Companhia de Saneamento Basico do Estado de Sao Paulo SABESP

BOVESPA:SBSP3

Earnings Call Transcript 2019-Q4

[Operator]

Good afternoon, ladies and gentlemen. At this time, I would like to welcome everyone to SABESP's conference call to discuss its results for the year 2019. The audio for this conference is being broadcast simultaneously through the Internet on the website, http://www.sabesp.com.br, 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 Benedito Braga, Chief Executive Officer; Rui Affonso Chief Financial Officer and Investor Relations Officer; Mario Arruda Sampaio, Head of Capital Market and Investor Relations; Sylvio Xavier, Head of Costs and Tariffs; and Marcelo Miyagui, Head of Accounting. Now I'll turn the conference over to Mr. Braga. Sir, you may begin the conference call.

[Benedito Pinto Braga, executive]

Thank you. Thank you very much. Good morning, good afternoon or good evening to all of you around the world. We are very happy to present to you today the excellent results, the excellent economic and financial results of our company during the year 2019. Unfortunately, we are in a situation today in Brazil and all around the world with the coronavirus pandemic that is frightening people and impacting different sectors of the economy as well and health and the lives of people. SABESP is, as you will see, very strong at the beginning of this pandemic in São Paulo state and in Brazil. Our company is prepared to help the authorities in solving the problem of the pandemic because more and more people at the highest level of decision-making are understanding the relationship between sanitation and health. We have been speaking about sanitation and health for decades. And this time is when everybody understands even more clearly this very close relationship because without water security, clean water, safe water security for drinking purposes and for cleaning purposes that is essential during this pandemic, and for cleaning the streets, hospitals and all these important elements for facing this pandemic, it becomes more and more apparent. And with this, I would like to stress some of the good positions we have today in order to help the government of São Paulo and Brazil to improve this very difficult situation in the health sector. We, in the last year, had a very important profit of the company. We managed to bring in important municipality services in our business, namely Santo André with water and sewage and in Guarulhos with the sewage contract in the company. This has improved our EBITDA margin, as you will see with the presentation of Mario Sampaio in a moment. I would like as CEO of this company to stress to you that we are prepared to face this new crisis the same way we faced the water crisis that [ have weighed ] over us in 2014, 2015. SABESP has already a record of facing important crisis situations, and this one is not going to be different from the previous one. We're going to face it, and we're going to win. And with this, I would like to pass the floor to Mario Sampaio to present to you the excellent results, and you will appreciate how prepared we are to help the pandemic in the state of São Paulo.

[Mario Sampaio, executive]

Okay. Thank you, Mr. Braga. Let's start on Slide 3. Here, we will present the evolution of the billed volume. So the total volume billed in 2019, disregarding the volumes of the municipality of Guarulhos and Santo André, grew by 2.7%, 2.4% in water and 3.1% in sewage. When we include Guarulhos and Santo André, the volume billed shows a total growth of 3.5% with 0.2% in water and 7.7% in sewage. This is reflecting the migration of this municipality situation in which our company supplied water in the wholesale for the situation, whether we directly today provide water -- both water and sewage service, as I said, on a direct basis. In retail, excluding the effects of Guarulhos and Santo André, the greatest relative growth was observed in the public category, with an increase of 4.6%, followed by the 2.7% increase in the residential category, 2.4% in the commercial category and 1.7% at the industrial category. Let's move to Slide 4. We will here comment on our financial results. In 2019, our net income reached BRL 3.4 billion compared to a net income of BRL 2.8 billion in '18. This is an increase in our bottom line of 18.8%. This variation results from several factors. The most significant being the recognition of an extraordinary revenue resulting from the signing of the contract with the municipality of Santo André of BRL 1.3 billion and the financial result that varied positively by BRL 230.6 million. Net operating was BRL 18 billion compared to BRL 16.1 billion in '18, representing an increase of 11.9% (sic) [ 11.8% ]. If we disregard the effect of Santo André in 2019 and Guarulhos in '18, net operating revenue was BRL 16.7 billion in '19 and BRL 15.2 billion in '18, which shows an increase of 9.8%. Regarding costs, administrative and commercial expenses and construction costs, there was an increase of 12%, mainly in services, electricity, general expenses and depreciation and amortization. Adjusted EBITDA for '19 reached BRL 7.5 billion, an increase of 14.8% or BRL 970 million in relation to BRL 6.5 billion presented in 2018. The adjusted EBITDA margin in the year was 41.8% compared to 40.7% in the previous year. If we disregard the effects of revenue and construction costs, the EBITDA margin was 49.5% this year compared to 48.8% last year. Let's go to Slide 5. Here, we will highlight the main events that impacted the result in 2019. Let's start with the signing of a contract with the municipality of Santo André, which was undoubtedly the highest highlight event for the results presented this year of '19. The company signed an agreement with the municipality in July, starting operations in August. In the year, the net nonrecurring effect of this agreement, as we mentioned, was BRL 1.3 billion in revenue. The operation in the municipality is still recent. It needs adjustment and investment, but it already shows a consistent perspective. So far, the transition has been successful and indicates that the results tend to be less impacted by adequacy costs that we observed in Guarulhos. In '19, there was a retail revenue of BRL 140 million. After a full year of effective operations in Guarulhos, even though circumstances were more challenging than initially expected with approximately 1 million people affected by the water rotation and not 800,000 as initially forecasted, Guarulhos positively impacted the 2019 net result, BRL 230.7 million (sic) [ BRL 231.7 million ], with BRL 424.6 million in operating revenue and BRL 192.9 million in costs and expenses. In the period, there was also the adaptation to the legislation in force with the formalization of contracts with the municipality of São Bernardo do Campo and Guarujá, extending the provision of service for a period of 40 and 30 years, respectively. However, this fact led to the closing of lawsuits, which had an impact of BRL 85.4 million in the company expenses. We also can highlight the first full year of operation of the São Lourenço water production system, generating an additional expense of BRL 137.9 million compared to 2018 when the system did not operate the entire year -- actually, as of midyear, on. Another highlight was the reversal of the provision of the retired TAC in the amount of BRL 173 million in the salaries, charges and benefits and social security obligation. This is due to the filing of the TAC for the retirees. On October 11, 2019, the prosecutor responsible for this TAC recognized that its object was fully complied with and filed it. Let's go to Slide 6. We highlight here the main variations that impacted costs and expenses in '19. As already mentioned on the previous slides compared to the same period last year, costs, administrative, commercial and construction costs increased by BRL 1.3 billion or 12%. If we disregard construction costs, cost and administrative and selling expenses increased by BRL 1.2 billion or 14.3%. The main variations were BRL 387 million or 27.8% with depreciation and amortization, BRL 333.7 million or 22.6% with services, BRL 213.8 million or 22.2% with general expenses and BRL 183.5 million or 19% in electricity. In services, several factors contributed to the increase in expenses such as maintenance of water and sewage networks and connection expenses with employees assigned by the city of Guarulhos and Santo André plus water metering and delivery of bills. General expenses increased by 22% or BRL 213 million. This is mainly due to the increase in the provision for lawsuits, the termination of legal proceedings resulting from the signing with the municipality of São Bernardo do Campo and Guarujá and the greater provision for transfers to municipality sanitation funds. We also observed an increase in electricity expenses with the emphasis on the entry into operation of the Jaguari-Atibainha Interconnection and of the São Lourenço water system plus the start of operations in the municipality of Guarulhos. On the other hand, it's worth mentioning the reversion of the retired TAC, which we mentioned prior, with BRL 133 million -- BRL 173 million, sorry, positively affecting the accounts of salary, charges, benefits and social security obligations; also the decrease in expenses with estimated losses on settlement credits for doubtful accounts by 23.2% from BRL 166 million in '18 million to BRL 128 million in '19. Further breakdown of these and other charges -- changes in costs, please refer to our press release. Let's move on to Slide 7. Here, we summarize the variations that affected the company's net income in 2019 compared to '18. Net income, as already mentioned, was BRL 3.4 billion. Net operating revenue increased BRL 1.9 billion. Costs and expenses, including construction costs, increased by BRL 1.3 billion. Other operating income and expenses, including equity income, had a negative variation of BRL 50.2 million. Financial results varied positively by BRL 230 million. And finally, income tax and social contribution, which grew by BRL 233 million due to the higher taxable income presented in 2019. To move in the next 3 slides, we would like to share with you a brief analysis of 3 management performance indicators, which is specifically -- which are more specifically that of the gross revenue per cubic meter, operating expenses per cubic meter and EBITDA per cubic meter billed. For this analysis, we used the historical series since 2014 of quarterly accounting data released by the company. Additionally, we made some adjustments to isolate some extraordinary and relevant events that would distort the result. Additionally, in order to look at the performance in the period on the same basis, we have brought all figures at average prices for the fourth quarter of 2019, updated by the IPCA, which is our inflation index.

Our objective with this approach is to look at the company's performance through indicators over time and on the same price basis and not in nominal values which -- quarter-by-quarter where specific events may lead to comparison basis as well impose difficulties in analyzing the company's evolution and performance over time. As you can see in the graph, gross revenue shows a consistent favorable evolution in relation to operating expenses. It's clear that it evolves in a controlled manner, and it's compatible with the expansion of our business in the period as a result certainly of disciplined cost management. Finally, as a result in large part of the behavior of gross revenue and operating expenses, we see a very consistent growth in EBITDA per cubic meter. Let's go to Slide 11. We would like to briefly highlight some points that we consider positive in 2019 and comment on how the company is facing the crisis generated by the COVID-19 pandemic and its impacts on activity -- economic activity and certainly complementing what -- Mr. Braga's speech at the beginning of the call. So first, we highlight net income of BRL 3.4 billion in fiscal year '19, which complemented by BRL 2.1 billion in new financing, supported investments of approximately BRL 5.1 billion. The company's performance in '19 was also marked by the significant expansion of its market, about 2.5 million people were added to the population served directly when we add the populations of Santo André, Guarulhos population growth. The incorporation of these municipalities last year as well as São Bernardo do Campo and Diadema in the past represents a historic change in delinquency of wholesale and with wholesale customers. In 2019, the company also regularized and added new contracts to its operated base. The number of contracts increased from 307 to 324 and its share in total revenue increased from 84.8% to 92.2%, what brings more strength to our cash flow. Moving on to Slide 12. The company's achievements in recent years with the implementation of new water production systems and expansion of connections between bulk water sources that serve the metro region of São Paulo consolidated in '20 a more favorable water situation to face the pandemic crisis compared to the existing conditions when facing the 2014 and '15 water crisis. Our current water production capacity in the metro region of São Paulo is 12% higher due to the addition of the São Lourenço Production System with a production capacity of 6.4 cubic meters per second of water and sufficient to meet 10% of the current water demand in the region. Transfers between water sources increased 163% and between distribution system over 300%, further increasing the water security in the region. At the same time, water storage capacity grew by 8%, and this does not include the Cantareira technical reserves. At the same time, the supply resilience in the metro region São Paulo has increased. Production demand fell from 69.1 cubic meters in 2013 to 62.6 cubic meters in December '19, but currently, we work with an average production level of 65 cubic meter, still below what we saw in '13. On the availability side, we also improved. In October '13, the volume of reservoirs in the metro region São Paulo amounted to 52% against 77% today. In other words, the company is better positioned to meet greater demand arising from the pandemic caused by the COVID-19. On the financial side, the 2019 results also puts us in a better position to face the situation of the first quarter of '20, marked by the very high uncertainty and volatility of the economy. We ended 2013 with EBITDA margin of 44.6% compared to 52.2% in December 2019. The total debt over EBITDA and the net debt over EBITDA covenants before the water crisis were 2.32x and 1.91x, respectively, against 1.7x and 1.45x in December '19, this is also respectively. As for foreign exchange exposure, at the end of 2013, it was 39.1% against 48% December last year. Despite the dollar value of the external -- despite that, the dollar value of the external debt remained at the same level, that is, in 2013, it was equivalent to [ BRL 1.579 billion ], and now in '19, it is [ BRL 1.78 billion ], yet the dollar estimated to exceed the total debt to EBITDA covenant in '13 was 5 in December with the dollar of 2, while in 2019, the break in dollar would be 13 with the dollar in December at 19 -- sorry, with the dollar in December of 4.03. The actions aimed at reducing the foreign exchange exposure defined last year and commented in our third quarter call remain a priority of the company in 2020 despite the effects of the COVID-19 pandemic on the volatility of the economy and exchange rates. Moving to Slide 13, our last slide. The economic recession caused by the pandemic should not significantly affect the company's revenues given the low elasticity of demand in the face of changes in GDP. Probably residential consumption, today 82% of the billed volume, will be maintained or will increase slightly, while the demand for commercial and industrial categories, today 10% of the billed volume, may be lower due to the reduction in the activity of companies in these segments. To conclude, as disclosed in the material pack yesterday, and considering that treated water is an essential asset in facing the pandemic of COVID-19, the Board of Directors approved the exemption for 90 days as of April 1 the payments of the bills for customers registered in the residential social and the residential favela categories that reaches a population of more than 2 million people with very low income, exactly the population that is in the situation of greater fragility to face the public health and economic crisis. Exemption for this period will be mitigated by reducing cost and expenses. But it's not affecting the company's economic and financial situation, which is something fundamental to maintain investments in regular water supplies, sewage collection and treatment. In addition to this initiative, we started to produce reused water with a higher concentration of chlorine to be used for cleaning streets and sidewalks in the vicinities of hospitals and other institutions dedicated to health care. To finalize, the role that a sanitation company plays in fighting the pandemic is absolutely essential. The interruption of water supply may simply compromise the guidance given by the World Health Organization for everyone to maintain good hygiene habits, especially washing their hands frequently and correctly. For this reason, SABESP operation capacity must be preserved, and the company must count on the active support of public authorities. Well, this ends our presentation and our speech -- initial speech. Then we now turn back to questions and answers. Thank you.

[Operator]

[Operator Instructions] And our first question will come from Lilyanna Yang of HSBC.

[Lilyanna Yang, analyst]

So I see your revenues are growing a lot, your costs are coming down, but you have 2 events on the tariffs, right? First is this May of 2020. So when can we expect to hear more about the level of tariff hike that you could get this year, should it be something closer to inflation? And maybe more importantly, the second question is about your rate review of May next year. So do you consider your current level of return as reasonable? Or how can we see the tariff outcome for next 2 years? And how can you make sure or how confident are you that the assets that you just acquired, Guarulhos, Santo André, they're going to be fairly reflected in the rate review? If you could give any color where you see the highest risks in the rate review process, if it is on the RAB, if it is on the OpEx level or if it is on the WACC level.

[Mario Sampaio, executive]

Lily, could you -- you said 2 events on the tariff. I got the one on the rate review outcome. But what was the first?

[Lilyanna Yang, analyst]

The first was on the tariff adjustment for this year, May 2020, if you think it's coming without risks in line maybe with inflation or above that.

[Mario Sampaio, executive]

Okay. Let's hear -- Mr. Braga, would you like to comment on the first -- on the tariff adjustment for this year? Hello? Well, let me convey...

[Benedito Pinto Braga, executive]

Hello? Yes, I'm here.

[Mario Sampaio, executive]

Okay.

[Benedito Pinto Braga, executive]

Thank you, Lily, for the very important and very good questions. There is no indication at this point in time that we will not have tariff adjustments. Yes, we should have tariff adjustments. And the -- now in April is the time when this adjustment will take place. But the only thing we must have in mind is that we are in the middle of a health war. The government of São Paulo is giving daily reports on the development of the pandemic in the state of São Paulo. And of course, we are expecting the adjustment at the mid of April, but we are following what are the developments of the pandemic daily. But at this point in time, we do not foresee any problem with the readjustment of the tariffs. Mario, please.

[Rui Affonso, executive]

Mr. Braga, can I add?

[Benedito Pinto Braga, executive]

Yes. Yes. Please, Rui, go ahead.

[Rui Affonso, executive]

Braga, it -- Lily, it's just one comment. As Mr. Braga said, we don't have any indication until now concerning the tariff readjustments. But we cannot close our eyes that the fact, and I believe that behind your concerns, some agencies, electricity agents like Enel, Endesa had already postponed some readjustments of tariffs in the electricity and water due to the -- yes, due to this huge epidemic and economic crisis. So if something like this happened to us, what we can say is, like in the past, like in the hydrological crisis, the Board of officers and the Board of Directors of SABESP will -- we indicated we will call for a rate review on our tariffs. Remember in 2015, we asked and we had it, we got the extraordinary tariff review in 2015. And if that is the case, for sure, the company will ask for a rate clearance, so that we can preserve our financials and economic indicators in a sustainability manner.

[Benedito Pinto Braga, executive]

Okay. Rui, thank you very much. So Lily, this is absolutely important what our CFO, very careful CFO, is informing you is that in the event of a postponement of the adjustment, we certainly will be compensated and no economic or financial impact will occur in the company. Mario, would you like to address the second question?

[Mario Sampaio, executive]

Yes. Lily, could you formulate it again, provided that we're talking here. I think Rui covered and Braga covered the tariff adjustment and the rate review side. I believe the other relates to cost.

[Lilyanna Yang, analyst]

Yes. The other question was more on the rate review of next year because all the works start already today for an outcome 1 year from now. So I wonder where you see your biggest concerns or where we could see the highest risks to the rate review, if it is on the regulatory asset base, for instance, the incorporation of Santo André and Guarulhos in the RAB. If you think it's more a WACC discussion or it is going to be like more than 8.5% like [ Conga ], where it's going to be more in the 7% level like electricity distribution companies. Or if you think that the controversy might be in the OpEx level because this was a big deal in the second rate review? So it's just a little bit more color what's [ more of a status ] here? And what's the biggest priorities and concerns here?

[Mario Sampaio, executive]

Okay. Just to make sure that -- Rui, do you want to try?

[Rui Affonso, executive]

Okay. Lily, we really are just starting the real conversation discussion with ARSESP, making our point and discussing the methodology of the RAB, specifically, that was an important step. When we -- all of us were caught by this epidemic and economic crisis that more than others it isolate everybody and put the [ reason ] of the discussions in a slow mode. So at the point that we are right now, I cannot see a major big risk. As I told in our Portuguese conference, the -- there is still a year ahead of us to the new tariff review, one. Second, and hopefully, we can pass this period in a shorter time than this, a shorter period of time. We -- I can see certain advantage and certain better points of view from the regulatory body at the beginning of this discussion, especially concerning the asset bases. Remember that we agreed to discuss this through the methodology of accounting numbers rather than replacement value that from our point of view is very good. The challenges, as you mentioned, of course, remain on the new acquisitions, because in this case, we have to go to the ground and to make the tests, and it's time costly. But at the same time, the agency will take in consideration that go to the ground and test the assets in the middle of isolation that we are all together will be more difficult. So we have to take in consideration in the final results of the tariff review. In the other side, remember that we have been discussed -- both in discussion on this and I believe that the agency disclosed this with you, the investors, the possibility to discuss and once discussed, we close finally this remaining BRL 6 billion, that was BRL 7 million and then there was BRL 6 billion and then we apply the corrections and inflation and everything, we still have BRL 6 billion out of our tariff -- our RAB. So this is a good news. The mere fact that after so many years, we start discussing these, from our point of view, is good. We are looking at this point to recover part at least of this asset base. So it's good. It's good news. If I have only -- the only concern I have is time. Not time just because of the tariff review, but time in general, as we are isolated, all of these things, the time frame, all of the things becomes slow -- slowly and slowly. That's the point. But conceptually, I believe that we have more grounds to be more optimistic than in the past. We have to deal with this 2 major issues. But my belief is that the huge discussion would be in the RAB and the treatment we have to make in the case of the big acquisitions, Santo André and Guarulhos.

[Operator]

[Operator Instructions] It looks like we do have a follow-up from Lilyanna Yang, HSBC.

[Lilyanna Yang, analyst]

I will take the opportunity, nobody is lining up yet. So one other question is regarding your foreign exchange debt exposure. And I understand from the call in Portuguese that you are already acting to negotiate a change in the contract with development agencies, mainly to change your exposure from dollar or yen maybe to something like local. Would you give us an indication of what could be your cost of debt or funding in local currency? I know it's difficult to say now maybe you can allude to a few data points that you might find helpful for us.

[Benedito Pinto Braga, executive]

Thank you, Lily. It's a very critical question that -- well, I think that before Rui will answer very specifically on this one, that the decision of the Board of Directors and the Board of the company on avoiding loans in foreign currency and making sure that we could find ways of transferring existing contracts, loans into local currency is now very clearly stated, and it's not related to COVID-19 or coronavirus. This was something we decided before this situation. And -- but I'm sure that Rui has the details to explain it to you. Please, Rui.

[Rui Affonso, executive]

Lily, it's Rui again. Well, we are under discussion with these 2 major big financers, IBRD and IDB banks that together represents some stock of FX that around USD 600 million. So it's a lot. We are discussing -- so I cannot state the costs. Remember that the union, the federal government and the state government, but especially the state -- the federal, are part of this because they are counter guarantee -- they provide us the counter guarantee for those sovereign funds. So we are currently in discussion with the World Bank and the IDB. We can -- what we can say to you is that we start the process to discuss and to reduce our exposure in foreign currency exactly in those cases that we have long-term, low-cost funding. And as they are multilaterals, sovereign banks funded by sovereign treasuries and countries, so it's easier -- it should be easier to do that at a lower cost and in a very shorter term. That's the strategy. So we are in it. The sooner we conclude at least part of these changes, we inform to you all the details you wanted and we also wanted to have. That's it.

[Lilyanna Yang, analyst]

That's great news. And for your bonds that are dollar denominated, how expensive would it be to hedge or is not worth it at this point in time? And I assume that you have not hedged any of those since December 2019, right, correct?

[Rui Affonso, executive]

Right. We don't hedged any of those, but they have under clauses of the contract the possibility to change with, say, less costly -- cost rather than in private capital markets. That's the important thing. And as the volatility starts to be present, an important issue in our macroeconomic scenario last year, many, many months before the coronavirus appeared, the recession war -- recession appeared, we started with this strategy. It's a long-term strategy. It's not just one movement strategy. And -- but it's important. We believe that we choose the lower fruits to catch, and I believe they are lower, but big and important fruits.

[Operator]

It appears that we have no further questions. Now I'll turn the conference back over to SABESP for their final remarks.

[Benedito Pinto Braga, executive]

Okay. Well, thank you for your participation in our call. Be assured that SABESP will continue to work very efficiently, very carefully regarding being prudent in all the movements that we make during this important health event that we're going through. Be assured also that we have water security in the area. Our sanitation sector is being preserved by the government as an important asset to solve the corona crisis. So we are part of the solution and not part of the problem. With the good results of 2019, we are very sure that we will face the challenge and we'll win the battles and finally the war. Thank you so very much. I don't know if Rui would like to say some words before we close.

[Rui Affonso, executive]

No, just to say, thank you very much. And our CEO in a clearer way has closed this call with optimistic or resilient message to all of you. Thank you very much.

[Benedito Pinto Braga, executive]

Thank you all. Thank you. Bye-bye.

[Operator]

And we thank you also to the management team. Again, we thank you all for attending today's presentation. At this time, you may disconnect your lines. Thank you, again, everyone. Take care, and have a wonderful day.