SABESP's Growth Prospects Solid Amid Debt, Political Risks

We issued an updated research report on Companhia de Saneamento Basico do Estado de Sao Paulo (NYSE:SBS) or SABESP on Dec 29.

SABESP currently carries a Zacks Rank #3 (Hold). Its market capitalization is approximately $7.5 billion.

The stock’s earnings estimates for 2017 have been revised upward by one brokerage firm in the last 60 days while that for 2018 have been lowered by one. Currently, the Zacks Consensus Estimate stands at $1.12 for 2017 and $1.19 for 2018, representing growth of 12% and decline of 0.8% from their respective estimates 60 days ago.

Below we discuss why it is the time to hold on to the company’s stock now:

Factors Working in Favor of SABESP

Vast Customer Base a Boon: Going by number of customers served, SABESP is considered one of the largest water and sewage service providers in the world. It primarily serves in the Brazilian state of Sao Paulo, covering approximately 66% of the urban population and 366 municipalities out of the 645.

At third-quarter 2017 end, SABESP served nearly 24.9 million customers for water and 21.5 million for sewage, representing year-over-year growth of 1.2% and 1.9%, respectively. Its water and sewage connections were approximately 8.8 million and 7.2 million, respectively.

Growth Prospects Bright in the Long Run: Over the long term, we believe that rising Brazilian population will increase demand for water and sewage services, benefitting SABESP. By 2022, the company aims to add nearly 1 million new water connections and 1.3 million new sewage connections.

Also, the company has planned investments worth R$13.9 billion for 2017-2021. These include R$7.1 billion to be spent on water, R$5.4 billion on sewage collection and R$1.4 billion on sewage treatment. Also, per a 12-year Corporate Program for Reduction of Water Losses, which started in 2009, the company aims at achieving a water loss ratio of 18% by 2020.

Gains From Lower Costs, Favorable Exchange Variations: SABESP’s margin profile in the third quarter of 2017 benefitted from roughly 8.5% decline in operating costs and 46.8% fall in selling expenses. Gross margin in the quarter increased 180 basis points (bps) year over year while adjusted earnings before interest, tax, depreciation and amortization margin expanded 550 bps. Also, gains from exchange variations supported the company’s net income growth in the quarter. Such positives will further solidify the company’s margin profile.

Factors Working Against SABESP

Interference From Principal Shareholder: The government of Sao Paulo holds approximately 50.3% of SABESP’s share capital. This gives it the power to select the majority of members comprising the board of directors and senior management.

Lack of regulatory clarity or unwarranted delay in taking any decisions by the government may prove to be detrimental to the company’s financial health.

High Debt Level an Issue: Being a highly leverage company, SABESP is compelled to bear the financial burden arising from it. Exiting third-quarter 2017, the company’s long-term debt was approximately R$10.5 billion while its net debt to equity for the first nine months of 2017 was 0.6x.

We believe, if unchecked, such high debt levels can lead to increased financial obligations, posing serious threats to the company’s financial health. In this regard, its plans to fund roughly 26% of its R$13.9 billion investment plan for 2017 to 2021 through institutional financing is worth mentioning.

Fall in Construction Revenues: In the third quarter, the company’s net operating revenues (including the sales generated from construction business) decreased 5.6% year over year primarily due to 35.1% decline in construction revenues as a result of lower investments in municipalities served.

Continuance of such weaknesses in the quarters ahead might adversely impact SABESP’s top-line results.

Share Price Performance and Stocks to Consider

Since the release of third-quarter 2017 results, SABESP’s American Depositary Receipts yielded 16.8% return, outperforming 4% gain recorded by the industry.



Some better-ranked stocks in the industry are American States Water Company (NYSE:AWR) , The York Water Company (NASDAQ:YORW) and Global Water Resources, Inc. (NASDAQ:GWRS) . All these stocks carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here.

American States Water’s earnings estimates for 2017 and 2018 remained stable in the last 60 days. Also, the company pulled off an average positive earnings surprise of 10.58% in the last four quarters.

The York Water’s performance was better than expected in the third quarter of 2017, with a positive earnings surprise of 10.71%. Its earnings estimates for 2017 and 2018 improved in the last 60 days.

Global Water Resources’ earnings estimates for 2017 improved in the last 60 days while remained stable for 2018. Its financial performance in the last quarter was impressive, with earnings surpassing estimates by 50%.

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Companhia de saneamento Basico Do Estado De Sao Paulo - Sabesp (SBS): Free Stock Analysis Report

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