We were interested in finding out what issues led to Zacks senior Latin American markets analyst Claudio Freitas, CFA to downgrade shares of Chilean utility company Enersis S.A. (ENI), so we checked his most recent update:

We are changing our recommendation on Enersis from Buy to Hold. The outlook for the electric utility industry in South America remains promising in the short-to-medium term, thanks to the continued improvement in the local economic environment. Nevertheless, we considered second quarter 2007 results disappointing.

We remain concerned with higher natural gas prices, export restrictions from the Argentine government and the extensive use of more expensive alternative fuels. Our current six-month target price is $17.50.

It is important to understand that three Chilean accounting rules underestimate the company's earnings. The first distortion is explained by the rule that determines that foreign fixed assets should be carried at historical US$ values. Most of Enersis international acquisitions were made during the 1990's, before the devaluation of many Latin American currencies; as a result of this distortion, depreciation remains high.

Additionally, the Chilean legislation also determines that all Chilean domestic fixed assets must be adjusted by inflation every period, increasing the book value of the fixed assets and increasing depreciation. This rule reduces net income. The last rule determines that international fixed assets should be carried at historical US$ value, while international financial assets and liabilities must be carried at the currency in which they were originally denominated. Since most of the Latin American currencies have been appreciating against the U.S. dollar, the local liabilities represent a loss while the fixed assets remain at the same level.