CIG

Business Context and Reporting Period

Company: Companhia Energética de Minas Gerais (CEMIG)
Reporting Period: Fiscal year ended December 31, 2003
Business Overview: CEMIG is a state-controlled mixed-capital company and the largest electricity distribution concessionaire in Brazil by GWh sold to final customers. It operates vertically integrated generation, transmission, and distribution businesses in the state of Minas Gerais, Brazil. The company also engages in natural gas distribution (via subsidiary Gasmig) and telecommunications (via subsidiary Infovias).
Regulatory Environment: The company is subject to extensive regulation by the Brazilian National Electric Energy Agency (ANEEL) and the Federal Government. A significant regulatory change, Law No. 10,848 (New Industry Model), enacted in March 2004, mandates the unbundling of generation, transmission, and distribution activities by December 2004.

Key Financial Metrics (Year Ended Dec 31, 2003)

Note: Financial data is presented in Brazilian Reais (R$). The exchange rate at period end was R$2.8950 to US$1.00.

Material Changes vs. Prior Period

• Revenue Growth: Net operating revenues increased 23.8% to R$6,032 million, driven primarily by a 31.5% increase in electricity sales to final customers (due to rate increases and volume growth) and a R$199 million deferred rate adjustment recognized in 2003.
• Profitability Turnaround: The company returned to profitability with a net income of R$1,396 million, compared to a net loss of R$12 million in 2002. This was largely due to a R$1,200 million swing in financial results (from R$525 million expense to R$674 million income) driven by the 18.2% appreciation of the Brazilian Real against the U.S. Dollar in 2003.
• Cost Management: Operating costs increased 8.2% to R$4,703 million. Notable increases included personnel costs (up 33.5% due to wage increases and a voluntary termination program) and electricity purchased for resale (up 4.7%). However, employee post-retirement benefits decreased 47.3% due to a higher expected return on plan assets.
• Regulatory Asset Reversal: A R$174 million reversal of the provision for loss on deferred regulatory assets was recorded in 2003, compared to a R$28 million provision in 2002, reflecting improved recoverability projections.

Guidance, Outlook, Risks, and Unusual Items

Outlook and Guidance

• Capital Expenditures: The company projects total capital expenditures of approximately R$1,081 million for 2004, focused on distribution infrastructure expansion and generation capacity increases.
• Debt Refinancing: CEMIG plans to raise approximately R$1.6 billion in 2004 to refinance R$1,660 million of debt maturing in 2004 and to lengthen debt maturities.
• Rate Adjustments: A 19.13% average rate increase was implemented in April 2004. However, ANEEL re-issued the resolution in May 2004, reducing the effective increase to an estimated 14%, which the company believes is insufficient to achieve authorized revenue levels. CEMIG has filed an administrative proceeding to reinstate the original rate.

Material Risks and Contingencies

• Unbundling Requirement: Failure to unbundle generation, transmission, and distribution activities by December 2004 could result in penalties, fines, or concession termination. The process requires State Law approval, which is outside the company's direct control.
• State Government Receivable: CEMIG holds a significant receivable (R$891 million net) from the State of Minas Gerais under the CRC Account Agreement. The State Government has a history of missing payments. While the company can offset dividends owed to the State against this receivable, there is no assurance of full collection.
• Foreign Exchange Exposure: Approximately 43% of total debt (R$1,712 million) is denominated in foreign currencies (primarily USD). A hypothetical 20% depreciation of the Real in 2004 could result in an additional annual cash outflow of R$337 million.
• Legal Proceedings: The company faces various lawsuits regarding rate increases, taxes, and environmental licensing. A significant dispute involves the shareholders' agreement with Southern Energy, which was declared null and void by the Superior Court of Justice in December 2003, though the decision remains subject to amendment requests.
• Insurance Gaps: The company lacks general third-party liability insurance and coverage for major catastrophes (earthquakes, floods) or business interruption.

Key Facts for Investor Verification

• State Control: Verify the extent of the State Government of Minas Gerais' influence (51.28% of common shares) on strategic decisions, dividend policies, and the unbundling timeline.
• CRC Account Collectibility: Assess the likelihood of collecting the R$891 million receivable from the State Government and the adequacy of the offset mechanism against dividends.
• Regulatory Rate Recovery: Monitor the outcome of the administrative proceeding against ANEEL regarding the re-issued Resolution No. 83 and its impact on 2004 revenue targets.
• Debt Maturity Wall: Confirm the successful execution of the R$1.6 billion refinancing plan in 2004 to cover the R$1,660 million debt maturing in the same year.
• Unbundling Progress: Track the legislative progress in the Minas Gerais State Assembly required to legally separate the company's operations by the December 2004 deadline.