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3 FEBRUARY 2015 Strategy, Utilities and Economics | Brazil

ELECTRICITY RATIONING IN BRAZIL THE NEVER-ENDING PROBLEM

Tatiana Pinheiro* Maria Carolina Carneiro* Fernanda Consorte* Brazil: Banco Santander S.A. Brazil: Banco Santander S.A. Brazil: Banco Santander S.A. +5511-3012-5179 | [email protected] +5511-3012-6682 | [email protected] +5511-3012-6682 | [email protected] Daniel Gewehr* Joao Noronha, CFA* Brazil: Banco Santander S.A. Brazil: Banco Santander S.A +5511-3012-5787 | [email protected] +5511-3012-5734 | [email protected]

Net/Net: The risk of a rationing scenario is high, in our view, given the bleak rainfall prospects for February (52% of historical average). In this report, we present a model (based on the BCB’s model) of the potential effects on GDP: the model suggests that if 5-10% rationing occurs, 12-month GDP growth could be reduced by 0.6-2.0 p.p. In the rationing scenario, we expect sectors that are short energy (i.e., not self-sufficient) and with cyclical or energy rationing exposed demand to be hardest hit. These sectors include: (1) materials (steel); and (2) industrials overall.

 The risk of a rationing scenario is high, in our opinion, given the bleak rainfall prospects for February; consequently, we expect pressure in March 2015 to be higher than in 2014. Water inflow as low as 52% of the historical average for February would necessitate a demand cut close to 10%, in our opinion, in order to alleviate low reservoir levels and guarantee supply for 2H15 and 1H16. Alternative measures, such as providing incentives to lower consumption and increase backup generation, could help offset pressure. However, we believe that reservoirs have reached critically low levels; thus, we estimate a larger demand cut will be needed to assure supply.

 We reproduced the a Brazilian Central Bank (BCB) model for measuring the effect in GDP growth of electricity energy rationing adopted in 2001; the model suggests that if 5-10% rationing occurs, 12-month GDP growth could be reduced by 0.6-2.0 p.p. We do not see a direct impact on inflation or fiscal costs, but we expect rationing to be inflationary (secondary impact of tariff hike). However, we believe that the monetary policy decision will be biased in favor of the economic activity level; we maintain our view that the Selic rate is cut throughout 2016.

 In the rationing scenario, we expect sectors that are short energy (i.e., not self-sufficient) and with cyclical or energy rationing exposed demand to be hardest hit. These sectors include: (1) steel (Usiminas and Gerdau); (2) industrials (capital goods) overall: with Mahle and Randon (higher share of production in Brazil) the most exposed to a potential energy shortage and Weg the least exposed; and (4) appliance and apparel: based on historical data, during 2001's energy rationing, appliances declined on average by 3.7% while apparel grew only 0.5% in nominal terms.

 If rationing occurs, we believe that the industries that will be least affected will be: (1) asset-light service-related such as banks and other financials (Itau, Bradesco, BB Seguridade, and Cielo); and; (2) self-sufficient energy users exposed to foreign or noncyclical demand: (a) pulp producers (Fibria and Suzano); (b) agribusiness (Sao Martinho and Cosan); (3) defensive names such as healthcare (Qualicorp). (See pages 9-11 for further details.)

IMPORTANT DISCLOSURES/CERTIFICATIONS ARE IN THE “IMPORTANT DISCLOSURES” SECTION OF THIS REPORT. U.S. investors’ inquiries should be directed to Santander Investment Securities Inc. at (212) 583-4629 / (212) 350-3918. * Employed by a non-US affiliate of Santander Investment Securities, Inc. and is not registered/qualified as a research analyst under FINRA rules.

ELECTRICITY ENERGY RATIONING: THE NEVER-ENDING PROBLEM Rationing is coming . . . We acknowledge that the risk of an electricity rationing scenario is increasing, given lower-than-expected rainfall in January. Water flow data from February has become more important in determining whether our bear-case scenario will materialize. The drought also constrains water supply in the most important metropolitan areas of Brazil, further restricting an already pressured economy.

. . . if rainfall and water inflow is meager. We are in the rainy season in Brazil, which occurs in the October-April period. In January, rainfall was below 50% of the long-term average, and Brazilian reservoir capacity reached an ultra-low level of 20% on average, which pressures the amounts needed from February onward to minimize the size of rationing and/or of a possible extraordinary tariff hike (mentioned by regulator as the application of a “tariff realism”). According to our utilities equity analysts team, the more likely scenario is rainfall around 52% of the long-term average in February; however, and in order to reduce the probability of a rationing scenario, it should exceed 80% of the long-term average. Considering this shortfall risk, the possible lack of water flow could have a negative impact on economic activity and inflation, particularly since the government has indicated recently by local press and official speeches from the ministry of finance that no fiscal resources will be available to the electric sector this year.

We present a rationing model for economic activity. The following analysis presents our estimates for reservoir levels with restriction of consumption and lower inflow, as well as a sensitivity analysis for GDP growth, inflation, and the fiscal impact of possible electricity energy rationing in 2015. We reproduced the BCB model for measuring the effect in GDP growth of electricity energy rationing adopted in 2001 in order to estimate the possible impact on GDP growth if rationing is adopted this year. For this purpose, we maintain the BCB assessment presented in June 2001 that if a bear-case scenario materializes, the economic segments most affected by a electricity rationing would be (1) mining, (2) manufacturing, (3) civil construction, and (4) utilities, followed by (5) retail, (6) transportation, and (7) financial institutional services.

MIND THE GAP Rationing too probable to be ignored. We estimate that with rainfall @ 52% of the long-term average in southeast region, our reservoirs would reach levels well below the security threshold of 10%, putting at risk not only supply for 2015 but also for 2016.We believe that if low February data are confirmed, the chances of a turnaround by March decrease—as the initial months of the rainy season disappoint, the conversion ratio of rainfall to water inflow and reservoirs decline. In order to achieve reasonable reservoir levels, assuming rainfall would be close to 80% of the long-term average from March to December, we believe a demand cut of ~10% would be needed by the end of April in order to avoid depleting reservoirs below the 10% level and to recover reservoirs to levels closer to the risk aversion curve.

Assumptions underlying our 10% demand cut scenario: (i) we included volumes increasing an average 1.5% YoY from February to April as a result of high temperatures; (ii) 2.2 GW capacity addition in 2015; (iii) stoppage for maintenance in thermals; (iv) full usage of transmission capacity in all systems; (v) February rainfall according to ONS’s recent estimates (January 30)—rainfall at 80% from April to December; rainfall in March at 80%, but lower conversion ratio based on depletion of reservoirs in January/February; and (vi) friction/losses in the conversion of rainfall to water inflow/reservoir capacity from March to May, as we assume the recovery slope from some large reservoirs should be slow.

Figure 1. Brazilian Water Reservoir Levels (%) Figure 2. Rationing Model Output—Base Case

90% 60.0% 80% 50.0% 70% 40.0% 60%

50% 30.0% 40% 20.0% 30% 20% 10.0%

10% 0.0% 0%

jan feb mar apr may jun jul ago sep oct nov dec 1-Jul-14 1-Jul-15 1-Jan-14 1-Jan-15 1-Jun-14 1-Jun-15 1-Oct-14 1-Oct-15 1-Apr-15 1-Apr-14 1-Feb-14 1-Sep-14 1-Feb-15 1-Sep-15 1-Dec-14 1-Dec-15 1-Aug-15 1-Aug-14 1-Nov-14 1-Nov-15 1-Mar-14 1-Mar-15 1-May-14 1-May-15 2001 2008 2013 2014 2015 NO RATIONING CAR (%) 5% CUT IN DEMAND 10% CUT IN DEMAND

Sources: ONS. Sources: ONS and Santander estimates.

Where could we be wrong? Our analysis is focused on the following parameters that, if changed, would impact the model. (i) Rainfall data—we assume that February rainfall will be as bad as the 52% estimate from ONS; therefore, there should be a negative impacts on the March rainfall conversion ratio. However, if February rainfall and water inflow is close to 90%, with a positive impact on the remaining months of the year, the likelihood of rationing drops considerably. (ii) Demand estimates—we assume that volumes from the residential and commercial segments would continue to sustain volumes/growth in positive territory; if the yet to be announced tariff increases have a negative impact on demand or weak economic activity takes a toll on overall consumption, a natural reduction in volumes could help relieve pressure on hydro production. (iii) Additional supply sources—after our recent visit to the Energy Research Bureau, we believe the government is seeking alternative supply additions to the system, a total of 930 MW (2 GW from Argentina at peak hours, 360 MW from alternative transmission line connection to Teles Pires plant, 150 MW from anticipation of construction of turbines in Santo Antonio project, 500 MW additional volume from Itaipu or usage of inefficient thermal capacity).

A possible 5% demand cut vs. our 10% assumption? As we discussed previously, some measures could help relieve short-term pressure on reservoirs. We highlight the following possible actions: (i)

additional supply of 930 MW; (ii) backup (diesel/gas) power generators to be used by the retail segment (malls/hospitals, among others) that could represent additional1 GW; and (iii) Lower volumes from industrials’ own capacity (total capacity from industrial segment for own consumption reaches ~14 GW), we expect ~5% contribution. Last but not least, a higher tariff increase would likely reduce potential consumption in 2015. All in all, the measures could reduce demand and/or increase supply by 2.6 GW. We believe the system would need relief by as much as 5 GW to provide adequate levels by year-end 2015/early 2016. Consequently, although extra measures could help, we still see room for additional demand cuts based on the current rainfall scenario.

BACK TO THE FUTURE: 2001 RATIONING PROGRAM

A wrap-up of 2001. During 2001’ apagão, when power rationing was applied, output in utilities and electricity-intensive sectors contracted markedly. Overall, GDP contracted 0.2% y/y in that period, but the performance was markedly different across sectors. Utilities output plunged by 13.5% y/y (other utilities partially offset the 20% cut in electricity supply), and electricity-intensive industries reduced production by some 3.9% (for detail, see our February 24, 2014 report, Crying in (No) Rain). In our opinion, electricity energy rationing will have suppress 2015 GDP growth.

How the 2001 rationing came about. After very low reservoir levels in the first quarter of 2001, and continuing depletion, in May 2001 the government created a special committee of key government figures to resolve the energy crises: the Chamber for Management of the Energy Crisis, or CGE. This committee had two main objectives: oversee the creation and implementation of the Program for Emergency Energy Consumption Reduction and the Emergency strategic energy plan. While the former involved solving the short-term energy supply shock, the latter involved planning to make sure that structural problems were resolved and that the country would not encounter the problem again.

Rationing announcement on June 1, 2001. The committee passed in July a Provisional Measure (PM 14 of 2001) decreeing rationing measures (locally known as “apagão”), which mainly consisted of a 20% cut in consumption from most customers and tariff increases for consumption above a certain level. If consumption quotas were not met, a cut in supply would ensue. Consumption levels and reduction quotas were based on average monthly consumption of the May-July 2001 period. The rationing period lasted from July 2001 to February 2002, with residential consumers heavily participating in the process, as they were given incentives (bonuses) for reducing consumption more than demanded.

Figure 3. 2001 Rationing Measures (%)

Industrial & Commercial Industrial & Commercial Residential (Low Tension) (High Tension)

Mandatory 15%-25% of Consumption 20% of consumption depending on customer; 20% of Consumption Consumption above 100kWh Exceptions for some Reduction industrials

• Bellow 100kWh: R$2 Optional. Tradeoff with Optional 5 days prior to for every R$1 saved energy accumulation for reading for consumers below Bonus • Bellow 250kWh: R$1 for every R$1 saved future consumption 2.5GW of contracted energy

• Bellow 100kWh: • <2.0GW exempt Optional 5 days prior to • Second time offenders: Max. 3 • Second time offenders: reading for consumers below Supply Cuts days. 4-6 days for repeat Max. 3 days. 4-6 days offenses 2.5GW of contracted energy for repeat offenses

• 201-500 kWh: 50% Prices when • R$245.64 tariff increases • Spot Price for Industries with • Spot Price not achieving • 500kWh +: 200% >2GW reduction tariff increase

• Can ccumulate energy for Other No Accumulation, future consumption Accumulation for future use, sale or purchase of Sale and purchase of energy Comments • Purchase and Sale of energy energy can be done intragroup allowed

Sources: CGE, Ministry of Mining and Energy, and MAE.

RATIONING MODEL: IMPACTS IN 2015 If the bear case materializes this time: we forecast no direct impact on official inflation or additional fiscal costs. Additional fiscal costs do not appear to be associated with the rationing per se. As for inflation, recall that in the 2001 “apagão,” the government established complex rules that set ambitious targets for energy saving for each consumer (who could then be rewarded with a bonus) but also implemented punitive charges for consumption above a certain level. Because of these complex rules, the statistical authorities, at that time, decided not to account for electricity tariff hikes due to the rationing in the inflation index (IPCA), given the complexity of the calculations involved. However, we believe the secondary impact of raising electricity tariff will have a clear impact on inflation, mainly because it will represent a general cost production increase. In this case, we see monetary conditions should be maintained tight in order to minimize the secondary impact of a tariff hike on inflation. However, we also see that tariff hike impact on GDP growth could be very significant. We believe that the monetary policy decision will be biased in favor of the economic activity level; consequently, we expect the Selic rate to be cut throughout 2016.

In terms of economic activity, we estimate that a rationing in the 5-10% range could reduce GDP growth in 12 months by 0.6-2.0 p.p. If a bear-case scenario materializes the economic segment most affected by electricity rationing could be (1) mining, (2) manufacturing, (3) civil construction, and (4) utilities, followed by (5) retail, (6) transportation, and (7) financial institutional and service sector. We

reproduced the BCB model to measure the effect in GDP growth of electricity energy rationing adopted in 2001, in order to estimate the possible impact on GDP growth. In this approach, we ran a Generalized Method of Moments (GMM) model to measure the elasticity electricity consumption-output coefficient, controlling for “endogeneity” problems, which occur when the economic variables are mutually dependent, as in this case. In this exercise, we controlled the relationship between the electricity consumption and output (industrial or service production) using the real interest real ex-ant (1-year DI discounted inflation expectation 12 months ahead).

BCB model. As in the BCB model, we are taking into account that total capacity from the industrial segment for its own electricity consumption and the transfer of energy between sectors will determine the magnitude of the impact of rationing on the economic activity. We believe that different than 2001 “apagão”, we do not see the following factors: (a) the redirection of production to regions not affected by rationing; (b) the replacement capacity of energy sources; and (c) the rationalization of energy use, producing relevant gains in order to reduce the rationing needed. In our opinion the industrial sector has already been fully used it.

Other assumptions. According to Energy Research Bureau (EPE), the total capacity from the industrial segment for its own electricity consumption is around 22.7%. We adopted the assumption of full transfer of energy among sectors in some of our exercises. In these cases, the transfer of energy among sectors represents a significant reduction in the magnitude that GDP growth could be affected by the electricity rationing.

What If “tariff realism” is adopted? This allows less severe rationing measures to be implemented. In the event that tariff adjustments occur early this year (as per Discos request), and not in the regular annual readjustment date of each Disco, a voluntary reduction of electricity consumption could be promoted, mainly due to the magnitude of the tariff hike, which we estimate to be around 30%. We believe an early tariff adjustment would be a positive sign from regulator—corroborating a positive stance from Aneel in relation to the sector, the regulatory agency announced on February 2 a new proposal for regulatory WACC that is higher than previous proposal, and thus more in-line with market parameters. Moreover, we believe the 5% rationing scenario would be the most probable to be adopted if tariff realism hike is put in place.

Figure 4. Overall GDP Growth Sensitivity to Different Rationing Scenarios (5% rationing)

GDP Impact (with Weight on energy transfer GDP Impact GDP among sectors) Industry 21.2% -0.2% -0.4% Extractive 3.5% 0.0% -0.1% Manufacturing 11.1% -0.1% -0.2% Civil Construction 4.6% -0.1% -0.1% Eletricity (distribution and production), gas and water 2.0% 0.0% 0.0%

Retail 10.8% -0.2% -0.3% Transportation, storage and mail 4.5% -0.1% -0.1% Finance services 5.9% -0.1% -0.2%

Total GDP -0.6% -1.0% Sources: IBGE and Santander estimates.

Figure 5. Overall GDP Growth Sensitivity to Different Rationing Scenarios (10% rationing)

GDP Impact (with Weight on energy transfer GDP Impact GDP among sectors) Industry 21.2% -0.5% -0.8% Extractive 3.5% -0.1% -0.2% Manufacturing 11.1% -0.2% -0.4% Civil Construction 4.6% -0.1% -0.2% Eletricity (distribution and production), gas and water 2.0% -0.1% -0.1%

Retail 10.8% -0.4% -0.6% Transportation, storage and mail 4.5% -0.1% -0.2% Finance services 5.9% -0.2% -0.3%

Total GDP -1.2% -2.0% Sources: IBGE and Santander estimates.

SANTANDER COVERAGE UNIVERSE POTENTIAL IMPACTS The current energy issue in Brazil will, in our view, negatively affect overall business in the country, either through: (1) lower consumer and business confidence; (2) lower margins, based on higher energy prices (spot in the short term, and contract renewals, as the calendar advances); and (3) lower output if (our bear case) a rationing occurs. In order to properly address the energy issue we show the possible scenarios:

• No rationing occurs, whereas the spot prices should continue to be high: In this scenario, we probably would see a negative impact on heavy electricity users exposed to the spot market. We do not see any company in our coverage universe as heavily exposed to the spot market, with the majority of companies being contracted throughout 2015. We do expect a negative impact on overall consumer demand as a result of the probable negative impact that the headlines may have on consumer confidence.

• Rationing occurs: In this scenario we believe that the least affected sectors will be:(1) asset-light services related: banks and other financials; (2) self-sufficient energy users exposed to foreign or less-cyclical demand: (a) pulp producers; (b) agribusiness; and (3) defensive names: healthcare.

If rationing occurs, we believe that the sectors that will be less affected will be: asset-light service- related such as banks and other financials (Itau, Bradesco, BB Seguridade, and Cielo) and self- sufficient energy users exposed to foreign or noncyclical demand: pulp producers (Fibria and Suzano); agribusiness (Sao Martinho and Cosan); defensive names such as healthcare (Qualicorp).

In the rationing scenario, we see sectors short energy (not self-sufficient) and with cyclical or energy rationing exposed demand as the most negatively affected. We highlight: (1) steel (Usiminas and Gerdau); (2) industrials (capital goods and Duratex) overall—the stocks most exposed to a potential energy shortage Mahle and Randon (higher share of production in Brazil). We also note that Mahle has 40% of energy needs being rolled over in 2015; and (4) looking at historical data, during 2001’s energy rationing, appliances declined on average by 3.7% while apparel grew only 0.5% in nominal terms.

Looking at our recommended portfolio, we screen names corresponding to the above-mentioned features that should be less negatively impacted by the current energy issue in Brazil, which we highlight in the following figure.

Figure 6. Brazil Equity Strategy Recommended Portfolio—Less Negatively Impacted Stocks Self-sufficient

Less-Cyclical Company Sector Services Related Foreign Demand Defensive Demand (Locally) BB Seguridade Financial Others X X Cielo Financial Others X X

Itau Banks X

Bradesco Banks X Kroton Education X

Qualicorp Healthcare X X Cosan Agribusiness X X Not in our recommended portfolio

Fibria Pulp and Forest Products X

Suzano Pulp and Forest Products X São Martinho Agribusiness X X

Source: Santander estimates.

Figure 7. Water Self-Sufficient Companies in Our Coverage Universe

Ticker Sector Self-sufficient?

Cosan Agribusiness Yes

Sao Martinho Agribusiness Yes

Queiroz Galvao EP Oil &Gas Yes Fibria Pulp & Forest Products Yes

Suzano Pulp & Forest Products Yes CSN Steel Yes

Source: Santander estimates.

Figure 8. Brazilian Coverage Universe—Exposure to Energy Shortage Scenario

Heavy Exposure to Electricity Blackout Company Electricity Self-sufficient? Exposure to Free Market Spot Market as a % of Scenario User? in 2015 (%) Cost Cosan Energia Neutral Yes Yes 0% 0% NA São Martinho Neutral Yes Yes 0% 0% NA Randon Group: 100% until 2016 (renewal Fras-le Negative No No costs may go up by up to 12% in 2016's 0% 0.6% roll over). ~5% (Possibly 40% being rolled over in 2015 (~@ R$300 higher as Mahle Metal MWh). Still to be decided if the whole 40% Negative No No 0% contracts Leve will be contracted of if there will be are still exposure to the spot market. being rolled) Iochpe Maxion Negative No No Mostly contracted for 2015. ~0% 3.0% 100% Contracted until 2017 (~@ R$150 Marcopolo Negative No No 0% 0.5% MW/h) Randon Group: 100% until 2016 (renewal costs may go up by up to 12% in 2016's Randon Negative No No 0% 0.6% roll over). Castertech fully contracted until 2018. Romi Negative No No 85% Contracted until 2017. 15% 2.9% 100% contracted for 2015. 95% contracted WEG Negative No No 0% 1.8% for 2016. Kroton Neutral No No 0% 0% 1.5% Banco do Brasil Neutral No No NA NA NA Bradesco Neutral No No NA NA NA Itausa Neutral No No NA NA NA Itaú Unibanco Neutral No No NA NA NA Banco Pine Neutral No No NA NA NA Brasil Insurance Neutral No No NA NA NA BM&F Bovespa Neutral No No NA NA NA Cielo Neutral No No NA NA NA Cetip Neutral No No NA NA NA Multiplus Neutral No No NA NA NA Porto Seguro Neutral No No NA NA NA Sul America Neutral No No NA NA NA Ambev Negative No No NA NA NA Minerva NA No NA NA NA NA No, but BRF started to develop Brasil Foods Negative No NA NA NA biomass and photovoltaic projects. Fleury Neutral No No 0% 0% 1.6% OdontoPrev Neutral No No 0% 0% 1.3% Qualicorp Neutral No No 0% 0% 0.9% Cyrela Brazil Neutral No No NA 100% NA Realty Even Neutral No No NA 100% NA EZTec Neutral No No NA 100% NA MRV Neutral No No NA 100% NA Engenharia PDG Realty Neutral No No NA 100% NA Rodobens Neutral No No NA 100% NA Tecnisa Neutral No No NA 100% NA BR Malls Neutral No No 100% 0% NA BR Properties Neutral No No 100% 0% NA Iguatemi Neutral No No 100% 0% NA Multiplan Neutral No No 100% 0% NA Magnesita Neutral No No 100% 0% 3.5% Vale Neutral No No 100% 0% 2.5% Braskem Negative Yes No 8% 8%* 2.8% Petrobras Negative No Yes 0% NA 1.0% Queiroz Galvão Neutral No Yes 0% NA NA E&P Ultrapar Negative No Yes 0% NA 0.2% Duratex Negative No No 95% 5% 6.0% Fibria Neutral Yes Yes 0% 0% NA Klabin Neutral Yes No 100% 0% 6.0% Suzano Neutral Yes Yes 0% 0% NA B2W Digital Negative No No NA NA NA

*Estimated. NA: Not available. Sources: Company data and Santander estimates.

Figure 8. Brazilian Coverage Universe—Exposure to Energy Shortage Scenario Continued

Heavy Exposure to Blackout Electricity as Company Electricity Self-sufficient? Exposure to Free Market Spot Market Scenario a % of Cost User? in 2015 (%) Partially. Stores in malls and Cia Hering Neutral No production facility have generators NA NA NA (street stores don't). IMC Neutral No No NA NA NA Lojas Americanas Neutral No No NA NA NA Over 90% of stores in malls Lojas Renner Neutral No NA NA NA (generator). Partially. The company has biomass Natura Negative No and ethanol boilers to help the NA NA NA production. Partially. Some stores have a 1.5% CBD Neutral No NA NA generator. (supermarkets) CSN Neutral Yes Yes 0% 0% 7.0% Gerdau Negative Yes No 100% 0% 5.0% Usiminas Negative Yes No 100% 0% 75.0% Linx Neutral No No 0% 0% 2.0% Positivo Neutral No No 0% 0% 3.0% Informatica Totvs Neutral No No 0% 0% 2.0% ALL Neutral No No NA NA NA Arteris Neutral No No NA NA NA CCR Neutral No No NA NA NA Ecorodovias Neutral No No NA NA NA Embraer Neutral No No NA NA NA Gol Neutral No No NA NA NA JSL Neutral No No NA NA NA Localiza Neutral No No NA NA NA Santos Brasil Neutral No No NA NA NA Tegma Neutral No No NA NA NA Anima Educação Neutral No No 0% 0% 2.8% Estácio Neutral No No 0% 0% 0.7% Ser Educacional Neutral No No 0% 0% 2.1% Saraiva Neutral No No 0% 0% 1.0% Partially. Some stores in malls Raia Drogasil Neutral No NA NA NA (generator). Most of the stores in malls Restoque Neutral No NA NA NA (generator). Partially. Some stores and malls Via Varejo Neutral No NA NA NA (generator). Hypermarcas Negative No No NA NA NA

Sources: Company data and Santander estimates.

Figure 9. Brazilian Coverage Universe—Exposure to Energy Shortage Scenario: Utilities Sector Company Blackout Scenario Why? Cesp Negative Fully hydro, rationing imply lower volumes sold (contracts).(but could be better than large hydro deficit) Initially, industries can focus on gas usage, in case they have this option; but lower volumes (industrial) and residential Comgas Neutral/Negative segments. Cemig Negative DISCO, NEUTRAL/NEGATIVE. TRANSCO NEUTRAL; GENCO, NEGATIVE. CPFL Energia Neutral/Negative DISCOS NEUTRAL/NEGATIVE. Lose volumes in long term, but holds regulatory revision Copasa Neutral Water utilities, no impact from power shortage Eletrobras Negative DISCO, NEUTRAL/NEGATIVE. TRANSCO NEUTRAL; GENCO, NEGATIVE. Eletropaulo Neutral/Negative DISCOS NEUTRAL/NEGATIVE. Lose volumes in long term, but holds regulatory revision Equatorial Neutral/Negative DISCOS NEUTRAL/NEGATIVE. Lose volumes in long term, but holds regulatory revision AES Tiete Negative Fully hydro, rationing imply lower volumes sold (contracts).(but could be better than large hydro deficit) Light Neutral/Negative DISCOS NEUTRAL/NEGATIVE. Lose volumes in long term, but holds regulatory revision Renova Energia Neutral Renewable, connected to the system, could increase effective generation and have some positive impact long term. Sabesp Neutral Water utilities, no impact TAESA Neutral Transco, not impacted Tractebel Negative Rationing imply lower volumes sold (but could be better than large hydro deficit) Transmissão Paulista Neutral Transco, not impacted Alupar Neutral Biggest part of the business is transmission. So there is almost no impact

Sources: Company data and Santander estimates.

Companies Mentioned Company Ticker Rating Current Price (R$) Usiminas USIM5 Underperform 3.48 Gerdau GGBR4 Buy 9.44 Duratex DTEX3 Hold 7.66 Mahle Metal Leve LEVE3 Buy 20.8 Randon RAPT4 Buy 3.92 WEG WEGE3 Hold 32.57 Itau ITUB4 Buy 33.32 Bradesco BBDC4 Buy 34.08 BB Seguridade BBSE3 Buy 30.00 Cielo CIEL3 Buy 40.03 Fibria FIBR3 Underperform 32.86 São Martinho SMTO3 Buy 34.00 Cosan CSAN3 Buy 25.03 Qualicorp QUAL3 Buy 26.80 Source:Santander.

IMPORTANT DISCLOSURES

Key to Investment Codes % of % of Companies Provided Companies Investment Banking Covered with Services in the Past 12 Rating Definition This Rating Months Buy (B) Expected to outperform the local market benchmark by more than 10%. 46.97 8.71 Hold (H) Expected to perform within a range of 0% to 10% above the local market benchmark. 45.45 7.58 Underperform Expected to underperform the local market benchmark. 7.58 0.76 Under Review (U/R) 0.00 0.00 The numbers above reflect our Latin American universe as of Wednesday, February 04, 2015.

For a discussion, if applicable, of the valuation methods used to determine the price targets included in this report and the risks to achieving these targets, please refer to the latest published research on these stocks. Research is available through your sales representative and other electronic systems. Target prices are year-end 2015 unless otherwise specified. Recommendations are based on a total return basis (expected share price appreciation + prospective dividend yield) unless otherwise specified. Stock price charts and rating histories for companies discussed in this report are also available by written request to Santander Investment Securities Inc., 45 East 53rd Street, 17th Floor (Attn: Research Disclosures), New York, NY 10022 USA. Ratings are established when the firm sets a target price and/or when maintaining or reiterating the rating. Ratings may not coincide with the above methodology due to price volatility. Management reserves the right to maintain or to modify ratings on any specific stock and will disclose this in the report when it occurs. Valuation methodologies vary from stock to stock, analyst to analyst, and country to country. Any investment in Latin American equities is, by its nature, risky. A full discussion of valuation methodology and risks related to achieving the target price of the subject security is included in the body of this report. The benchmark used for local market performance is the country risk of each country plus the 1-year U.S. Treasury yield plus 5.5% of equity risk premium, unless otherwise specified. The benchmark plus the 10.0% differential used to determine the rating is time adjusted to make it comparable with the total return of the stock over the same period. For additional information about our rating methodology, please call (212) 350 3974. This research report (“report”) has been prepared by Santander Investment Securities Inc. ("SIS"; SIS is a subsidiary of Santander Investment I, S.A. which is wholly owned by Banco Santander, S.A. "Santander"]) on behalf of itself and its affiliates (collectively, Grupo Santander) and is provided for information purposes only. This report must not be considered as an offer to sell or a solicitation of an offer to buy any relevant securities (i.e., securities mentioned herein or of the same issuer and/or options, warrants, or rights with respect to or interests in any such securities). Any decision by the recipient to buy or to sell should be based on publicly available information on the related security and, where appropriate, should take into account the content of the related prospectus filed with and available from the entity governing the related market and the company issuing the security. This report is issued in Spain by Santander Investment Bolsa, Sociedad de Valores, S.A. (“Santander Investment Bolsa”) and in the United Kingdom by Banco Santander, S.A., London Branch. Santander London is authorized by the Bank of Spain. This report is not being issued to private customers. SIS, Santander London and Santander Investment Bolsa are members of Grupo Santander. The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed, that their recommendations reflect solely and exclusively their personal opinions, and that such opinions were prepared in an independent and autonomous manner, including as regards the institution to which they are linked, and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report, since their compensation and the compensation system applying to Grupo Santander and any of its affiliates is not pegged to the pricing of any of the securities issued by the companies evaluated in the report, or to the income arising from the businesses and financial transactions carried out by Grupo Santander and any of its affiliates: Tatiana Pinheiro*, Maria Carolina Carneiro*, Fernanda Consorte*, Daniel Gewehr* and Joao Noronha, CFA*. As per the requirements of the Brazilian CVM, the following analysts hereby certify that we do not maintain a relationship with any individual working for the companies whose securities were evaluated in the disclosed report. That we do not own, directly or indirectly, securities issued by the company evaluated. That we are not involved in the acquisition, disposal and intermediation of such securities on the market: Tatiana Pinheiro, Maria Carolina Carneiro, Fernanda Consorte, Daniel Gewehr and Joao Noronha. Grupo Santander receives non-investment banking revenue from Alupar, Ambev, B2W Digital, Banco do Brasil, Banco Pine, BM&F Bovespa, BR Malls, BR Properties, Bradesco, Brasil Foods, Brasil Insurance, Braskem, CBD, CCR, Cemig, Cesp, Cetip, Cia Hering, Cielo, Comgas, Copasa, Cosan Energia, Cosan Limited, CPFL Energia, CSN, Cyrela Brazil Realty, Duratex, Eletrobras, Eletropaulo, Embraer, Equatorial, Fleury, Gerdau, Gol, Hypermarcas, Iguatemi, IMC, Iochpe Maxion, Itausa, Itaú Unibanco, Klabin, Light, Localiza, Lojas Americanas, Lojas Renner, Magnesita, Mahle Metal Leve, Marcopolo, Minerva, MRV Engenharia, Multiplan, Natura, OdontoPrev, PDG Realty, Petrobras, Porto Seguro, Positivo Informatica, Qualicorp, Raia Drogasil, Randon, Renova Energia, Rodobens, Romi, Sabesp, Santos Brasil, Saraiva, Sul America, Suzano, São Martinho, TAESA, Tecnisa, Tegma, Totvs, Tractebel, Ultrapar, Usiminas, Vale, and WEG. Within the past 12 months, Grupo Santander has managed or co-managed a public offering of securities of Arteris, Banco do Brasil, Banco Pine, Brasil Foods, Cetip, Gerdau, Gol, JSL, Lojas Renner, Minerva, Multiplan, Petrobras, Positivo Informatica, Sabesp, Usiminas, and Via Varejo. Within the past 12 months, Grupo Santander has received compensation for investment banking services from ALL, Anima Educação, Arteris, Banco do Brasil, Banco Pine, Brasil Foods, Braskem, Cemig, Cetip, Eletrobras, Estácio, Gerdau, Gol, IMC, JSL, Lojas Renner, Minerva, Multiplan, Positivo Informatica, Sabesp, São Martinho, Usiminas, and Via Varejo In the next three months, Grupo Santander expects to receive or intends to seek compensation for investment banking services from Braskem, Cosan Energia, Renova Energia, Vale, and Via Varejo. Grupo Santander or its affiliates beneficially own 1% or more of any class of common equity securities of BR Properties, Cesp, Renova Energia, and TAESA. Santander or its affiliates and the securities investment clubs, portfolios and funds managed by them do not have any direct or indirect ownership interest equal to or higher than one percent (1%) of the capital stock of any of the companies whose securities were evaluated in this report (with the exception of BR Properties, Cesp, Renova Energia, and TAESA ) and are not involved in the acquisition, disposal and intermediation of such securities on the market. The information contained within this report has been compiled from sources believed to be reliable. Although all reasonable care has been taken to ensure the information contained within these reports is not untrue or misleading, we make no representation that such information is accurate or complete and it should not be relied upon as such. All opinions and estimates included within this report constitute our judgment as of the date of the report and are subject to change without notice. From time to time, Grupo Santander and/or any of its officers or directors may have a long or short position in, or otherwise be directly or indirectly interested in, the securities, options, rights or warrants of companies mentioned herein. Any U.S. recipient of this report (other than a registered broker-dealer or a bank acting in a broker-dealer capacity) that would like to effect any transaction in any security discussed herein should contact and place orders in the United States with SIS, which, without in any way limiting the foregoing, accepts responsibility (solely for purposes of and within the meaning of Rule 15a-6 under the U.S. Securities Exchange Act of 1934) for this report and its dissemination in the United States.

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