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Edited Transcript of EDN.BA earnings conference call or presentation 11-Mar-19 2:00pm GMT

Q4 2018 Empresa Distribuidora y Comercializadora Norte SA Earnings Call

Buenos Aires Mar 14, 2019 (Thomson StreetEvents) -- Edited Transcript of Empresa Distribuidora y Comercializadora Norte SA earnings conference call or presentation Monday, March 11, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Leandro Carlos Montero

Empresa Distribuidora y Comercializadora Norte Sociedad Anónima - CFO

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Conference Call Participants

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* Frank J. McGann

BofA Merrill Lynch, Research Division - MD

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and thank you for waiting. At this time, we would like to welcome everyone to Edenor's Fourth Quarter 2018 Results Conference Call. We would like to inform you that this event is being recorded. (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.

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Leandro Carlos Montero, Empresa Distribuidora y Comercializadora Norte Sociedad Anónima - CFO [2]

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Thank you very much. Good morning, everyone, and thanks for joining our fourth quarter 2018 earnings conference call. First, we will focus on the main events that recently took place and then briefly review the results of the quarter. As you know, you can always call any member of our team for more details on the results of the period or any doubts you might have.

In first place, it was mentioned in that, because of the Argentine economy is understood as hyperinflationary pursuant to International Accounting Standard No. 29, as of December 31, 2018, financial statements have been restated to reflect changes in national purchasing power of the company's functional currency, the Argentine peso. Consequently, the company's financial statements are presented in terms of the measuring unit current at the end of the reporting period. As regards this report, especially for the readers' convenience, figures will be kept at historical levels to continue the previously published periods.

Regarding the transfer of Edenor's concession tariff fixing, on February 28 this year, the federal government, the province of Buenos Aires and the autonomous city of Buenos Aires executed an agreement which provides that from March 1 this year, the process for the transfer of Edenor and Edesur to the jurisdiction of the province and city of Buenos Aires begin, whereby this jurisdiction will be vested within [informant] power, our utility service provided by the concessionaires.

The main 3 aspects of the agreement are: first, the creation of a bipartite regulatory agency within the province of Buenos Aires and the autonomous city of Buenos Aires to monitor and regulate the electricity distribution utilities as well as to perform all necessary actions so that this entity may become operative under their legal systems as appropriately as possible -- as promptly as possible. Second, as from January this year, the province of Buenos Aires and the city of Buenos Aires will bear the expenditures associated with the social tariff with own resources. Finally, the national government undertakes to conduct all necessary administrative proceedings to resolve claims pending with concessionaires, including claims associated with the performance between January 6, 2002 and February 1, 2017 period, date on which the comprehensive tariff review entered into effect; claims associated with the payment of consumptions by low-income neighborhoods with community meters generated until December 31, 2018, exclusively regarding the percentage committed by the federal government; and claims on differences resulting from the application of the bill cap for users benefiting from the social tariff.

In principle, this agreement does not involve any substantial changes in the regulation and determination of tariffs, future increases or service quality paths established in the last comprehensive tariff review. However, it will be necessary to await confirmation by the new regulatory entity substituting the ENRE, which will temporarily maintain its functions until the new agency is created. It should be highlighted that Edenor has not been a party to this agreement, and it is still analyzing its full scope and implications.

Moreover, on January 31 this year, pursuant to Resolution No. 27, the regulator approved the distribution added value, or VAD update for the second semester of 2019 and the pending update corresponding to the first semester of the same year -- of last year, totaling a 32% increase applicable as of March 1 this year. Additionally, the application of the new E factor adjustment is deducted from cumulative inflation updates for a total adjustment of 1.59% because of this E factor.

Furthermore, the cost of deferrals for the August 2018-February 2019 period and for the month of February 2019 in the amount of approximately ARS 1 billion and ARS 840 billion (sic) [ARS 841 million], respectively, will be recoverable in 5 installments payable as from March 2019.

Finally, around ARS 51 million will be collected under the same modality on account of the partial recognition of the appeal filed by Edenor to acknowledges costs not previously passed into tariff.

Regarding the seasonal price of electricity. On December 27 last year, Resolution No. 366 was issued by the Secretariat of Electric Power, approving the summer season programming for the wholesale utility market submitted by CAMMESA, thus determining new prices for power capacity, energy and transmission for the February-October 2019 period. Furthermore, the social tariff and saving bonuses for the residential tariff were eliminated as beneficiaries have been transferred to the provincial jurisdictions, which will bear their costs and implementation, as I mentioned before. In our case, the province of Buenos Aires and the city of Buenos Aires decided to continue with the social tariff regime as it has been implemented by the federal government, with no changes to the clients benefited by this measure.

Later, on January 31, 2019, the regulator issued Resolution No. 25 that approved the new values for -- of Edenor's tariff scheme as from February 1 this year and incorporated the new power capacity reference price and stabilized prices for energy determined by the Secretariat of Electric Power until April 30, 2019.

Moving on to penalties. On November 22, 2018, the ENRE issued Resolution No. 91, regulating a new punitive proceeding for breaches in reading and billing terms. Furthermore, it determined that the large part of penalties imposed in kilowatt-hour should be valued as of the punitive event's occurrence date and not to the value of the kilowatt-hour at the date of the event as determined previously by the regulator. This applies even though the delay may be due to the regulation -- regulator itself. These modifications have been quantified and accounted for in the fourth quarter of 2018, resulting in charges in the amount of approximately ARS 500 million and ARS 300 million, respectively. This is more important to note that we have appealed both decisions.

Regarding the real estate contractual termination disclosed in the third quarter of 2018, upon the failure by Ribera Desarrollos to refund the purchase price plus interest, in November 2018, Edenor brought an arbitration proceeding against Ribera Desarrollos before the Buenos Aires tax exchange arbitration court seeking to enforce the payment of the compensation stipulated in the bill of sale, which, as of December 31, 2018, amounts to almost ARS 3 billion. This proceeding is pending as of date. Additionally, the process was launched for the collection of the surety bond, warranting the performance of Ribera Desarrollos' obligation, which, under the terms of the policy, results in a more than $50 million claim, covering over 60% of the amount claimed to Ribera Desarrollos. In the opinion of our leader counselors, the company's collections claim is extremely sound and should result in a favorable decision, both in the mentioned arbitration proceeding and in the legal action which may be brought against the insurance company in case of breach of its obligation to pay the surety bond. However, taking to consideration that Ribera Desarrollos filed a voluntary petition for reorganization on February 1, 2019, added to the publication in the official gazette on February 28 this year, prohibited the insurance company to execute new agreements and keeping the general restraint on the alienation of property until the deficit situation is regularized, Edenor has partially provisioned the credit -- the claim value, weighting the possibility of recovery, not because of the quality of its claim, which is indisputable, but based on Ribera Desarrollos' financial situation and insurance company legal situation. Consequently, the current claim balance disclosed as of December 31, 2018, net of provisions, amounts to ARS 766 million.

Finally, after successfully completing the first program for the repurchase of our shares for 2018, on December 4 last year, our Board of Directors approved a second program for a maximum amount of up to ARS 800 million. Acquisitions are being made with net realized income, and the term of the program is 120 calendar days starting on December 5, 2018. As of today, almost 11 million own shares have been purchased under this program for a total amount of around ARS 420 million at an average price of $27 per ADR. Thus, the company holds 29 million own portfolio shares, representing 3.2 percentage of the capital stock.

Now taking into consideration our results in the fourth quarter 2018. Net sales increased by 59% to around ARS 10.7 billion in the fourth quarter 2018 against ARS 6.8 billion in the fourth quarter 2017, mainly on account of the increase in the cost of energy purchases, which represents 74% of devaluation, and the rest for the entry into effect of the whole update in the VAD provided by -- for in the comprehensive tariff review process, together with bi-annual inflation assessments.

Between the comparison periods, updates for a total 88% were applied, while the last update corresponding to the first semester of 2019 was given partially in August last year, while the remainder was deferred for March 2019. If the full VAD update have been recorded in the fourth quarter of 2018, sales would have increased by an additional ARS 410 million. Furthermore, under the deferred income recoverable in 48 installments accrued during the February 2017-January 2018 period, ARS 381 million were disclosed in the fourth quarter 2018.

The increase in revenue from sales was reduced significantly by an 8.1% decrease in the volume of energy sales, which reached 4.65 terawatt hour in the fourth quarter this year against 5.06 terawatt hour in the same period last year. This decrease is mainly explained by 10.2% decrease for residential customers, 7.9% decrease for medium and small commercial customers and 8.2% decrease for large users. The residential demand decreased as a result of the lower average temperatures recorded in December and November, approximately 1.7 lower degrees Celsius compared to the previous year, as well as the impact of tariff increases. Small and medium commercial consumers were adversely affected by the lower commercial activity resulting from the recession, while large users by the lower industrial activity, which is reflected in the fall in industrial production index.

Furthermore, Edenor's customers base grows by 3.1%, mainly on account of the increase in residential customers, which have risen to levels above their historical growth, as a result of implemented market discipline actions and installations during 2018 of approximately 10,000 integrated energy meters that were mostly destined to regularize clandestine connections.

The electricity power purchases increased 91% to ARS 6.8 billion in the fourth quarter of 2018 against ARS 3.6 billion for the same period in 2017, mainly due to a 105% increase in the average price of purchases resulting from the entry into effect in December 2017, February and August 2018 of the new reference seasonal prices for electricity set forth by the former Secretariat of Electric Energy, aiming to reduce subsidies but at the same time, affected by the devaluation of the peso.

Despite of -- despite this increase, the reference seasonal price for residential customers is still subsidized by the national government, especially in the case of residential customers where the subsidy reached approximately 45% of the system's average generation cost in the fourth quarter of 2018. Additionally, the energy loss rate increased from 16.4% in fourth quarter 2017 to 17.1% for the same period last year, and was mainly generated by an increased incentive to fraud as a result of the economic recession and the impact of tariff increases. In turn, costs associated with these losses increased by 97%, mainly on account of the application of the new average seasonal price for its determination.

Meanwhile, operating expenses increased by 91%, reaching ARS 4.6 billion in the fourth quarter last year, against ARS 2.4 billion for the same period in 2017. This is mainly explained by 2 reasons. The first one is a ARS 1 million -- ARS 1 billion increase in penalties, mainly as a result of the new penalties imposed by ENRE Resolution No. 91 last year. Penalties for breaches in readings and billing terms amounted to ARS 506 million, and the change in the methodology for the calculation of penalties resulted in a ARS 308 million increase in values. In second place, for a ARS 433 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 preventive and corrective maintenance works such as pruning, changes of posts, the gathering of data and anomalies, the rental of generating units and the repair of sidewalks; higher expenses associated with the distribution of bills; and lastly, an increase in the cost of IT services and new hirings, such as project to manage technical workgroups and success factors, a cloud-based human resources platform. And third, by a ARS 283 million increase in salaries and social security charges on account of salary increases totaling 41% and a 1% increase in other stuff.

Regarding our financial results. We experienced a 383% increase in losses, reaching a ARS 2.1 billion loss in the fourth quarter against a ARS 443 million loss for the same period in 2017. This is mainly accounted for by higher commercial interest from the debt with CAMMESA for almost ARS 1 billion. This is part of the claims we mentioned before, against the national government, and a ARS 729 million decrease in other financial resource due to the impairment of a credit claim for our real estate assets; lastly, by higher interest in the amount of ARS 107 million as a result of the increasing exchange rates compared to the same period in 2017. These effects were partially offset by an appreciation of the pesos against the U.S. dollar during the quarter, against our U.S. dollar net position -- debt net position, resulting in a total positive impact on account of exchange rate differences for ARS 567 million. Also, higher commercial and financial interests for ARS 116 million were recorded.

Finally, net results decreased by ARS 2.3 billion, recording losses for ARS 2.2 billion in the fourth quarter of 2018 against profits for ARS 22 million for the same period in 2017. The improvement in gross margins as a result of the tariff increases has been overshadowed by lower demand and the partial deferral of the VAD update for the first semester of 2019. In turn, losses are explained by these January penalties, changes in criteria for the calculation of penalties and the previously described operating and financial expenses.

Talking about Edenor's adjusted EBITDA. It shows that ARS 110 million loss in the fourth quarter of 2018, almost ARS 650 million lower than in the same period of 2017. Adjustment corresponds to penalties implemented after the tariff review for other period, changes in the penalty calculation methodology and commercial interest. Moreover, it is important to note that the deferred income accrued in the fourth quarter because of the partial assessment deferral, which is not included in the VDA, amounts to ARS 410 million for the quarter. Considering this effect, EBITDA would have turned positive ARS 300 million.

Regarding Edenor's capital expenditures. During this quarter, our investment totalized ARS 3.2 billion compared to ARS 1.3 billion in the same quarter last year, from which 58% corresponds to network infrastructure and expansion and the remaining 42% 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. The total amount invested in 2018 amounts to ARS 7.6 billion or ARS 8.6 billion at restated figures, being the highest investment level for the company since creation and ARS 1.6 billion higher than required by regulator. This achievement (inaudible) a higher (inaudible) assessment in February 2019 from 2.40, respective, to 2.71 finally approved, that will impact our revenue in the current year.

Taking into account our energy losses, they show with an increase reaching 17.1% against 16.4% for the same period in 2017. The tariff increases inside the comprehensive tariff review have generated a greater incentive to fraud of certain customers, generating a 187 gigawatt-hour increase in the level of losses in physical units. Additionally, the drop in demand from large users, which have a substantial lower loss level, have a negative impact on the indicator. Likewise, the rise in the average energy purchase price increases the value in pesos of these losses.

Furthermore, in the fourth quarter 2018, we continued taking actions to reduce energy losses on 2 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 nonregular 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 $216 million, while net debt amounts to $97 million. Financial debt consists of $166 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. During the fourth quarter 2018, the company purchased corporate bonds in different open market operations for a total nominal value of $9.6 million. Currently, both liability bear interest at a fixed rate.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Frank McGann with Bank of America.

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Frank J. McGann, BofA Merrill Lynch, Research Division - MD [2]

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Just 2 things, if I could. One is just there are a lot of tariff adjustments that are moving around and some which will have a bigger impact as you go through the first quarter and the rest of the year. I was wondering how you were thinking about overall profitability in 2019 versus 2018, relative to the adjustments that we know about currently. And then secondly, in terms of the regulatory changes and the moving of the jurisdiction for tariffs and other issues to the province and a city, will ENRE still be making all of the determinations until those new regulatory agencies are fully set up? I was just wondering if you had any thoughts on the time frame that's involved in that change.

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Leandro Carlos Montero, Empresa Distribuidora y Comercializadora Norte Sociedad Anónima - CFO [3]

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Going to the first question, I can say that maybe the good thing is that since March 1, we have our tariff fully implemented. All the assessments set under the comprehensive tariff review are applied in the tariff, and the deferred adjustment, which was one in August 2018 and the other in February this year, because it was deferred 1 month, is fully included in the tariff. So today, we have a normalized tariff, which includes the recovery of the difference between the money we should have collected during the last 7 months and that we didn't collect because of the deferred increases. So the next increase should take place in August this year, including or taking into consideration the inflation for the first semester 2019. So that's the following step in which we will have our tariff review. And going to the second question, the -- with the province of Buenos Aires, city of Buenos Aires and the national government and with last February 28 was to start the process in order to change the jurisdiction for the company from the federal government to the local government. As I said, it's a process. So the following steps we think will be -- or we are waiting for 2 following steps. The first one is a new agreement in which the companies, Edenor and Edesur, should be part. We are waiting for resolution for the pending claims. This is an agreement we should sign or agree with the national government, with the federal government. And the third part is the creation of the new regulatory agency, which should be enforced as soon as possible. And -- but what we have till now is that, for the moment, all the rules and the decisions made under the last comprehensive tariff review will be kept in place.

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Operator [4]

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(Operator Instructions) And with Bank of America. Please go ahead.

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Frank J. McGann, BofA Merrill Lynch, Research Division - MD [5]

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Just in terms of demand level, I was just wondering what you've been seeing to date in the first quarter. Any changes in the churns that you had seen in the fourth quarter? Similarly, with losses, if there's any potential for an improvement as you get through this year or with the tariff increases, maybe you would expect some further deterioration so you see those bottoming out.

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Leandro Carlos Montero, Empresa Distribuidora y Comercializadora Norte Sociedad Anónima - CFO [6]

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Okay. Well, this first quarter, what we are watching is -- the first thing is that demand is still lower. In fact, in January, the demand decreased in comparison to the previous -- to the same month last year. We should take into account that the first quarter in 2018 was a very high-growth quarter in comparison to this quarter in terms of industrial activity. And on the other hand, in particular with your -- regarding your question about energy losses, we have been implementing the different actions or additional actions, especially to have more presence in the streets in our grid in order to avoid fraud from our residential customers. And we are developing a new kind of grid in order to -- especially to those areas where we don't have a current grid, where we don't have any facility. We are building a new kind of grid in order to avoid the fraud from our residential customers. But we will see the result of these actions, I hope so, during the second quarter.

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Operator [7]

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This concludes the question-and-answer session. At this time, I would like to turn the floor back to Mr. Montero for any closing remarks.

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Leandro Carlos Montero, Empresa Distribuidora y Comercializadora Norte Sociedad Anónima - CFO [8]

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Thank you. Well, thank you very much for joining the conference call. We hope the following year will be a better one so -- and thanks all of you for joining all the conference calls during the year and following our results of operation. Thank you very much, and have a nice day.

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Operator [9]

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Thank you. This concludes today's presentation. You may disconnect your line at this time, and have a nice day.