SABESP Offers Balanced Risk-Reward - Analyst Blog

On Apr 10, 2014, we issued an updated research report on Companhia de Saneamento Basico do Estado de São Paulo SBS or SABESP.

Long-Term Growth Prospects

SABESP's performance in the last 5 years has been impressive as evident by a nearly 194% increase in its share price. The company appears to be a long-term gainer, well positioned to reap benefits from economic developments in Brazil.

Over the 1995−2013 period, the company invested R$9.3 billion to improve its water production capacities and services and plans to spend 31% of the total capital expenditure planned (R$12.8 billion) for the 2014−2018 period. In 2009, the company started a 12-year Corporate Program for Reduction of Water Losses, which aims to achieve a billing water loss ratio of 18% by 2020 on an investment of R$5.9 billion. Until 2013, nearly R$1.5 billion was spent on the program. Additionally, the company intends to spend R$2.2 billion to improve its Sao Lourenco production system.

SABESP targets to achieve 100% water coverage ratio between 2013 and 2020 and add nearly 1.3 million new water connections. For sewage services, the company aims nearly 95% coverage ratio by adding 1.7 million new sewage connections by 2020. SABESP moved a step forward toward its goal after it signed a 30-year agreement to control the water and sewage services of Diadema in Aug 2013.  

Near-Term Headwinds

Rising expenses, potential losses from adverse movement of foreign currencies, governmental interference and dependence on electricity as a source of energy restrict the company's growth momentum.

Over the last 5 years, SABESP has recorded nearly 34% and 3% increase in its cost of sales and services and operating expenses (in local currency) respectively. Also, the company's mounting debt levels cloud our view.

Furthermore, SABESP's fourth-quarter 2013 results were not impressive. Net earnings were down 23% year over year despite a 4% increase in revenues in the quarter. Earnings per American Depository Receipt (ADR) were $0.38.

Conclusion

SABESP offers a balanced risk-reward profile and is expected to perform in line with the broader market in the next 6−12 months.  The water and sewage service provider presently has a $6.5 billion market capitalization and carries a Zacks Rank #4 (Sell).

Investors interested in the water supply utility industry can consider adding American States Water Co. AWR, Middlesex Water Co. MSEX and Connecticut Water Service Inc. CTWS to their portfolio. While American States Water and Middlesex Water hold a Zacks Rank #1 (Buy), Connecticut Water Service carries a Zacks Rank #2 (Buy).