard to say that this – you are reducing CapEx because the effects of our wages is hard to know, which is the real number in dollar terms. It doesn’t seems that it’s picking up significantly quarter-over-quarter in order to see that they’re going to be getting to a much higher level of CapEx to what we saw in the last few years. Can you give us some guidance on what are you doing? What you would be doing different in order to achieve the targets? How are you going to be increasing CapEx over time? Thank you.

[Leandro Montero, Chief Finanical Officer]

Hi, good morning, Gustavo. First, regarding the – your question about losses, we should say that to – we compare both quarter, we had increased – significantly increased the activity levels in the – in all the actions we take to fight against energy losses. The main issue is that the difference between the temperature in July and August last year and July and August this year was dramatically different. This year, temperature was 2.4 Celsius degree lower than last winter. And as you know, our main issue regarding energy losses is because of energy losses in the poorest neighborhoods where they use electricity for heating. So that's the main cause because we have this increase in energy losses, despite the increase we are showing in the activity related to energy losses.

And on the other side, regarding CapEx, we have maintained the same level of CapEx we have estimated for the year. For sure, the devaluations have an impact on our CapEx, but we are – now, we are working or we are analyzing the CapEx for 2018. And we will see how – which is the final impact of the devaluation in our CapEx. But by the moment, we are keeping the level of CapEx we have set for the Comprehensive Tariff Review period.

[Gustavo Fingeret, Bradesco]

Okay. Thank you very much. One follow-up question on that on losses is do you expect losses in the fourth quarter to be similar to last year? Lower? Higher? What are – which is the guidance here?

[Leandro Montero, Chief Finanical Officer]

we expect losses to be – should be a bit lower than last year but just slightly. I suppose that it will be the same level.

[Gustavo Fingeret, Bradesco]

Thank you very much.

[Leandro Montero, Chief Finanical Officer]

You’re welcome.

[Operator]

[Operator Instructions] And this will conclude our question-and-answer session. With this time, I would like to turn the floor back to Mr. Montero for any closing remarks.

[Leandro Montero, Chief Finanical Officer]

Okay. Thank you very much for joining our conference call. And as you know, the team is always available for any questions you may have. Have a nice day. Bye-bye.

[Operator]

Thank you. This concludes today’s presentation. You may disconnect your line at this. And have a nice day.