damodaran corporate finance valuation presentation

Corporate Finance Final Project Brazilian Companies

André Botelho Bastos, Leonardo Boguszewski, Henrique Morsoletto and Paula Nestrovski

aswath

Sticky Note

Impressive… Would you mind if I added this to my online list of "model" projects?Overall grade: 30/30

Corporate Governance Power 2 0 2 0

Approach on Beta Bottom-up Bottom-up Bottom-up Bottom-up

Beta 0.44 0.33 0.53 0.84

Jensen's Alpha 20.68% 7.10% 12.00% (13.44%)

R2 8.6% 0.9% 18.3% 55.1%

ROE – COE (0.75%) 9.54% 13.64% (3.31%)

ROC – WACC 4.56% 8.81% 7.56% (2.47%)

EVA in BRL million $412.05 $227.14 $34.89 ($908.24)

Current Debt Ratio 23.19% 52.88% 5.06% 33.15%

Optimal Debt Ratio 0% 0% 10% 20%

Change in WACC (0.22%) (2.05%) (0.14%) (0.16%)

Change in Value 4.83% 103.77% 2.17% 3.02%

Dividends (1) $27.12 $98.53 $63.33 $745.70

FCFE (1) ($353.90) ($122.70) $36.38 $448.43

Value/share $39.33 $3.72 $13.63 $16.64

Price/Share $23.90 $2.25 $10.15 $16.44

Upside 64.56% 65.33% 34.29% 1.22%

(1) Average of the past 5 years.

Summary

Founded in 1949, BRMalls is the largest integrated shopping mall company in Brazil, with participation in 46 shopping centers. It also engages in the promotion and management of its real estate enterprises; has interest and management in parking operations; and provision of management and leasing services to shopping centers. The company has 321 employees. BRMalls’ 2011 revenues were BRL 861 million being 100% from Brazil ; EBITDA margin was 33%. The company made it IPO in 2007 and is currently listed in the Brazilian stock exchange Bovespa, ticker BRML3. Vision: To be a global organization and a benchmark in any business that we conduct. Values: - Develop owners: hire, train and retain the best people and provide an environment in which thrive. - Prioritize productivity and growth: improve productivity and profitability in the short and long term. - Teamwork and a disciplined way to consistently beat challenging targets. - Execute with consistency and efficiency: objectivity, sense of urgency and humility, and consistently satisfy the

expectations of our customers and partners. - Simplicity and Agility - Focus on results and meritocracy

Founded in 1905, Energisa operates in the electricity distribution and supply segment through its five distributors in the center east and north east estates of Brazil. It covers 352 municipalities in a total concession area of 91,180 km², serving 2.4 million consumers and a population of 6.7 million. The company has 4,891 employees. Energisa’s 2011 revenues were BRL 2,426 million being 100% from Brazil ; EBITDA margin was 26%. The company made it IPO in 1907 and is currently listed in the Brazilian stock exchange Bovespa, ticker ENGI3, ENGI4 and ENGI11. Mission: To transform energy into comfort, development and new sustainable possibilities, offering innovative energy solutions to its clients, aggregating value for its stockholders and offering opportunities to its collaborators. Vision: With a balanced portfolio between distribution and generation activities, Energisa aims to be the most profitable electricity group in its operating region by 2014. Values: - Commitment to the present-day and the future - Simplify the lives of our clients - Our energy comes from people - Overcoming challenges to achieve results - Safety first - Innovation to make a difference

Founded in 1940, Eternit is the largest manufacture of corrugated fiber cement roofing sheets and water tanks in the Brazilian market - one of the largest construction markets in the world. The company has 2,500 employees. Eternit’s 2011 revenues were BRL 820 million being 88% from Brazil ; EBITDA margin was 17%. The company made it IPO in 1948 and is currently listed in the Brazilian stock exchange Bovespa, ticker ETER3. Mission: To develop, manufacture and sell raw materials, products and solutions of excellence to the building industry, ensuring the competitiveness, profitability and longevity of the business, hand-in-hand with social responsibility and respect for the environment. Vision: To be a diversified and profitable supplier of raw materials, products and solutions to the building industry. To maintain its leadership in the roof coverings sector, while achieving a significant market share in other segments, positioned in the top five most recognized brands in the building materials sector. Values: - Agility - Flexibility - Commitment to Results - Ethics - Excellence - Focus on Client

Founded in 1901, Gerdau is the leading producer of long steel in the Americas and one of the largest suppliers of specialty long steel in the world. The company has 45,000 employees and industrial presence in 14 countries with operations in the Americas, Europe, and Asia, together representing an installed capacity of over 25 million metric tons of steel per year. Gerdau’s 2011 revenues were BRL 35,406 million being 57.1% from Brazil ; EBITDA margin was 13%. The company made it IPO in 1984 and is currently listed in three stock exchanges: Bovespa (GGBR3 and GGBR4), NYSE (GGB) and Latibex (XGGB). Mission: To create value for our customers, shareholders, employees and communities by operating as a sustainable steel business. Vision: To be a global organization and a benchmark in any business that we conduct. Values: - Flexibility - Commitment to results - Ethics, Excellence - Focus on Client - Respect for the environment - Transparency

• 1 Corporate Governance

• 2 Social Obligation and Image in Society

• 3 Stockholder Analysis

• 4 Risk Analysis

• 5 Investment Analysis

• 6 Capital Structure

• 7 Dividend Policy

• 8 Valuation

• 9 Conclusion

Agenda

Board of Directors CEO in the Board?

Total of 7 members, where 2 are Independent

CEO is in the Board

Total of 5 members, where 2 are Independent.

CEO is in the Board


CEO is in the Board


CEO is in the Board

Salary of Board of Directors (Monthly)

The Board is not compensated, except for its two independent directors, who receive each a compensation of BRL 7,000.00

Min – BRL 12,337.60 Average – BRL 38,552.58 Max – BRL 53,568.20 Salary (77%) Profit Sharing (22%) Benefits (1%)

Min - BRL 14,416.67 Average - BRL 15,916.67 Max - BRL 20,333.33

Average salary - fixed plus bonus is BRL 23,000. Independent board members receive 55% of their compensation in stock option.

Online Voting No No Yes No

Issues related with conflict of interest

CEO participates in the Board as Vice-Chairman. He has served since 2007 as chairman and since 2010, as vice-chairman of the board. He is a partner of GP Investments since 2002. He came from outside of the company. He holds 0.58% of the company's outstanding shares. Board of Directors - Average of 3.2 yeas in the board. 2 from GP, one from Equity International. Chairman came from an acquired company. Three inside directors. Two are CEO from other companies.

Chairman of the Board, CEO and CFO are from the same family, No board member representing the stock holders from the free float.

The company does not have the figure of a specific controller. However, most individual investors who have relevant positions in the stock are members of the Board of Directors. The directors are relatively independent from the managers. Directors are indicated by a diversified shareholders base and have the conditions to make a fair assessment of managers' job. However, the long time some directors and managers have been working under their positions might indicate the opposite.

Four board members compose the largest shareholders, CEO and COO are part of the controlling family and are also on the board. Only two board members have not worked in the company before.

Classes of Shares 100% Voting

Shares 47% Voting Shares

53% Non-Voting Shares 100% Voting

Shares 33% Voting Shares

66% Non-Voting Shares

Relationship with stockholders (1) 1 1 3 1

(1) Level 1: Individual Stockholders have little to no control over firm.

Level 2: Individual Stockholders have limited control over firm. Some board members are major stockholders.

Level 3: Major stockholders have members in the board. Easy access to stockholder meetings

1 Corporate Governance

Corporate Governance

aswath

Sticky Note

Good summary. If you can, talk about anything that the board has done/said that reflects their effectiveness of lack thereof. A board can look good and be completely ineffective or look bad and be very effective.

Minimum free float None 25% 25% 25%

Type of Shares

Common and preferred shares

Common and preferred shares

Common and preferred shares (with

additional rights)

Common shares

Board of Directors

Minimum of 3 members

Minimum of 3 members Minimum of 3 members and 20%

independent

Minimum of 3 members and 20% independent

Additional Financial Statements Reporting

None None US GAAP or IFRS US GAAP or IFRS

Tag Along Right

At least 80% to common shares

At least 80% to common shares

100% to common shares, and at least 80% to preferred

shares

100% to common shares

Number of Companies Listed 360 39 17 119



ISE: Corporate Sustainability Index, a stock index created to be a benchmark for socially responsible investments. IGC: Special Corporate Governance Stock Index, a stock index designed to measure the return of a theoretical portfolio composed of shares of companies with a good level of corporate governance.

(1) Level 1: Low volume of trade or the company has a history of delayed or misleading information.

Level 2: The stock is widely traded and has an average number of analysts covering it.

Level 3: The stock is widely traded and has a large number of analysts covering it.



Auditors Pricewaterhouse Coopers KPMG Auditores Independentes

Deloitte Touche Tohmatsu Deloitte Touche Tohmatsu

Corporate Governance Level Novo Mercado Regular Listing Novo Mercado Nivel 1

Is the stock included in the IGC?

Yes No No Yes

Float 9.0% 12.0% 63.6% 56.4%

Analyst Coverage 36 - Stock 5 - Bonds

4 - Stocks 3 - Bonds

6 24

Relationship with the markets (1) 3 1 2 3

The 4 companies present different levels of corporate governance. Gerdau and Energisa, although public companies, may still be considered family-owned business, given the high influence that major stockholders have in the company.

This influence is evidenced by the distribution of the different classes of shares: the majority of voting shares belong to the families while the majority of the preferable shares are part of the float.

Eternit has a diversified shareholders base and does not have the figure of a specific controller. However, most individual investors who have relevant positions in the stock are members of the Board of Directors and were not considered independent members in our analysis.

Eternit is one of the Brazilian companies giving a good example of corporate governance, offering shareholders the possibility of online voting to increase their participation in the company’s meetings.

BR Malls gives a good example as the majority of its board members, although not independent, are not compensated by having this function.

All companies are aware of their social obligations and have good examples of social initiatives.

Eternit pays special attention to its image in society as the social pressure against asbestos observed in other countries starts to be observed in Brazil.

Highlights






• 4 Risk Analysis




• 8 Valuation

• 9 Conclusion

Agenda

Is the stock included in the ISE ? No No No Yes

Example of Good Citizenship Initiatives

All malls managed by BR Malls participate in programs related to reducing environmental impact.

Malls participate in

programs to receive cold weather clothes donations for poor communities

New investments in electricity generation projects from alternative sources, in line with Energisa's policy of diversifying its operations into clean and renewable energy.

Distance learning program earned

Energisa the title of "Benchmark" as a result of winning the E-Learning Brazil 2011-2012 award, awarded by the company MicroPower.

Social responsibility and cultural

support in the communities it serves. The entity's flagship is its "Cultural Workshops", a project which consists of creating and maintaining cultural centers in the main cities in which the Group's distribution companies have concession areas.

Eternit engages in the exploration, mining, and processing of chrysotile asbestos as part of its production process. Although this kind of asbestos is not the one that offers risk to people's health, the company pays special attention to its social obligations and the management of its image in society.

Market competition in the

cement-asbestos segment, between Eternit and a French group that also is active in Brazil in the manufacturing and use of synthetic fibers, has led some Brazilian states, especially where the plants are located, to approve anti-asbestos legislation. It is worth mentioning that the validity of these laws awaits a merit decision on the part of the Supreme Federal Court.

Gerdau is the largest recycler in Latin America and around the world it transforms millions of metric tons of scrap into steel every year.

24.1% of the employees engage in Gerdau's volunteering programs.

In 2011 the company invested BRL 370 million in environmental impact management.

Good Citizen Standing

Yes Yes Yes Yes

Relationship with society (1) 3 3 1 1

(1) Level 1: The industry is not regulated. High social costs

Level 2: The industry is regulated. Medium to High Social Cost. Few initiatives to reduce social costs

Level 3: The industry is regulated, low to medium social costs. Various initiatives to reduce social costs.

2 Social Obligation and Image in society

Social Obligation and Image to Society

All companies are aware of their social obligations and have good examples of social initiatives.

Gerdau has significant costs to society dues to its steel-making business and mining operations

Eternit pays special attention to its image in society as the social pressure against asbestos observed in other countries starts to be

observed in Brazil.

Highlights

2 Social Obligation and Image in society

Social Obligation and Image to Society




• 4 Risk Analysis




• 8 Valuation

• 9 Conclusion

Agenda

Types of Stockholders

Investment Advisor - 65.5% Other - 15.8% Mutual Fund - 12.0% Individual - 6.7%

88% Insiders (Individuals) 12% Mutual Fund

Individual Investors - 70.36% Institutional Investors - 27.30% Other Companies - 2.34%

Institutional Investors: 8.5% Mutual: 2.6% Others: 88.9% "

Stock Exchange BOVESPA BOVESPA BOVESPA BOVESPA, NYSE and LATIBEX

Voting Stock % held by Top 5 Description of Top 5

27.58% of the voting stocks are held by the top 5 shareholders, that consists of institutional investors

73% of the voting stocks are held by the family that controls the company, 22% by a wealth individual investor and 5% by the market in general

43.63% are held by the Top 5 shareholders. The first 3 are individual investors and responsible for 38.41% of the shares. The balance is held by institutional investors, specifically Brazilian investment funds.

84.3% are held by top five; - 76.9% is held by top investor, Metalurgica Gerdau"

Marginal Investors

Fidelity Management & Research Company (7.61%)

BlackRock Institutional Trust Company, N.A. (5.23%)

HSBC Global Asset Management (UK) Limited (4.61%)

Dimensional Fund Advisors, LP Coinvalores CCVM Ltda. Credit Suisse Hedging-Griffo

Asset Management S.A.

Individual Investors (43.63%)

Dimensional Fund Advisors, LP (1.02%)

UBS Global Asset Management Americas Inc (0.95%)

Schroeder Investment Management Group (0.86%)

Insiders

Geographic Breakdown of Investors

Brazil – 10.5% International - 89.5%

Brazil - 95% International - 5%

Brazil - 92.10% International - 7.90%

Brazil: 98.3% International: 1.7%

3 Stockholder Analysis

88%

Outsider

Insiders12%

95%

Outsider

Insiders5%

88%

Outsider

Insiders12%

78%

Outsider

Insiders22%

Stockholder Analysis

Stockholder Analysis


All marginal investors are global investor and well diversified, including the individual investors from Eternit. Therefore, we can focus only

on market risk.

Gerdau and Energisa, although public companies, may still be considered family-owned business, given the high influence that major stockholders have in the company.

Takeover attempt: Alliant Energy company (LNT) was one of the major stockholder at Energisa with non-voting shares. During 2004, Energisa was not paying dividends for the second time in almost one century because of financial difficulties generated by one of the biggest drought in the country. Alliant Energy tried to take the control of Energisa obligating the company to not pay dividends for the third consecutive year consecutive. In this case, the non-voting share would gain voting rights.

Highlights

aswath

Sticky Note

Good. You tied the marginal investor to diversification and explained why we care… They care only about risk that you cannot diversify away. Allows us to use beta or betas in coming up with a cost of equity.


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Financial Markets

Society

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Bondholders

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Real-World Conflicts of Interest

aswath

Sticky Note

I have no idea how to read these (Is more blue better or worse?) but they look great….




• 4 Risk Analysis




• 8 Valuation

• 9 Conclusion

Agenda

Market Risks Firm Specific Risk

Economic downturns on regions where shopping centers are located may adversely affect occupation levels and sales of the stores located in the malls;

Problems due to the shopping centers being considered public spaces and are susceptible to accidents of different forms;

Problems regarding utilities service; Changes in the regulation in the sector.

Stores may not renovate rent contracts; New shopping centers being built close to malls owned by the

company may affect the necessity of new investments; Unsuccessful attempts in acquiring new malls; Share ownership with other investors that may have conflicts of

interest.

Political risk from changes in the Brazilian energy legal framework (ANEEL);

Highly regulated segment; Inflation can affect operating margins with higher costs that cannot

be transferred to consumers; Cost basis depends on natural resources such as level of rain and

water.

Incorrect forecast of energy consumption can obligate the company to buy energy at the spot market with a higher cost;

Concession Contracts will terminate in the next 15 years without any guarantee that they will be renewed;

Family controlled company can generate conflict interest with other stockholders;

New acquisition can distract the focus of management.

Good performance dependent on economic growth and inflation under control;

Exchange risk from revenues obtained in international markets; Investments affected by the level of real interest rates.

Political risks from the regulation of activities based on chrysotile asbestos;

Potential pressure from largest shareholders regarding dividend payments;

Risk of diversifying revenues, currently concentrated on fiber cement products, through expensive acquisitions.

Risk of change in commodities' prices; it may affect cost of supplies (iron scrap) and sales prices.;

Risk of interest rates change; it may affect cost of debt; Risk of exchange rates; it may affect debt expenses.

Risk of not successfully integrating recently acquired companies; Risk of not decreasing financial leverage, resulting in higher costs of

capital; Risk of not being able to raise capital due to high leverage.

4 Risk Analysis

Diversifiable Risk Assessment

Regression Beta 0.70 0.15 0.45 1.30

R2 of Regression 8.6% 0.9% 18.3% 55.3%

Intercept of Regression 0.41% 0.28% 0.31% -0.33%

Weekly Jensen's Alpha 0.36% 0.13% 0.22% -0.28%

Annual Jensen's Alpha 20.68% 7.10% 12.00% -13.44%

The regressions were run based on weekly returns for the past 2 years.

Gerdau is the company with the highest R2, in line with our intuition , since the company has the largest market capitalization, has its revenues linked to commodity prices and is part of the Brazilian Stock Exchange Index.

The low liquidity of Energisa’s shares presents a relevant impact on its R2, close to 0. Yes, it is really 0.9%, instead of 0.9. We see it as a positive aspect for investors, since the majority of the risk of investing in the company is diversifiable.

The Jensen’s Alpha calculation assumed the Brazilian nominal interest rate, discounted by the country default risk, as the risk free of the

period.

Highlights

4 Risk Analysis

Risk and Return

4 Risk Analysis

20.68%

7.10%

12.00%

-13.44%

-20.00%

-15.00%

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

Jensen’s Alpha

aswath

Sticky Note

Talk a little bit about the link between what the company has done and its Jensen's alpha. Is there a story here?

Market Value of Equity $10,697.80 $2,331.70 $908.43 $29,009.00

Market Value of Debt $3,229.40 $2,616.96 $48.44 $14,386.22

Debt-to-Equity Ratio 30.20% 112.23% 5.33% 49.59%

Marginal Tax Rate 34% 34% 34% 34%

Bottom-up Unlevered Beta 0.37 0.19 0.51 0.63

Bottom-up Levered Beta 0.44 0.33 0.53 0.84

The betas were calculated based on a bottom-up methodology, taking into consideration the sectors in which the companies operate. The low values reflect how their businesses are not much correlated to the overall market.

Gerdau may be considered the exception, with a Beta closer to 1. This is aligned with the higher R2 and the higher Beta we found through our regression analysis.

The very low Unlevered Beta of Energisa reflects the inelastic demand observed by utilities companies, which guarantees revenue generation even during periods when the overall market is not performing well. Furthermore, the company has a low volume of trading at Bovespa.

Highlights

4 Risk Analysis

Bottom-up Levered Beta

4 Risk Analysis

0.44

0.33

0.53

0.84

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

Bottom-up Levered Beta

Country Risk Premium = Country Default Spread2 x

Volatility of Brazilian Stock Exchange3

= 1.59% x

19.87%

= 3.07%

Volatility of Brazilian 10 Year Bond4 10.29%

Total Risk Premium = Mature Risk Premium5 + Country Risk Premium = 6.06% + 3.07% = 9.16%

Differential Inflation1 =

Long Term Inflation in Brazil

=

1 + 4.5%

= 1.0245

Long Term Inflation in U.S. 1 + 2.0%

1Long Term Inflation formally targeted by Brazil and informally pursued by United States.

2Brazilian CDS Spread on May 4, 2012.

3Volatility of Brazilian Stock Exchange in the past 100 weeks, on May 4, 2012.

4Volatility of Brazilian 10 Year Bond in the past 100 weeks, on May 4 2012.

5Damodaran Online on May 4, 2012.

4 Risk Analysis

Parameters used in the analysis

Risk Free Rate1 1.88% 1.88% 1.88% 1.88%

Bottom-up Levered Beta 0.44 0.33 0.53 0.84

Total Risk Premium 9.13% 9.13% 9.13% 9.13%

Cost of Equity in USD 5.93% 4.90% 6.70% 9.51%

Cost of Equity in BRL 8.53% 7.47% 9.32% 12.2%

110 Year T-Bond on May 4, 2012.

4 Risk Analysis

Cost of Equity

aswath

Sticky Note

Well done!

Credit Rating BB BB - BBB

Synthetic Credit Rating BBB B BB+ BBB

Interest Coverage Ratio 2.7x 1.7x 3.9x 3.0x

Credit Default Spread 2.50% 6.00% 3.75% 2.50%

Pre-Tax Cost of Debt in USD 5.97% 9.47% 7.22% 5.97%

Marginal Tax Rate 34.0% 34.0% 34.0% 34.0%

After-Tax Cost of Debt in USD 3.94% 6.25% 4.77% 3.94%

After-Tax Cost of Debt in BRL 6.49% 8.85% 7.33% 6.49%

Cost of Debt

The ratings of the companies already reflect the Brazilian sovereign risk, still in the first levels of investment grade.

Eternit currently does not have a rating as it does not have any bond issued. The company’s debt is composed solely of bank loans and exchange contracts related to revenues coming from the international market.

The smaller market capitalization of Eternit has a negative impact on its synthetic rating – although the company has the best interest coverage ratio among the sample, its synthetic rating is worse than others.

All companies have a marginal tax rates equal to 34%, which reflects a 9% of social contribution on net profits added to a corporate tax rate of 25%. Their effective tax rates, in turn, are lower than this percentage.

Highlights

Cost of Equity in USD 5.93% 4.90% 6.70% 9.51%

Cost of Equity in BRL 8.53% 7.47% 9.32% 12.20%

Pre-Tax Cost of Debt in USD 5.97% 9.47% 7.22% 5.97%

After-Tax Cost of Debt in USD 3.94% 6.25% 4.77% 3.94%

After-Tax Cost of Debt in BRL 6.49% 8.85% 7.33% 6.49%

Debt-to-Capital Ratio 23.19% 52.88% 5.06% 33.15%

Cost of Capital in USD 5.47% 5.61% 6.60% 7.67%

Cost of Capital in BRL 8.05% 8.20% 9.22% 10.31%

4 Risk Analysis

Cost of Capital

8.05% 8.20%

9.22%

10.31%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

BR Malls Energisa Eternit Gerdau

Cost of Equity in USD After-Tax Cost of Debt in USD Cost of Capital in USD Cost of Capital in BRL

4 Risk Analysis

Cost of Capital




• 4 Risk Analysis




• 8 Valuation

• 9 Conclusion

Agenda

EBIT in 2011 $1,139.70 $496.35 $117.30 $2,879.00

Tax Rate 34.0% 34.0% 34.0% 34.0%

After-Tax EBIT in 2011 $752.20 $327.59 $77.42 $1,900.14

Net Income in 2011 $470.90 $212.05 $97.19 $2,005.70

Book Value of Equity in 2010 $6,624.45 $1,188.16 $412.49 $20,147.62

Book Value of Equity in 2011 $5,482.10 $1,304.28 $438.11 $24,997.00

Average Book Value of Equity $6,053.28 $1,246.22 $425.30 $22,572.31

Book Value of Debt in 2010 $2,288.90 $1,794.90 $23.93 $14,670.00

Book Value of Debt in 2011 $3,672.00 $2,276.70 $48.44 $13,684.00

Average Book Value of Debt $2,980.45 $2,035.80 $36.19 $14,177.00

Total Invested Capital $9,033.73 $3,282.02 $461.49 $36,749.31

5 Investment Analysis

Measuring Investment Returns

$412.05

$227.14

$34.89

-$908.24 -$1,000.00

-$800.00

-$600.00

-$400.00

-$200.00

$0.00

$200.00

$400.00

$600.00

Economic Value Added (EVA)


0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00% 20.00%

RO

E

ROC

Size of Bubble = WACC

Comparison


aswath

Sticky Note

Would it not make more sense to graph out the excess returns? I am not sure how to read this graph….

Project Analysis


Typical Project

Real State developments Acquisitions of already existing

malls

Maintenance and Improvement of Distribution

Systems Construction of hydropower

Increase plant capacities Build new plants

Launch of new brands Acquisitions

Installation of heavy plates and hot-rolled coil rolling mills

Extend operating capacity,

Life Long term investments Long term investments

Long term investments

Long term investments

Investment needs High Investment needs High Investment needs Medium / High Investment needs High Investment needs

Cash Flow Patters Cyclical Cash Flow pattern Steady Cash Flow Steady cash flow pattern Cyclical Cash Flow patters

Project Quality

Positive, albeit low, EVA The company is still building 6 greenfield projects, which is

delaying cash flow correspondent to the invested capital. This is

reflected on a negative Equity EVA

Positive EVA and Equity EVA. Positive EVA and Equity EVA.

Negative EVA, The company has high financing

costs, this should change since the company has raised equity in 2011

to reduce its leverage cost. The return on the project are close

related to commodities, wich are really volatile nowadays

Do future projects look like past projects?

Yes

No Investing in new alternative

generation of energy: Small hydro plans and wind farms

Yes Yes

Examples of Current Projects

Estação BH’s inauguration is scheduled for 2Q12. The Construction evolution achieved 81.0% in line with initial schedule, and 85.9% of total GLA has been leased. The mall is expected to generate NOI of R26.0 million for BRMALLS. Thanks to the strong pace leasing, the real and unleveraged of this project is 19.2%

Small Hydropower Plants (SHP) are hydroelectric with a capacity no greater than 30 MW and reservoirs of an area no greater than 300 hectares (3km2). They represent clean generation at a low environmental cost. In addition to three SHP plants on Rio Grande, Energisa is developing a number of other projects using hydropower and other renewable energy sources (including wind and solar energy). Our goal is to achieve 200 MW of installed capacity by 2014.


In August 2011, the unveiling of the Company’s sixth plant, located in São José do Rio Preto (SP) for developing markets in the Northeast area of the state of São Paulo and the central region of the state of Minas Gerais (known as the Triângulo Mineiro)

Flat steel rolling mill (heavy plates and coiled hot-rolled strips) at Gerdau Açominas in Minas Gerais, with capacity of 1.9 million metric tons per year, generating a product with more value added to the customer.

Examples of Current Projects


aswath

Sticky Note

This is the place to introduce an assessment of the company’s competitive advantages and whether it can maintain them. You cannot just assume that the past is a precursor for the future.




• 4 Risk Analysis




• 8 Valuation

• 9 Conclusion

Agenda

Loans 64%

Bonds

36%

Floating 100%

Domestic 73%

Foreign 27%

Type of Debt:

Rate:

Currency:

Loans 63%

Bonds

37%

Fixed 94%

Flo

ating

6%

Domestic 78%

Foreign 22%

Loans 100%

Fixed 25%

Floating 75%

Domestic

25% Foreign 75%

Loans 39%

Bonds 61%

Floating 100%

Domestic

23% Foreign 77%

Debt Due (BRL) 3,672 2,277 48 13,684

Maturity 7.62 years 4.3 years 1.3 years 5.5 years

Leases No apparent operating leases No apparent operating leases No apparent operating leases No apparent operating leases

6. Capital Structure

Current Capital Structure

Tax Benefit High

Marginal Tax Rate of 34% and Effective Tax Rate close to 30%

High Marginal Tax Rate of 34% and

Effective Tax Rate close to 21%.

High Marginal Tax Rate of 34% and

Effective Tax Rate close to 26%.

High Marginal Tax Rate of 34%.

Gerdau has tax deferred credits, that offset the marginal

rate.

Added Discipline

High Of the major shareholders, only

two are part of the board (Chairman of the Board)

Low Family controlled company with strong positions in the board and

management. Family wants to continue in control.

Low The company's major

shareholders are part of the board.

Low Family controlled company with

strong positions in the board and management

Bankruptcy Cost

Medium The company has a strong

generation of cash flows but is in a cyclical industry with high fixed

costs.

Medium Strong generation of cash flow. Company segment is regulated

by ANEEL. Changes in regulation will be

voted at the Congress next years. Concessions cannot be renewed.


generation of cash flows but faces uncertainties related to

political risks from the exploration, mining, and

processing of chrysotile asbestos.


generation of cash flows but is in a cyclical industry with high

fixed costs.

Agency Cost

Medium The company has significant tangible assets, but they are

illiquid

Low The company has significant

tangible assets and allows lenders to monitor how the

borrowed money is invested.

Low The company has significant

tangible assets and allows lenders to monitor how the

borrowed money is invested.

Medium The company has significant

tangible assets but the majority is not liquid. Investment projects allow lenders to

monitor how the borrowed money is being invested.

Loss of Flexibility High

The company is still growing, with investment needs still uncertain

High The company has a Debt to

Capital of 53% that is already high compared to the Debt to Capital calculated of the 10%. Beside the risk of Bankruptcy

cost cited.

High Given the uncertainties related to the regulation of chrysotile asbestos, the company cannot

perfectly forecast future funding needs.

Low The company is mature and investment needs are well

established..


Benefits and Costs of Debt

Revenues

Earnings

Ch

oic

es

of

Fin

anci

ng Stage 1 – Start-up

Accessing Private Equity

Stage 2 – Rapid Expansion Initial Public Offering

Stage 3 – High Growth Seasoned Equity issue

Stage 4 - Mature Growth Bond Issues

Stage 5 - Decline


Current Capital Structure

BR Malls is a growing company, with a recent IPO, and a growth strategy towards new shopping centers development, acquisitions and expansions. It presents high revenue growth rates.

Eternit is in a high growth phase, driven by the housing deficit in the Brazilian market.

Highlights

aswath

Sticky Note

Good. Tie into life cycle.

Recommendation Reduce leverage Do nothing or Deleverage Do nothing Reduce Leverage

Principal Reason Reduce cost of capital Risk to lose control The current capital structure

is close to optimal Risk of reduced flexibility

Optimal Debt-to-Capital 0% 0% 10% 20%

Change in D/C Ratio -23.19% -52.88% 4.94% -13.15%

WACC 8.05% 8.2% 9.22% 10.31%

Change in WACC -0.22% -2.05% -014% -0.16%

Increase in Value per Share

(Perpetual Growth) 4.83% 103.77% 2.17% 3.02%

$13,927 $14,443

Firm Value(Perpetual Growth)

Optimal Firm Value(Perpetual Growth)

$4,949.0

$7,365.0



$956.9 $976.4



$43,396 $44,267




Optimal Capital Structure



0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Current Debt to Capital ratio

Optimal Debt to Capital ratio

Co

st o

f C

apit

al

Debt to Capital Ratio

Eternit is the only under levered firm of the group; its current debt-to-capital ratio of 5% is slightly lower than its optimal 10%. However, we believe that the company may actually be at its optimal. Brazilian companies can distribute cash to their shareholders as interest on own capital, which are tax deductible, instead of dividends, which are not, reflecting on the tax advantage of debt.

Given their current low operating income as percentage of enterprise value, Energisa and BR Malls have optimal debt ratios of 0%.

Energisa is the company analyzed whose actual capital structure is the most different from the optimal. Our calculation shows that

significant value can be generated by the company through an effective management of its level of debt. Gerdau’s business is inherently cyclical implying that the company should have a lower debt ratio when compared to other large cap

companies. Smaller debt ratio will ensure the company higher flexibility.

aswath

Sticky Note

Good. You looked at why the optimal debt ratio is what it is. It is more than a number from a black box.

Is the company over levered or under levered?

Over levered Over levered Close to optimal Over levered

Speed of transition of Cap Structure

Slow/Gradual The interest coverage ratio is still high, which decrease the chance

of bankruptcy

Slow/Gradual Since under levered firms are a more likely target of takeover, if

the debt ratio is reduced suddenly, it may become a target

for takeovers

According to our recommendation, Eternit should

not change its current capital structure

Slow/gradual The company raised capital in

2011 and already decreased its debt to equity ratio. There is still

some extra debt, but it can be decreased gradually.

Means of new Cap Structure - Buyback Stock - Retire Debt

Issue new equity Use retained earnings to Retire

Debt Same as above

Retire debt. The company has been doing stock buybacks in

the recent years.

What should it do with new financing - Invest in new projects - Change how much it returns to stockholders

Take good projects with the new equity, since it is a growing

company

The company will not have a new financing. It will retire debt through retained earnings.

Same as above Keep current ration of investments to payout.

Lifetime of financing Long Term Long Term Medium Term Long Term

Currency of Financing The currency should be in BRL, since its revenue and costs are

entirely in BRL

The currency should be in BRL, since its revenue and costs are

entirely in BRL

90% BRL and 10% in USD, aligned to its revenues composition.

Although the company's ratio of international to BRL debt is not the same as its revenues, the

lower cost of debt in USD makes the difference worthwhile.

Should the financing have any special features?

The company's revenues follow economic cycles, floating rates should be preferred over fixed

ones.

Since it is difficult to change prices due to regulations, the

bonds should have a fixed rate.


ones.


ones.



We did not analyze the optimal capital structure according to the variations in cash flows and firm value due to variations from macroeconomic variables due to lack of macroeconomic data from the Emerging Markets data.

Note:




• 4 Risk Analysis




• 8 Valuation

• 9 Conclusion

Agenda

Cap

acit

y to

pay

div

ide

nd

s

7. Dividend Policy

Revenues

Earnings

Stage 1 – Start-up None

Stage 2 – Rapid Expansion None

Stage 3 – High Growth Low

Stage 4 - Mature Growth Increasing

Stage 5 – Decline High

BR Malls is in the initial phases of generating cash flow, therefore it should use the money in new projects, instead of giving it back to shareholders.

Although Eternit is in a high growth phase, where it should be using cash in new projects, it has an aggressive policy to maintain high payout ratios.

Energisa is a mature companies that can benefit from distributing dividends

Highlights

Capacity to pay dividends

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

140.0%

160.0%

2007 2008 2009 2010 2011

Pay

ou

t R

atio

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

2007 2008 2009 2010 2011

Div

ide

nd

Yie

ld

7. Dividend Policy

Cash distributed to shareholders

BR Malls only started to distribute dividends to shareholders in the last couple of years.

Eternit has always exercised a high payout ratio. Energisa and Gerdau have consistently distributed cash to

shareholders

Highlights

($1,700.0)

($700.0)

$300.0

2007 2008 2009 2010 2011

($600.0)

($400.0)

($200.0)

$0.0

$200.0

2007 2008 2009 2010 2011

($50.0)

$0.0

$50.0

$100.0

2007 2008 2009 2010 2011

-10000

-5000

0

5000

10000

15000

2007 2008 2009 2010 2011

Cash to Stockholders FCFE

7. Dividend Policy

Cash to shareholders vs FCFE

Official Dividend Policy

According to the company’s bylaws, 25% of the net income

after legal deductions is destined as dividends to shareholders


after legal deductions is destined as dividends to

shareholders


after legal deductions is destined as dividends to

shareholders


after legal deductions is destined as dividends or

interest on capital stock to shareholders

Expectations from Marginal Investors

Marginal Investors do not expect high dividend payoffs, since it is a

company in initial phases of growth, with high CAPEX.

Marginal investors expect good amount of dividends

Marginal investors expect good amount of dividends.

Marginal investors expect good amount of dividends

Investment Opportunities

Significant investment opportunities in mall expansions,

new acquisitions and renovations.

The company is going through major expansions in the

northeastern part of Brazil, increasing alternative energy

generation.

Expansion in production line to capture opportunities from the World Cup and Olympic Games

Significant investment opportunities in expanding the

flat steel line.

Leverage Over levered

the company should distribute low to nothing as dividends.

Over levered the company should distribute

low to nothing as dividends.

Under levered the company can afford to pay

dividends to shareholders.

Over levered the company should distribute

low to nothing as dividends.

Necessity to use dividends as signal to market

No necessity. The company is widely covered by analysts.

There is a necessity to signal the market using dividends, due to low analyst coverage and low

trading volumes.

No necessity. The company is maintains a clear channel with

financial markets.

No necessity. The company is widely covered by analysts.

7. Dividend Policy

Gerdau and Energisa should reduce their dividend distribution to accommodate future CAPEX necessity.

BR Malls can maintain its current dividend policy, since it is very small in relation to its future CAPEX necessity, albeit its negative FCFE in the last two years.

Eternit should maintain its dividend policy, since most marginal investors already expect it from the company.

Highlights

Dividend Policy

0.80%

1.33%

BR Malls Dividend Yield Industry Dividend Yield

2.40%

3.00%

Gerdau Dividend Yield Industry Dividend Yield

3.70%

4.44%

Energisa Dividend Yield Industry Dividend Yield

9.00%

1.98%

Eternit Dividend Yield Industry Dividend Yield

7. Dividend Policy

Except for Eternit, all companies have a dividend yield lower than its industry peers.

In the case of Energisa and BR Malls, his low yield is due to its high CAPEX necessity.

In the case of Gerdau, this low yield is due to poor performances in the last year.

Highlights

Dividend Policy

aswath

Sticky Note

Tie your analysis of dividend policy to your assessment of optimal capital structure. If you are significantly under levered, not paying out enough in dividends will make you even more so. If you are over levered, paying out too much in dividends will make you more so.




• 4 Risk Analysis




• 8 Valuation

• 9 Conclusion

Agenda

8. Valuation

Historical Stock Performance

Revenue Growth 44.00% 7.00% 10.00% 30.00%

Target EBIT (as a % of sales)

77.33% 18.00% 14.00% 10.00%

Current Stock Price $23.90 $2.25 $10.15 $16.44

-45.00%

-25.00%

-5.00%

15.00%

35.00%

55.00%

2008 2009 2010 2011

Historical Revenue Growth

8. Valuation

Valuation: Assumptions

Enterprise Value $21,316.98 $5,647.65 $1,198.98 $41,278.65

Equity Value $17,814.83 $4,087.71 $1,219.46 $32,172.65

Estimated Value per Share

$39.33 $3.72 $13.63 $16.64

Current Stock Price $23.90 $2.25 $10.15 $16.44

Upside 64.56% 65.33% 34.29% 1.22%

$39.33

$3.72

$13.63 $16.64

$23.90

$2.25

$10.15

$16.44

$0.00

$5.00

$10.00

$15.00

$20.00

$25.00

$30.00

$35.00

$40.00

$45.00

BR Malls Energisa Eternit Gerdau

Estimated Value per Share Current Stock Price

8. Valuation

Valuation: Results

8. Valuation

BR Malls only presents positive FCFF in the last year and at the terminal value, even though it presents an upside of approximately 65%. This occurs mainly due to the company still holding 6 projects in greenfields and recent acquisitions, which is delaying cash flows that could better represent the investments made. This only reinforces the idea that BR Malls should keep the current dividend policy of distributing only the minimum dividend required and to reassess its current capital structure.

Energisa is improving its operating margins diminishing the lost of energy in its system. Furthermore, is investing a substantial amount of the FCFF in new projects related with alternative energy generation such as wind power and small hydro power (SHP). Those project present better margins, however are risker and don’t have a proven model. Energisa expects to pay less dividends next years in order to do these investments.

Eternit valuation is aligned with the expect growth of the housing industry due to the high demand from investments for the World Cup in 2014 and the Olympic games in 2016.

Gerdau, after suffering due to the financial crisis of 2008, lost a great share of market cap value. The fact that the price of the stock is very close to its fair value may mean that the market is not expecting any big surprises in the near future for the company or for the industry.

Highlights

Valuation: Conclusion




• 4 Risk Analysis




• 8 Valuation

• 9 Conclusion

Agenda

BR Malls is over levered, with its current debt-to-capital ratio 23.19% above the optimal of 0%. The firm is cyclical in nature, with costs and revenues mainly in BRL. This lead to an optimal financing instrument being a BRL denominated, floating rate, long term bond. The company enjoys great benefits and has medium cost from debt.

Although there aren’t any apparent conflicts of interest, the company does not enjoy a good representation of its current major shareholders in the board. The company serves as an example where its current board members are not compensated, except independent directors, and the chairman is one of the main shareholders. Dividend policy should keep dividends to a minimum, where the company can use the cash to invest in more profitable projects.

BR Malls follows an aggressive strategy of growth through acquisitions, expansions and construction of new malls. Its malls present a high margin and a positive EVA, but construction projects take a long time to be executed and, once undertaken, have a high cost of cancelation. The company still has a ROE smaller than the cost of capital, but if it undertakes its optimal capital structure, its cost will reduce by a significant amount, making investments more attractive and profitable.

BR Malls is in an industry where it is highly correlated to the economic cycles. Its shopping malls require a great deal of capital expenditures and maintenance and, while during cycles of growth, generate growing cash flows.

9. Conclusion

Conclusion

Assets Liabilities

Assets in place

Debt

Growth Assets

Equity

aswath

Sticky Note

I like this set up.

Assets Liabilities

Assets in place

Debt

Growth Assets

Equity

Energisa is over levered , being 52.88% above optimal debt ratio. The company has debt in USD with swap to BRL because it is cheaper and easy to raise money internationally. We do not foresee bankruptcy because of its strong cash flow generation and regulated segment. The company probably will not migrate to the optimal level given the possibility of dilution of current major shareholders it decides to raise capital.

Major stockholders have strong presence both in the management and in the board of directors. This reflects a high dividend payout ratio of 45.03% We recommend that the company decreases the payout ratio to 25%, the minimum required by Brazilian law, and use the money to continue investing in its projects that represent good returns.

Energisa has good investments projects. It is reducing the lost of energy in its recent acquired system in northeast, therefore improving operating margins significantly. The new projects to generate alternative sources of energy, such as wind power and small hydropower, are in construction and presents good perspective of return, however with more risk imbed.

Energisa‘s assets in place are yielding returns greater than its hurdle rate. The company integrated very well with several acquisitions in the northeast of Brazil during the last 10 years. The company also has more than 100 years and navigated well during all economic and political changes that occurred in Brazil.

9. Conclusion

Conclusion

Assets Liabilities

Assets in place

Debt

Growth Assets

Equity

9. Conclusion

Eternit has a combination of assets currently generating positive returns to its shareholders. The firm’ s business has been benefited by the good moment of the Brazilian real estate and infrastructure markets and has exceed expectations of investors based on different measures, such as Jensen’s Alpha and EVA. The pressure agaisnt asbestos is a red flag for the company.

Eternit’s balance sheet gives a good indication of how the firm has prepared itself to benefit itself from the future growth currently expected. The positive expectations come from the large housing deficit observed in Brazil, a constant driver for the company’s revenues, as well as from the infrastructure investments necessary for such events as the 2014 Soccer World Cup and 2012 Olympic Games.

Eternit has a capital structure close to its optimal. The actual debt-to-capital ratio of 5% is slightly lower than the optimal of 10%. However, it is relevant to note that the company also distribute cash to its shareholders as own capital interest, which are tax deductible, instead of dividends, which are not. Therefore, we believe that the company may currently be at its optimal level of debt.

Eternit has a large number of individual investors who expect it to pay a good amount of dividends, aligned to the current strategy applied by the company. We believe that the company’s generation of cash flows allows it to keep this distribution in future years. The firm currently gives a good example of corporate governance offering shareholders the possibility of online voting to increase their participation in the company’s meetings.

Conclusion

Assets Liabilities

Assets in place

Debt

Growth Assets

Equity

Gerdau is over levered, being 13% above optimal debt ratio. The company raised capital in 2011 and reduced its leverage. The financing is in a good currency and interest rate mix level. We do not foresee bankruptcy possibility; however, due to the cyclical nature of its business, Gerdau should migrate to its optimal.

Major stockholders have strong presence both in the management and in the board of directors. This reflects a high dividend payout ratio - an average of 28% in the last 5 years - even though in 2008 net income dropped by 70%. We recommend that the company decreases the payout ratio to 25% (the minimum required by Brazilian law) and use the remaining amount to pay out debt.

Gerdau has good investments projects. The new flat-steel equipment in Brazil will enable the company to take more advantage of the country’s growth and increase its operating margins – flat-steel has higher added value. We recommend the maintenance of this project for it will increase Gerdau’s scope of consumer industries.

Gerdau ‘s assets in place are not yielding returns greater than its hurdle rate. The company is integrating several acquisitions it has made in North and Latin America. Increased competition in the Brazilian long-steel market is also pressuring margins down. We recommend that no other acquisitions be made until current units are fully integrated.

9. Conclusion

Conclusion

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