Companhia de Saneamento Basico do Estado de Sao Paulo SABESP

BOVESPA:SBSP3

Earnings Call Transcript 2017-Q4

[Operator]

Good afternoon, ladies and gentlemen. At this time, we would like to welcome everyone to SABESP's Conference Call to discuss its results for the full year of 2017. The audio for this conference is being broadcast simultaneously through the Internet on the website, www.sabesp.com.br, and on the MCIQ platform, where you can also find a slide show presentation available for download. [Operator Instructions]

Before proceeding, let me mention that forward-looking statements are being made under the safe harbor of the Securities Litigation Reform Act of 1996. Forward-looking statements are based on the beliefs and assumptions of SABESP's management and on information currently available to the company. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions because they relate to future events, and therefore, depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of SABESP and could cause results to differ materially from those expressed in such forward-looking statements. Today with us, we have Jerson Kelman, CEO; Rui Affonso, Chief Financial Officer and Investor Relations Officer; Mario Arruda Sampaio, Head of Capital Market and Investor Relations; Sílvio Xavier, Head of Costs and Tariffs; and Marcelo Miyagui, Head of Accounting. Please note this event is being recorded. Now I'll turn the conference over to Mario Sampaio. Sir, you may begin your conference.

[Mario Arruda Sampaio, executive]

Okay. Thank you, and welcome, everybody. We would like to thank you for participating of our teleconference to discuss the results of 2017. And we will also update you on the tariff review and comment on the hydrological condition. We have a 8-slide presentation. And as usual, after this we will go to our question-and-answer session. So let's move to Slide 3. Here, we can see the company's billed water and sewage volume, which was up 4.3% in 2017, with an increase of 4.3% in water and 4.2% in sewage. Despite the awareness of part of the population with incorporation of rationale consumption habits acquired during the water crisis, the largest growth volume occurred mostly in the residential sector and in the industrial sector. The decline in consumption can be explained mostly by a small or low growth economy. On the slide, you may also note that billed water volume has been rising since the third quarter of 2015, among the main factors that contributed to this increase in volume, we highlight the increase in the number of water and sewage connections, a rise in the volume billed to the wholesale market, and a slight increase in average consumption. So let's now move to Slide 4. This is where we comment on our financial results. Revenue was impacted by a number of factors such as the growth in billed volume, already commented; the tariff adjustment of 8.4% in 2016; and the tariff repositioning or the preliminary tariff review of 7.88%. And this also added 0.5% of the pass-through of ARSESP's regulation, control and inspection fee, which is also in place since last November. We should also remember that this -- that there was an intense work with the regulator, with ARSESP, in the first stage of the second ordinary tariff review. And although the increase of 7.88% had a small impact in 2017 as it came fairly closer to then, it will have certainly a relevant effect on revenues on the year 2018. It's also worth mentioning the lower recognition of estimated loss with wholesale revenue in 2017. This added BRL 225 million, and it was due mostly to receipts -- receivables from the wholesale, but mainly from the municipality of Guarulhos. The operating revenue related to rendering sanitation services and the amount of -- added to the amount of BRL 12.2 billion. This does not considered construction revenue, in this case showed an increase of BRL 1.1 billion or 9.9% when compared to BRL 11.1 billion total in 2016. Net operating revenue increased by 3.6% or BRL 510 million. As for cost in 2017 was a decrease of 0.3% when considering administrative and commercial expenses and construction costs, much less in comparison to the 9.9% increase in gross revenue. Excluding construction costs and non-recurring revenues arising from pension fund migration from the defined benefit plan to the defined contribution plan in 2016, this in the amount of BRL 207 million. So was a 3.2% increase in costs, still well below gross revenues -- revenue growth at 9.9%.

As a consequence of the aforementioned variations, adjusted EBITDA reached by BRL 5.3 billion. This is an increase of 15.3% and compared -- much more compared to the BRL 4.6 billion reported in 2016. The adjusted EBITDA margins for '17 was 36.1% compared to 32.4% in 2016. If we exclude the effect of revenue construction costs, adjusted EBITDA margin resulted in 45.4% in '17 against 43.3% in '16. Also in '17, reported profit was BRL 2.5 billion against a profit of BRL 2.9 billion presented in 2016. Let's move on to Slide 5. And let's comment on the main variations in the year -- or cost variations in the year '17. As discussed in the previous slide, compared to '16 costs, administrative and commercial expenses and construction costs decreased by BRL 31.4 million or up to -- or about 0.3%. If we exclude construction costs and expenses, the increase was in the order of BRL 540 million or 7.7%. The items that presented significant growth were salaries, benefits and Social Security obligations with a close to 20% variation; depreciation and amortization with a growth of 13.5%; and general expenses with an increase of 8.6%.

With regards to salaries, benefits and Social Security obligation, we should note that of the BRL 533 million total amount, BRL 307 million refers to the revenue recognized in 2016 related to the anticipated reduction of the actuarial deficit as a result of the migration of participants from the defined-benefit plan to the defined contribution plan, something that we have already highlighted previously. It is worth noting the decrease of also -- it is also worth noting the decrease of 14.9% in electricity due to the average reduction of, and this is important, 12.7% reduction in the free contracting environment tariffs. This compensated in part by a close to 17% increase in consumption in this category; 27.5% reduction in the distribution system rates, but compensated in part by an increase of close, again, to 20% in consumption and 5.3% reduction in regulated contracting environment tariffs. But in this case, there was a leverage because there was a decrease of 5.7% in the consumption. In general expenses, we highlight the increase of BRL 7.3 million related to the agreement signed with EMAE on October 28, 2016. This is a non-recurring item of expenses, which puts an end to all the existing actions between the 2 companies, whose suspension clause were fulfilled on October 19, 2017. For more details on the variations of our costs, please always refer to our press release results. Let's move on to Slide 6, and comment on the main variations that affected our net income. In this case, this is always in comparison with the same period of 2016. Net income, as already mentioned, was BRL 2.5 billion. Net operating revenues increased BRL 510 million. Costs and expenses added to construction costs decreased by BRL 31.4 million. Other operating income and expenses decreased by BRL 9.3 million. Financial expenses increased by BRL 1.16 billion, mainly as a result of the BRL 1.18 billion increase in exchange variation on loans and financing. This is mostly due to the appreciation of the dollar and the yen against the real in 2017 with 1.5 and 5.3 percentage respectively. And this compared to a devaluation in 2016 of 16.5% and 13.9%, same thing, in terms of dollars and yen respectively.

Income tax and social contribution decreased close to BRL 200 million. This is due to lower taxable results presented in the period; also mainly impacted by the appreciation of the dollar and the yen against the real in 2017, once more compared to the devaluation in 2016. What is really important to emphasize is that the operating results was the main driver for this year's profit. And contrary to 2016, 2017 profit was not favored by the impact of exchange variation. Let's go to Slide 7. Here we will briefly discuss the situation of the reservoirs that supply the Metro region of São Paulo. Rainfall in 2017-'18 hydrological year, which began last October, was below the historical leverage of [indiscernible] March 23. Until this day, the Cantareira received 78% of the expected volume; the Alto Tietê 72% and the Guarapiranga 69%. The Cantareira system, as you know the main system that supplies the Metro region of São Paulo, began the hydrological year of '17-'18 at 51.6% operational volume. That's equivalent to 506 billion liters of water and held on March 23, 533 billion liters of water or 54% of the operational volume. Looking at the Metro region of São Paulo integrated system. Today the total available volume, as you can see in this slide is practically the same that was observed last year for the same day. This volume accumulated and the startup of the São Lourenço Production System and the Jaguarí-Atibainha interconnection at the beginning of this year, about which we will comment in more details in the next slide, together with a lower water production due to the reduction in demand after the water crisis. The company understands that water security in the Metro region of São Paulo is short to say hydrological situations of similar magnitude as observed in the years of '14 and '15. Let's move to Slide 8. Let's comment on the water projects in the Metro region and give you more details on where they are. Let's start with the Jaguarí-Atibainha interconnection, which has an average pumping capacity of 5.13 cubic meters per second of water from the Jaguarí reservoir in the Paraíba do Sul water basin to the Atibainha reservoir in the Cantareira system. This investment is already in the preoperational phase and thus practically ready to provide more water for treatment in the Cantareira system if in case necessary.

The other important investment is the São Lourenço Production System. This will be inaugurated in the coming weeks representing close to 6.4 cubic meters per second in the water availability and the production capacity of the São Paulo Metro region. In fact, with this new system, the number of systems that are part of the Metro region integrated system rises to 9. So today we add these 2 new investments to those that were already made since 2015, there's an increase of 18 cubic meters per second in water availability and 7.4 cubic meters in the capacity to produce treated water. In addition, and also part of the initiative to increase water security in the Metro region, SABESP continues with the negotiations to begin the work of transposing Itapanhaú River that flows to the Atlantic to revert it to the Alto Tietê system, which will bring a further 2 cubic meters per second of water availability. In this case, the expectation is that the beginning of the work will occur in 2018 and the conclusion and operation in 2019. Let's go to the slides on investments. Here we will comment on the investments we made in '17 and the investments plan for the period of '18 to '22. In '17, investments totaled BRL 3.4 billion, of which BRL 1.4 billion were investments with no cash effect for SABESP such as the São Lourenço water system, which was made under a PPP contract. And the approximate value -- amount, sorry, of BRL 900 million. It should be noted that the estimated CapEx value of BRL 2.3 billion for the year of 2017, when we announced as much as the one we're announcing now, did not include investments without effect on the company's cash such as the São Lourenço project. For the period from '18 to '22, we expect to invest approximately BRL 7.3 billion (sic) [ BRL 17.3 billion ] of which BRL 7.1 billion in water and BRL 10.2 billion in sewage collection and treatment.

Regarding the investment mix in '17, 66% of the investments were made in water. However, considering that investments in water security expansion are almost concluded, the mix will change and the proportion of investments in sewage collection and treatment will return to precrisis levels such that by 2018, investments in sewage already will rise to 50% and will reach almost 75% by 2020. Let's go on to Slide 10. As you already are aware, ARSESP published on March 26, the Preliminary Technical Note number 004/2018 with the proposal of calculation of the maximum average tariff or the P0 for the second regular rate review of SABESP in Factor X, we call this the final stage. As well as it informed that the consultation period and the public hearing period -- and the public hearing will take place between March 27 and April 17. And the final date for the review continues in May 10. On the slide, we highlight the most relevant points of the proposal presented by the regulator for the final stage in relation to the preliminary stage, where the regulator, as you can see, establishes the value of the asset base at BRL 38.4 billion, therefore, lower than the preliminary one defined last October. It also defines value of the productivity factor in 0.9287%. It maintains the preliminary stage WACC at 8.11% per year and proposes a tariff reset of 4.7744% to be applied on top of current tariffs. Before entering into some of the specific points, we would like to emphasize that in our opinion, the tariff revision process of the second cycle shows improvement over the first cycle, among which we highlight the following: Improvement in transparency and technical quality of the technical notes; inclusion of the transfer of municipal funds; WACC value of 8.11%, still higher than the 8.06% in the first cycle; rates for uncollectible revenues of 1.3%, that is higher than the first cycle of 1.1%; and 6-year reduction in asset amortization period; and lower volume of asset-based write-offs.

However, this is important, it's necessary to deepen the discussion and clarification of the following points. Methodology and process affecting the X Factor, balance of gains and losses of the first cycle and... [Technical Difficulty]

[Operator]

We'll stay on the call and we'll join you to the speakers as soon as possible. Thank you for your patience I would now like to join you to the speakers.

[Mario Arruda Sampaio, executive]

Okay. May I continue? So let's start from Slide 10. I believe that's where we left. So we continue there. As you know, ARSESP published on March 26 Preliminary Technical Note 04/18 with the proposal for calculation of the maximum average tariff of the second rate review of SABESP and X Factor. That is the final stage now as well as they informed that the consultation period and the public hearing will take place between March 27 and April 17. And also just confirming the date for the final review, it continues on May 10. On this slide, we highlight the most relevant points of the proposal presented by the regulator for the final stage in relation for the preliminary stage, where as you can see, establishes the value of the asset base at BRL 38.4 billion. Therefore, lower than the preliminary one defined last October. We define the value of this productivity factor at 0.9287%. It maintains the preliminary stage WACC at 8.11% a year and proposals of tariff reset of 4.7744% to be applied on current tariffs. Before entering in some of these specific points here, we would like to emphasize that in our opinion the tariff revision process of the second cycle shows improvement over the first cycle. And among these, we would like to highlight the following: First, the improvement in transparency and technical quality of the technical notes; the inclusion of the transfer of municipal funds; the WACC value of 8.11% is still slightly higher, but still higher than the 8.06% in the first cycle; the rate for uncollectible revenues of 1.3%, that is higher than the first cycle of 1.1%; a 6-year reduction in asset amortization period; and WACC's lower volume of asset-based write-off. However, important to -- and necessary to deepen the discussion and clarify the following points of the technical note. First, the methodology of process of estimating the X Factor; the balance of gains and losses of the first cycle and preliminary review; the methodological inconsistency between OpEx and volume projection; calculation of the current established tariffs; the criterion for the movement of the asset base during the cycle; the change in water loss target levels in this agreement within methodology; the capital structure estimating methodology; and the initial asset base proposal of BRL 38.4 billion.

In fact in relation to this last point, there was a reduction of BRL 1.9 billion in the initial asset base of BRL 40.3 million. So to explain that -- to clarify this variation, we set up 2 tables that you can see at the bottom of the slide. The one in the left side, we analyze the variation in absolute terms, and on the right side the relative terms. Obviously, we will not comment line-by-line, but highlight some of them, some of the points, such as the value of asset write-offs, which was relatively small; the PPP values that are now treated at OpEx and not CapEx. And it's important to recall that PPPs in OpEx are amortized over a shorter term than they would have previously been amortized if they were in the asset base. The next point is the change in methodology for the incorporation of WACC in the asset base, which went from the moment there was a disbursement to this project to the moment the asset actually began operations. This methodological change had a negative impact with the rate of assets coming into operations in the second cycle with slower than the disbursement rate, something that we understand will be adjusted over this cycle. The second 2, the most important. One is the non-inclusion of working capital representing 33% of the total. And also the non-inclusion of assets associated to new municipalities we now operate such as Diadema, in this case representing 21% of the total. Now this pretty much finalizes what we comment on this slide. But before we go through to questions, we would like to comment on SABESP's corporate reorganization process. On March 11, we published a material fact stating that the Government of São Paulo received from a group of investors the lever for the potential acquisition of part of the shares which will owned by the Government of São Paulo to be issued by the parent company. And that the lever will be evaluated by the Board of Directors of the State Privatization program called CDPED, which is the body responsible for providing on the continuity and conditions for the formation of the holding company and corporate reorganization for SABESP. We also at the time informed that the transaction contemplated in the letter structured to record exclusively with the scope -- within the scope of the controlling company and will not affect in any ways the corporate control of SABESP, which will remain with the Government of São Paulo in a matter consistent with the legal provision. As to the identity of the investors and content of the said letter matter, they will keep -- they will be kept confidential in accordance with the rules applicable to the administrative procedures established by the CDPED for the full purpose of this operation. Since the publication of the material fact in March, there was no new and relevant fact that deserves to be informed to the market.

So this concludes this part of our meeting. And let's now move to the question-and-answer session.

[Operator]

[Operator Instructions] Since there appears to be no further questions, I would like to turn the conference back over to SABESP for any closing remarks.

[Mario Arruda Sampaio, executive]

Okay. Well, let's do this. If there is any question, maybe we'll hang in a little bit more to see if Lilyanna can get in. Just a couple, 1 or 2 minutes to see if there is anybody can. We will see if Lilyanna tries to get in. So we'll give you 1 or 2 more minutes. Okay, guys. It seems that there remains some difficulties here. But let's make sure of the following. If you have any questions and if you need any support, we are Investor Relation are available. Please let us know. We will get in contact as soon as possible and we're available for that. So thank you very much for your time and here we conclude our call. Thank you. Bye-bye.

[Operator]

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.