Damodaran Corporate Finance Valuation Presentation

Corporate Finance
Final Project

Brazilian Companies

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

Summary

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%
(1)
Dividends $27.12 $98.53 $63.33 $745.70
(1)
FCFE ($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.

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

Agenda

• 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

Corporate Governance

Total of 7 members, where 2 are Total of 5 members, where Total of 7 members, where 3 are Total of 9 members, where 3
Board of Directors
Independent 2 are Independent. Independent are Independent
CEO in the Board?
CEO is in the Board CEO is in the Board CEO is in the Board CEO is in the Board
Min – BRL 12,337.60 Average salary - fixed plus bonus
The Board is not compensated,
Average – BRL 38,552.58 Min - BRL 14,416.67 is BRL 23,000. Independent
Salary of Board of except for its two independent
Max – BRL 53,568.20 Average - BRL 15,916.67 board members receive 55% of
Directors (Monthly) directors, who receive each a
Salary (77%) Profit Sharing Max - BRL 20,333.33 their compensation in stock
compensation of BRL 7,000.00
(22%) Benefits (1%) option.
Online Voting No No Yes No

CEO participates in the Board as Vice- The company does not have the figure of a
Chairman. He has served since 2007 as specific controller. However, most individual
chairman and since 2010, as vice- investors who have relevant positions in the
chairman of the board. He is a partner of stock are members of the Board of Directors.
Four board members compose the
GP Investments since 2002. He came from
Chairman of the Board, CEO and largest shareholders, CEO and COO
outside of the company. He holds 0.58% The directors are relatively independent from
Issues related with CFO are from the same family, No are part of the controlling family and
of the company's outstanding shares. the managers. Directors are indicated by a
conflict of interest board member representing the are also on the board. Only two board
diversified shareholders base and have the
stock holders from the free float. members have not worked in the
Board of Directors - Average of 3.2 yeas in conditions to make a fair assessment of
company before.
the board. 2 from GP, one from Equity managers' job. However, the long time some
International. Chairman came from an directors and managers have been working
acquired company. Three inside directors. under their positions might indicate the
Two are CEO from other companies. opposite.

100% Voting 47% Voting Shares 100% Voting 33% Voting Shares
Classes of Shares
Shares 53% Non-Voting Shares Shares 66% Non-Voting Shares

Relationship with
1 1 3 1
stockholders (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


None 25% 25% 25%
Minimum free float

Common and Common and preferred Common and Common shares
preferred shares shares preferred shares (with
Type of Shares additional rights)

Minimum of 3 Minimum of 3 members Minimum of 3 Minimum of 3 members and 20%
Board of Directors members members and 20% independent
independent

Additional Financial Statements None None US GAAP or IFRS US GAAP or IFRS
Reporting

At least 80% to At least 80% to common 100% to common 100% to common shares
common shares shares shares, and at least
Tag Along Right 80% to preferred
shares

360 39 17 119
Number of Companies Listed

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.



KPMG Auditores
Auditors Pricewaterhouse Coopers Deloitte Touche Tohmatsu Deloitte Touche Tohmatsu
Independentes

Corporate Governance Level Novo Mercado Regular Listing Novo Mercado Nivel 1

Is the stock included in the
Yes No No Yes
IGC?
Float 9.0% 12.0% 63.6% 56.4%
36 - Stock 4 - Stocks
Analyst Coverage 6 24
5 - Bonds 3 - Bonds

Relationship with the
3 1 2 3
markets (1)

(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.



Highlights

 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.


Social Obligation and Image to Society

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

 All malls managed by  New investments in electricity  Eternit engages in the exploration,  Gerdau is the largest
BR Malls participate in generation projects from mining, and processing of recycler in Latin
programs related to alternative sources, in line with chrysotile asbestos as part of its America and around
reducing Energisa's policy of diversifying its production process. Although this the world it
environmental impact. operations into clean and kind of asbestos is not the one transforms millions of
renewable energy. that offers risk to people's health, metric tons of scrap
 Malls participate in the company pays special into steel every year.
programs to receive  Distance learning program earned attention to its social obligations
cold weather clothes Energisa the title of "Benchmark" and the management of its image  24.1% of the
donations for poor as a result of winning the E- in society. employees engage in
communities Learning Brazil 2011-2012 award, Gerdau's volunteering
awarded by the company  Market competition in the programs.
Example of Good
MicroPower. cement-asbestos segment,
Citizenship Initiatives
between Eternit and a French  In 2011 the company
 Social responsibility and cultural group that also is active in Brazil in invested BRL 370
support in the communities it the manufacturing and use of million in
serves. The entity's flagship is its synthetic fibers, has led some environmental impact
"Cultural Workshops", a project Brazilian states, especially where management.
which consists of creating and the plants are located, to approve
maintaining cultural centers in anti-asbestos legislation. It is
the main cities in which the worth mentioning that the validity
Group's distribution companies of these laws awaits a merit
have concession areas. decision on the part of the
Supreme Federal Court.

Good Citizen
Yes Yes Yes Yes
Standing

Relationship with
3 3 1 1
society (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

Highlights

 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.

2 Social Obligation and Image in society

Stockholder Analysis

Investment Advisor - 65.5%
Individual Investors - 70.36%
Other - 15.8% 88% Insiders (Individuals) Institutional Investors: 8.5% Mutual:
Types of Stockholders Mutual Fund - 12.0% 12% Mutual Fund
Institutional Investors - 27.30%
2.6% Others: 88.9% "
Other Companies - 2.34%
Individual - 6.7%

Stock Exchange BOVESPA BOVESPA BOVESPA BOVESPA, NYSE and LATIBEX

43.63% are held by the Top 5
73% of the voting stocks are held by shareholders. The first 3 are
Voting Stock % held by Top 5 27.58% of the voting stocks are held by the family that controls the individual investors and responsible 84.3% are held by top five; - 76.9% is
the top 5 shareholders, that consists of company, 22% by a wealth for 38.41% of the shares. The balance held by top investor, Metalurgica
Description of Top 5 institutional investors individual investor and 5% by the is held by institutional investors, Gerdau"
market in general specifically Brazilian investment
funds.

 Fidelity Management & Research  Dimensional Fund Advisors, LP
Company (7.61%)  Dimensional Fund Advisors, LP (1.02%)
 BlackRock Institutional Trust  Coinvalores CCVM Ltda.  UBS Global Asset Management
Marginal Investors  Individual Investors (43.63%)
Company, N.A. (5.23%)  Credit Suisse Hedging-Griffo Americas Inc (0.95%)
 HSBC Global Asset Management (UK) Asset Management S.A.  Schroeder Investment
Limited (4.61%) Management Group (0.86%)

Outsider Outsider Outsider Outsider

5% Insiders 12% Insiders 22% Insiders 12% Insiders

Insiders

95% 88% 78% 88%

Geographic Breakdown of Brazil – 10.5% Brazil - 95% Brazil - 92.10% Brazil: 98.3%
Investors International - 89.5% International - 5% International - 7.90% International: 1.7%

3 Stockholder Analysis

Stockholder Analysis

Highlights

 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.


Real-World Conflicts of Interest

Stockholders
Stockholders 3
3
2.5
2.5
2
2
1.5
1.5
1
1
0.5
0.5
Society 0 Bondholders

Financial Markets
Financial Markets

Stockholders
Stockholders 3
3 2.5
2.5 2
2 1.5
1.5 1
1 0.5
0.5 Society 0 Bondholders

Financial Markets
Financial Markets


Diversifiable Risk Assessment
Market Risks Firm Specific Risk

 Economic downturns on regions where shopping centers are located
 Stores may not renovate rent contracts;
may adversely affect occupation levels and sales of the stores
 New shopping centers being built close to malls owned by the
located in the malls;
company may affect the necessity of new investments;
 Problems due to the shopping centers being considered public
 Unsuccessful attempts in acquiring new malls;
spaces and are susceptible to accidents of different forms;
 Share ownership with other investors that may have conflicts of
 Problems regarding utilities service;
interest.
 Changes in the regulation in the sector.

 Political risk from changes in the Brazilian energy legal framework
 Incorrect forecast of energy consumption can obligate the company
(ANEEL);
to buy energy at the spot market with a higher cost;
 Highly regulated segment;
 Concession Contracts will terminate in the next 15 years without
 Inflation can affect operating margins with higher costs that cannot
any guarantee that they will be renewed;
be transferred to consumers;
 Family controlled company can generate conflict interest with other
 Cost basis depends on natural resources such as level of rain and
stockholders;
water.
 New acquisition can distract the focus of management.

 Political risks from the regulation of activities based on chrysotile
 Good performance dependent on economic growth and inflation
asbestos;
under control;
 Potential pressure from largest shareholders regarding dividend
 Exchange risk from revenues obtained in international markets;
payments;
 Investments affected by the level of real interest rates.
 Risk of diversifying revenues, currently concentrated on fiber
cement products, through expensive acquisitions.

 Risk of change in commodities' prices; it may affect cost of  Risk of not successfully integrating recently acquired companies;
supplies (iron scrap) and sales prices.;  Risk of not decreasing financial leverage, resulting in higher costs of
 Risk of interest rates change; it may affect cost of debt; capital;
 Risk of exchange rates; it may affect debt expenses.  Risk of not being able to raise capital due to high leverage.

4 Risk Analysis

Risk and Return

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%

Highlights

 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.

4 Risk Analysis

Jensen’s Alpha

25.00%

20.68%
20.00%

15.00%
12.00%

10.00%
7.10%

5.00%

0.00%

-5.00%

-10.00%

-15.00% -13.44%

-20.00%

4 Risk Analysis

Bottom-up Levered Beta

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

Highlights

 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.

4 Risk Analysis

Bottom-up Levered Beta

0.90
0.84

0.80

0.70

0.60
0.53

0.50
0.44

0.40
0.33

0.30

0.20

0.10

0.00

4 Risk Analysis

Parameters used in the analysis

Long Term Inflation in Brazil 1 + 4.5%
1
Differential Inflation = = = 1.0245
Long Term Inflation in U.S. 1 + 2.0%

Volatility of Brazilian Stock Exchange3 19.87%
2
Country Risk Premium = Country Default Spread x = 1.59% x = 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%

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

Cost of Equity

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 Debt

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%

Highlights

 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.

Cost of Capital

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

12.00%

10.31%
10.00%
9.22%
8.05% 8.20%
8.00%

6.00%

4.00%

2.00%

0.00%

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

Measuring Investment Returns

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

Economic Value Added (EVA)

$600.00

$412.05
$400.00

$227.14
$200.00

$34.89
$0.00

-$200.00

-$400.00

-$600.00

-$800.00

-$908.24
-$1,000.00


Comparison
30.00% Size of Bubble = WACC

25.00%

20.00%
ROE

15.00%

10.00%

5.00%

0.00%
4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00% 20.00%

ROC


Project Analysis

Typical Project  Maintenance and  Increase plant capacities
 Real State developments  Installation of heavy plates and
Improvement of Distribution  Build new plants
 Acquisitions of already existing hot-rolled coil rolling mills
Systems  Launch of new brands
malls  Extend operating capacity,
 Construction of hydropower  Acquisitions

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

Negative EVA,
Positive, albeit low, EVA
The company has high financing
The company is still building 6
costs, this should change since the
greenfield projects, which is
company has raised equity in 2011
Project Quality delaying cash flow correspondent Positive EVA and Equity EVA. Positive EVA and Equity EVA.
to reduce its leverage cost. The
to the invested capital. This is
return on the project are close
reflected on a negative Equity EVA
related to commodities, wich are
really volatile nowadays
No
Do future projects look Investing in new alternative
Yes Yes Yes
like past projects? generation of energy: Small hydro
plans and wind farms


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.


Examples of Current Projects

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.


Current Capital Structure

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

Loans Bonds Loans Bonds Loans Loans Bonds
Type of Debt:
64% 36% 63% 37% 100% 39% 61%

Floating
Floating Fixed Fixed Floating Floating
6%
Rate:
100% 94% 25% 75% 100%

Domestic Foreign Domestic Foreign Domestic Foreign Domestic Foreign
Currency:
73% 27% 78% 22% 25% 75% 23% 77%

6. Capital Structure

Benefits and Costs of Debt

High
High High High Marginal Tax Rate of 34%.
Tax Benefit Marginal Tax Rate of 34% and Marginal Tax Rate of 34% and Marginal Tax Rate of 34% and Gerdau has tax deferred
Effective Tax Rate close to 30% Effective Tax Rate close to 21%. Effective Tax Rate close to 26%. credits, that offset the marginal
rate.
Low
High Low Low
Family controlled company with
Of the major shareholders, only The company's major Family controlled company with
Added Discipline strong positions in the board and
two are part of the board shareholders are part of the strong positions in the board
management. Family wants to
(Chairman of the Board) board. and management
continue in control.
Medium Medium
Medium Strong generation of cash flow. The company has a strong Medium
The company has a strong Company segment is regulated generation of cash flows but The company has a strong
Bankruptcy Cost generation of cash flows but is in a by ANEEL. faces uncertainties related to generation of cash flows but is
cyclical industry with high fixed Changes in regulation will be political risks from the in a cyclical industry with high
costs. voted at the Congress next years. exploration, mining, and fixed costs.
Concessions cannot be renewed. processing of chrysotile asbestos.
Medium
Low Low The company has significant
Medium
The company has significant The company has significant tangible assets but the majority
The company has significant
Agency Cost tangible assets and allows tangible assets and allows is not liquid. Investment
tangible assets, but they are
lenders to monitor how the lenders to monitor how the projects allow lenders to
illiquid
borrowed money is invested. borrowed money is invested. monitor how the borrowed
money is being invested.
High
High
The company has a Debt to
Given the uncertainties related Low
High Capital of 53% that is already
to the regulation of chrysotile The company is mature and
Loss of Flexibility The company is still growing, with high compared to the Debt to
asbestos, the company cannot investment needs are well
investment needs still uncertain Capital calculated of the 10%.
perfectly forecast future funding established..
Beside the risk of Bankruptcy
needs.
cost cited.


Current Capital Structure

Revenues

Earnings

Stage 1 – Start-up Stage 2 – Rapid Stage 3 – High Stage 4 - Stage 5 - Decline
Choices of Financing

Expansion Growth Mature Growth

Accessing Private Initial Public Seasoned Equity Bond Issues
Equity Offering issue

Highlights

 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.


Optimal Capital Structure

Recommendation Reduce leverage Do nothing or Deleverage Do nothing Reduce Leverage
The current capital structure
Principal Reason Reduce cost of capital Risk to lose control Risk of reduced flexibility
is close to optimal
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
4.83% 103.77% 2.17% 3.02%
(Perpetual Growth)

$14,443 $976.4
$44,267
$13,927 $7,365.0 $956.9 $43,396

$4,949.0

Firm Value Optimal Firm Value Firm Value Optimal Firm Value Firm Value Optimal Firm Value Firm Value Optimal Firm Value
(Perpetual Growth)(Perpetual Growth) (Perpetual Growth)(Perpetual Growth) (Perpetual Growth)(Perpetual Growth) (Perpetual Growth)(Perpetual Growth)


18.0%

16.0%
Optimal Debt to
14.0% Capital ratio

12.0%
Cost of Capital

10.0%

8.0%

6.0%
Current Debt to
4.0% Capital ratio

2.0%

0.0%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
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.



Is the company over
Over levered Over levered Close to optimal Over levered
levered or under levered?
Slow/Gradual Slow/gradual
Slow/Gradual Since under levered firms are a According to our The company raised capital in
Speed of transition The interest coverage ratio is still more likely target of takeover, if recommendation, Eternit should 2011 and already decreased its
of Cap Structure high, which decrease the chance the debt ratio is reduced not change its current capital debt to equity ratio. There is still
of bankruptcy suddenly, it may become a target structure some extra debt, but it can be
for takeovers decreased gradually.
Means of new Cap
Retire debt. The company has
Structure Use retained earnings to Retire
Issue new equity Same as above been doing stock buybacks in
- Buyback Stock Debt
the recent years.
- Retire Debt

What should it do with
new financing Take good projects with the new The company will not have a new
Keep current ration of
- Invest in new projects equity, since it is a growing financing. It will retire debt Same as above
investments to payout.
- Change how much it company through retained earnings.
returns to stockholders

Lifetime of financing Long Term Long Term Medium Term Long Term
Although the company's ratio of
The currency should be in BRL, The currency should be in BRL, international to BRL debt is not
90% BRL and 10% in USD, aligned
Currency of Financing since its revenue and costs are since its revenue and costs are the same as its revenues, the
to its revenues composition.
entirely in BRL entirely in BRL lower cost of debt in USD makes
the difference worthwhile.
The company's revenues follow The company's revenues follow The company's revenues follow
Since it is difficult to change
Should the financing have economic cycles, floating rates economic cycles, floating rates economic cycles, floating rates
prices due to regulations, the
any special features? should be preferred over fixed should be preferred over fixed should be preferred over fixed
bonds should have a fixed rate.
ones. ones. ones.

Note:
 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.


Capacity to pay dividends

Revenues

Earnings

Stage 1 – Start-up Stage 2 – Rapid Stage 3 – High Stage 4 - Stage 5 – Decline
Capacity to pay dividends

Expansion Growth Mature Growth

None None Low Increasing High

Highlights

 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
7. Dividend Policy

Cash distributed to shareholders

12.0%

10.0%
Highlights
Dividend Yield

8.0%  BR Malls only started to distribute dividends to shareholders in
the last couple of years.
6.0%
 Eternit has always exercised a high payout ratio.
4.0%
 Energisa and Gerdau have consistently distributed cash to
shareholders
2.0%

0.0%
2007 2008 2009 2010 2011 160.0%

140.0%

Payout Ratio 120.0%

100.0%

80.0%

60.0%

40.0%

20.0%

0.0%
2007 2008 2009 2010 2011
7. Dividend Policy

Cash to shareholders vs FCFE

$300.0

2007 2008 2009 2010 2011
($700.0)

($1,700.0)

$200.0

$0.0
2007 2008 2009 2010 2011
($200.0)

($400.0)

($600.0)

$100.0

$50.0

$0.0
2007 2008 2009 2010 2011
($50.0)

15000
10000
5000
0
2007 2008 2009 2010 2011
-5000
-10000

Cash to Stockholders FCFE

7. Dividend Policy

Dividend Policy

According to the company’s
According to the company’s According to the company’s
According to the company’s bylaws, 30% of the net income
bylaws, 25% of the net income bylaws, 100% of the net income
Official Dividend bylaws, 25% of the net income after legal deductions is
after legal deductions is after legal deductions is
Policy after legal deductions is destined destined as dividends or
destined as dividends to destined as dividends to
as dividends to shareholders interest on capital stock to
shareholders shareholders
shareholders
Marginal Investors do not expect
Expectations from high dividend payoffs, since it is a Marginal investors expect good Marginal investors expect good Marginal investors expect
Marginal Investors company in initial phases of amount of dividends amount of dividends. good amount of dividends
growth, with high CAPEX.
The company is going through
Significant investment
major expansions in the Expansion in production line to Significant investment
Investment opportunities in mall expansions,
northeastern part of Brazil, capture opportunities from the opportunities in expanding the
Opportunities new acquisitions and
increasing alternative energy World Cup and Olympic Games flat steel line.
renovations.
generation.
Over levered Over levered Under levered Over levered
Leverage the company should distribute the company should distribute the company can afford to pay the company should distribute
low to nothing as dividends. low to nothing as dividends. dividends to shareholders. low to nothing as dividends.
There is a necessity to signal the
Necessity to use No necessity. The company is
No necessity. The company is market using dividends, due to No necessity. The company is
dividends as signal to maintains a clear channel with
widely covered by analysts. low analyst coverage and low widely covered by analysts.
market financial markets.
trading volumes.

Highlights

 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.

7. Dividend Policy

Dividend Policy
1.33% 4.44%

3.70%

0.80% Highlights

 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.
BR Malls Dividend Yield Industry Dividend Yield Energisa Dividend Yield Industry Dividend Yield

9.00%  In the case of Gerdau, this
low yield is due to poor
3.00%
performances in the last
year.
2.40%

1.98%

Eternit Dividend Yield Industry Dividend Yield
Gerdau Dividend Yield Industry Dividend Yield

7. Dividend Policy

Historical Stock Performance

8. Valuation

Valuation: Assumptions

Revenue Growth 44.00% 7.00% 10.00% 30.00%

Target EBIT
77.33% 18.00% 14.00% 10.00%
(as a % of sales)

Current Stock Price $23.90 $2.25 $10.15 $16.44

Historical Revenue Growth
55.00%

35.00%

15.00%

-5.00% 2008 2009 2010 2011

-25.00%

-45.00%

8. Valuation

Valuation: Results

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
$39.33 $3.72 $13.63 $16.64
Share

Current Stock Price $23.90 $2.25 $10.15 $16.44

Upside 64.56% 65.33% 34.29% 1.22%

$45.00
$39.33
$40.00
$35.00
$30.00
$23.90
$25.00
$20.00 $16.64 $16.44
$13.63
$15.00
$10.15
$10.00
$3.72 $2.25
$5.00
$0.00
BR Malls Energisa Eternit Gerdau

Estimated Value per Share Current Stock Price

8. Valuation

Valuation: Conclusion

Highlights

 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.

8. Valuation

Conclusion

Assets Liabilities

Assets in place Debt

BR Malls is in an industry where it is highly correlated to BR Malls is over levered, with its current debt-to-capital
the economic cycles. Its shopping malls require a great ratio 23.19% above the optimal of 0%. The firm is cyclical
deal of capital expenditures and maintenance and, while in nature, with costs and revenues mainly in BRL. This
during cycles of growth, generate growing cash flows. 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.

Growth Assets Equity
BR Malls follows an aggressive strategy of growth through Although there aren’t any apparent conflicts of interest,
acquisitions, expansions and construction of new malls. Its the company does not enjoy a good representation of its
malls present a high margin and a positive EVA, but current major shareholders in the board. The company
construction projects take a long time to be executed serves as an example where its current board members
and, once undertaken, have a high cost of cancelation. The are not compensated, except independent directors, and
company still has a ROE smaller than the cost of capital, the chairman is one of the main shareholders. Dividend
but if it undertakes its optimal capital structure, its cost policy should keep dividends to a minimum, where the
will reduce by a significant amount, making investments company can use the cash to invest in more profitable
more attractive and profitable. projects.

9. Conclusion

Conclusion

Assets Liabilities


Energisa‘s assets in place are yielding returns greater than Energisa is over levered , being 52.88% above optimal
its hurdle rate. The company integrated very well with debt ratio. The company has debt in USD with swap to
several acquisitions in the northeast of Brazil during the BRL because it is cheaper and easy to raise money
last 10 years. The company also has more than 100 years internationally. We do not foresee bankruptcy because
and navigated well during all economic and political of its strong cash flow generation and regulated segment.
changes that occurred in Brazil. The company probably will not migrate to the optimal
level given the possibility of dilution of current major
shareholders it decides to raise capital.

Energisa has good investments projects. It is reducing the Major stockholders have strong presence both in the
lost of energy in its recent acquired system in northeast, management and in the board of directors. This reflects
therefore improving operating margins significantly. The a high dividend payout ratio of 45.03% We recommend
new projects to generate alternative sources of energy, that the company decreases the payout ratio to 25%,
such as wind power and small hydropower, are in the minimum required by Brazilian law, and use the
construction and presents good perspective of return, money to continue investing in its projects that represent
however with more risk imbed. good returns.

9. Conclusion

Conclusion

Assets Liabilities


Eternit has a combination of assets currently generating Eternit has a capital structure close to its optimal. The
positive returns to its shareholders. The firm’ s business actual debt-to-capital ratio of 5% is slightly lower than
has been benefited by the good moment of the Brazilian the optimal of 10%. However, it is relevant to note that
real estate and infrastructure markets and has exceed the company also distribute cash to its shareholders as
expectations of investors based on different measures, own capital interest, which are tax deductible, instead of
such as Jensen’s Alpha and EVA. The pressure agaisnt dividends, which are not. Therefore, we believe that the
asbestos is a red flag for the company. company may currently be at its optimal level of debt.


Eternit’s balance sheet gives a good indication of how the Eternit has a large number of individual investors who
firm has prepared itself to benefit itself from the future expect it to pay a good amount of dividends, aligned to
growth currently expected. The positive expectations the current strategy applied by the company. We believe
come from the large housing deficit observed in Brazil, a that the company’s generation of cash flows allows it to
constant driver for the company’s revenues, as well as keep this distribution in future years. The firm currently
from the infrastructure investments necessary for such gives a good example of corporate governance offering
events as the 2014 Soccer World Cup and 2012 Olympic shareholders the possibility of online voting to increase
Games. their participation in the company’s meetings.

9. Conclusion

Conclusion

Assets Liabilities


Gerdau ‘s assets in place are not yielding returns greater Gerdau is over levered, being 13% above optimal debt
than its hurdle rate. The company is integrating several ratio. The company raised capital in 2011 and reduced
acquisitions it has made in North and Latin America. its leverage. The financing is in a good currency and
Increased competition in the Brazilian long-steel market interest rate mix level. We do not foresee bankruptcy
is also pressuring margins down. We recommend that no possibility; however, due to the cyclical nature of its
other acquisitions be made until current units are fully business, Gerdau should migrate to its optimal.
integrated.

Gerdau has good investments projects. The new flat-steel Major stockholders have strong presence both in the
equipment in Brazil will enable the company to take management and in the board of directors. This reflects
more advantage of the country’s growth and increase its a high dividend payout ratio - an average of 28% in the
operating margins – flat-steel has higher added value. last 5 years - even though in 2008 net income dropped
We recommend the maintenance of this project for it will by 70%. We recommend that the company decreases the
increase Gerdau’s scope of consumer industries. payout ratio to 25% (the minimum required by Brazilian
law) and use the remaining amount to pay out debt.

9. Conclusion

Damodaran Corporate Finance Valuation Presentation

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