Basic Sanitation Company of the State of Sao Paulo SABESP

SWB:SAJA

Earnings Call Transcript 2018-Q1

[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 first quarter of 2018. 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 slideshow 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 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. Good afternoon, everybody. We would like to thank you for being with us for this teleconference. We're going to discuss the results for the first quarter and, obviously, update on relevant matters and Q&A at the end. This will be a 6-slide presentation that we, again, will discuss the main events of the period. But before, I would like just to inform and make sure everybody is aware that yesterday we issued a material fact to announce that the Board of Directors elected Ms. Karla Bertocco Trindade to the position of Chief Executive Officer replacing Mr. Jerson Kelman who presented his resignation also yesterday.

Additionally, pursuant to our bylaws, Ms. Karla will be a member of the Board of Directors, while she holds the position of CEO. Karla, just very quickly, was a former Undersecretary of Partnership and Innovation at the Secretary of Government of the State of São Paulo. She was responsible directly for coordinating many PPP and concession projects in the State of São Paulo, and was directly involved and responsible for the holding and capitalization process of SABESP. In other words, she is very, very knowledgeable of the company.

Well, first of all, let me introduce Karla. Ms. Karla will be with us and before that, we will -- she will be meeting with analysts, shareholders, investors and the market in general.

Okay, so, let's go on then to our presentation.

Let's start on Slide 3. We can see the company's billed water and sewage volume, which was up 2.1% in the first quarter '18, with an increase of 2.1% in water and 2% in sewage. Despite the awareness of the population and the incorporation of rational consumption habits that were acquired during the water crisis, the largest volume growth in this quarter occurred precisely with the residential sector.

From the slide, you can also note that the billed water volume has been rising constantly and steadily since the third quarter of '15. Among the many factors that contributed to this increase in volume, we have, like, especially the increased the number of water and sewage connections.

Let's move to Slide 4. Let's comment on our financial results. First quarter '18 reported profit was BRL 580 million against BRL 674 million profit presented in the first quarter of '17. The main variation between the first quarter '18 result compared to the same period of '17 is due to the exchange rate variation in this quarter. There was a negative exchange rate impact resulting from devaluation of the real against dollar and the yen in the amount of BRL 112 million, while in the first quarter of '17, there was a positive exchange rate variation of BRL 89 million. Both of which led to a negative variation impacting our results of BRL 201 million between the period.

The gross operating revenue related to the rendering of sanitation service in the amount of BRL 3.3 billion, which does not consider construction revenue shows an increase of BRL 251 million or 8.3%, this when compared to the BRL 3 billion that totaled in the first quarter of '17. Revenue was mainly impacted by the growth in billed volume by 2.1%, as we already mentioned, and by the tariff adjustment of 7.888% relative to the initial stage of the tariff review in effect since last November. Net operating revenue, which considered the construction revenue, increased by 4% or BRL 140 million. As for costs, in first quarter, there was an increase of 3.6% when considering costs, administrative and commercial expenses, and construction costs.

As a consequence of the variations highlighted, adjusted EBITDA reached BRL 1.4 billion in third quarter -- BRL 1.4 billion in this quarter and that is 3.5% higher than the BRL 1.35 billion recorded in the same period last year. The adjusted EBITDA margin for this quarter was 37.8% compared to 38% same quarter last year. In the last 12 months, the margin reached 36%. If we exclude the effects of construction revenue and costs, the adjusted EBITDA margin resulted in 45.4% this quarter versus 47.2% first quarter last year.

Let's move to costs. On this slide, we comment on the variations between quarters. As mentioned in the previous slide, compared to the same period of the previous year, costs administrative and commercial expenses and construction costs increased BRL 92.2 million or 3.6%. If we exclude construction costs, costs in administrative and commercial expenses increased by BRL 166 million or 99.1%. The main variations that resulted in an increase occurred in general supplies with 52.8%, services 33.3%, general expenses 17.3%, electric power 11.1%; and wages, charges and benefits of social security obligations by 7.1%. For more details, please refer to our press release.

Now let's move to Slide 6. Here, we will comment on the main variations affecting the company's net income in this first quarter. This, again, all was in comparison to the same period last year. Net income, as mentioned, was [ BRL 540 million ]. Net operating revenue increased BRL 140 million. Costs and expenses added for construction costs decreased by BRL 92.2 million. Other operating revenues and expenses had a positive variation of BRL 1.9 million. Financial expenses increased BRL 197 million, driven in its majority by the devaluation of the real against the dollar and the yen. Net income -- sorry, income tax and social contributions decreased BRL 53 million, this again, due to the lower taxable results presented in first quarter, driven mainly by the devaluation of the real in relation to the dollar and yen, as we mentioned.

Now let's go to next to slide. On this one, we will briefly discuss the situation of the reservoirs that supply the São Paulo Metro region from October '17 to March '18. Rainfall was below the historical average. The Cantareira system received 80% of the expected volume; the Alto Tietê 72%; and the Guarapiranga 76%. Remembering that these are the 3 main supply systems for the Metro region of São Paulo. In mid-May, the reservoir of the Metro region of São Paulo stored, as you can see, 1.157 trillion cubic meters of water for treatment compared to the 1.28 trillion cubic meters in May last year despite the slightly lower level of reservoirs. We have to note that the current water production for the Metro region of São Paulo was 12% lower than the production level before the water crisis.

In April '13, we were producing 69.6 cubic meters per second; and in April this year, 61.6 cubic meters per second. So there's less -- significantly less pressure from demand on our reservoir. In addition to this, water losses in the Metro region of São Paulo are almost 30% lower today than in the period prior to the water crisis. In March of '13, the absolute number of water loss in terms of connections per day, liters per day per consumer was 451. And in April '18, this figure was 322 liters per connection day, so significantly below. With the current reservoir level, the lower water production and consequently, demand, lower absolute water losses and the beginning of operations of both the São Lourenço Production System and the Jaguarí-Atibainha interconnection, we understand -- the company understands that water security in the Metro region is in place and ready to face hydrological situations of similar magnitude as that observed in the years of '14 and '15.

Let's go to our last slide, talk about the second tariff review. As you know, ARSESP published on Wednesday, May 9, the final results of SABESP's second tariff cycle. We would like to highlight the following points. We authorized tariff repositioning of 3.507. This will be applied on top of the current tariffs that already contemplate the increase of 7.888% approved for the initial stage of the review and such is in effect since November '17. They also highlight the asset base for the final stage, right now at BRL 39.03 billion. This amount is BRL 580 million above the asset base initially proposed in March by ARSESP for the final stage. WACC closed at 8.11%, slightly above first cycle figures of 8.06%, but below our proposed 8.25%. Productivity factor closed at 0.888%, that is below the 0.9287% that ARSESP had in March initially proposed for the final stage. The final FX value for the second cycle is BRL 21.6 billion. In the initial stage of the review, it was BRL 22.8 billion. And in our business plan, we proposed 24.3 billion.

Looking at the final stage of the second cycle review process. We understand the following points contributed to an increase in the tariffs. This is basically the increase -- due to the increase in the asset base, reduction of other revenues, increase in depreciation, increase in working capital, reduction of compensatory adjustments, reduction in the X Factor, increase in the revenue base of the city of São Paulo for the purpose of estimating the transfer of 4% to the municipal fund. Obviously, all these details we can go through, not now, but later if needed with you. As for the points that resulted in the reduction in tariffs, the highlight is OpEx. Here the final relative value was 11.1% below what was initially proposed like the best in its business plan, and 5.3% below the value proposed by ARSESP in the initial stage of the review.

There are, however, 2 relevant points, which in our view have not been adequately addressed. One of them refers to the first cycle balance. Here we understand that the treatment given by the regulatory agency for revenue, OpEx and electric power was inadequate since they are in disarray for the methodology established by the regulator for the first cycle. The other point refers to the regulatory mechanism for the recognition of transfers to municipal funds established in 4% of the revenue obtained by providing service to the municipality. Although this introduction was a very positive breakthrough, it does not adequate -- sorry, it does not equate the situation of the São Paulo City contract, where the contractual transfer rate is 7.5%. Well, considering the relevance and weight of these 2 issues, the company is evaluating what measures to take in face of the completion of the second tariff review period.

So that concludes our comments. And now, we are open for questions and answers.

[Operator]

[Operator Instructions] And our first question comes from [ Julianna Diaz ] with UBS.

[Marcelo Sá, analyst]

This is Marcelo here. I have one question regarding the initial dispute with some of the municipalities, Guarulhos, and so I want to know if you can give us an update of the process. And how are the discussions with the other municipalities as well.

[Mario Arruda Sampaio, executive]

Okay. Just a second. Okay, Marcelo, Mario. Let's just start saying the following. There is no dispute with Guarulhos or any other municipality. But we are always open for negotiation, open for discussion. There are formal discussions and negotiations with Guarulhos and Mauá -- I'm sorry, Guarulhos and Santo André, and initial conversations with Mauá, specifically in the last stage for a specific service area, which was actually a matter of communication by SABESP. We think that -- one thing that helps in the regulatory process that will help also these discussions and their development is the possibility to transfer the pass-through to tariff of what is transferred to the municipal fund. So in summary, that's where we are.

[Marcelo Sá, analyst]

Okay. And another question is about the capitalization process. I know that you said that you're going to evaluate the timing for that. But just to understand, I mean, after this disappointing tariff reset, how is the government thinking about this process? Do you think it is possible to finish this process this year? Is there like a deadline in which you cannot do because of elections? What you can comment about, especially the timing and if in the likelihood of doing it this year before elections?

[Rui Affonso, executive]

Marcelo, it's Rui speaking. We are just in the middle of this process, starting a new government with a new CEO also. So we have just starting few days discussing this process. We reiterate the importance of this process of capitalization for SABESP. And -- but the time frame to do that, the process is under evaluation with new governor and the new CEO. But we reiterate the importance of this process for the company and it also -- this view is shared with the -- by the new CEO of the company.

[Operator]

[Operator Instructions] The next question comes from Snehal Amin with WindAcre.

[Snehal Amin, analyst]

I've 2 questions. One, the [ SSP ] tariff review, I think, is essentially stealing over BRL 1 billion from shareholders and EBITDA every year. I think, actually, even more than a BRL 1 billion a year, which is a terrible result. I want to know in more detail, what are you guys going to do to protect the shareholders and get the situation corrected. And second, what can you do on both OpEx and CapEx to preserve the company better, because you're not getting credit -- especially on the OpEx side, you're not getting credit for what you spend. So how are you going to spend less so that there isn't a huge difference between the regulatory model and what you're spending?

[Mario Arruda Sampaio, executive]

Okay, Snehal, just a second for us to distribute questions here.

Just a second. It's Mario. Snehal, it's Mario. Well, first off, we were frustrated with the result. On the OpEx side, just so you understand, the year that they based the reference for OpEx was 2016. We argued that, that was not a proper year. That was the year immediately after we came out of the water crisis. Still -- we're still somewhat affected by that, and we're coming out of that. Our OpEx are slightly going up, actually going back to where it should be if we were not, during the crisis, obviously, working to hold back some -- keep some of that gain. So there's a point there. So what we are ultimately going to do is that we can still -- despite the revision has been concluded, we can still appeal on a administrative level and a legal level, okay. As we mentioned, there are 2 big issues bigger than eventually the OpEx that we highlighted, which are clearly subject to what we need to see. And obviously, there may be others related to OpEx in other parts that we might come in to. But at first, before we announce it to you how we're going to react in terms of CapEx, reductions in OpEx, we need to clean the situation and go to the last condition for us to try to revert this decision or part of the decision. So before we begin the discussion with Rui and everybody on what we can do to now that, that's the last thing to do, we think there are still measures we can work on before really jumping in to a new plan if needed. Okay?

[Snehal Amin, analyst]

Let me ask a follow-up on that. I'm sure you can understand that some shareholders like us now have very little faith in this regulator, right, and the regulator's willingness to be fair, right, in technical and objective. So I understand you have to go through whatever administrative process there is with the regulator and you should follow that. But if the regulator is just inherently not fair or political or corrupt, you're not going to get the right result, right? So how quickly can we get this into the hands of the courts, because maybe there, there's a chance that you get a fair judgment, because it's pretty clear this regulator is not going to give you a fair judgment and doesn't care about what's fair. And even further, do you have the legal power to sue the directors of ARSESP, so you can really go after them because what's happening here, I mean, you can't ask shareholders to eat a loss of over BRL 1 billion a year in EBITDA and do nothing, right? So I'm not saying you're not doing anything, but not -- we got to do everything we can is my point. And can we sue the directors? Can the company sue the directors? Can the shareholders sue the directors of ARSESP? How do we get this into the hands of the courts quickly so that we can get the right result?

[Mario Arruda Sampaio, executive]

Snehal, what we...

[Snehal Amin, analyst]

And is the company dedicated -- is the company dedicated to pursuing this until the very end and not giving up, because this is an enormous amount of value that's just been lost?

[Mario Arruda Sampaio, executive]

I'm next to Rui here and he just said, yes, we're going to pursue. It's an obligation. It's a fiduciary obligation. We have to run the company. The company needs that cash for investment and to grow evidently. So we're going to exactly find and do the steps that are needed, and it begins with administrative and it will, if needed, reach any other level, as judicial, the legal. But you can be sure that this company is not going to stand still and let things go. We want to protect shareholders, and we want to protect the business, and we want to protect sanitation, okay? So I believe, I expressed here the company's view. We have to make it happen. And we are at this moment exactly working on that. We have a time frame to move, and we're not going to lose the window -- opportunity. You'll hear from us soon. Okay?

[Operator]

[Operator Instructions] The next question comes from Larry Tedeschi with STRS of Ohio

[Lawrence Tedeschi, analyst]

Why did the CEO resign and why was the replacement CEO picked?

[Mario Arruda Sampaio, executive]

Okay, just a second. Larry, the question is basically why the CEO was replaced. I think that's it, right? Was there anything else to that?

[Lawrence Tedeschi, analyst]

And why was the person who replaced the CEO picked?

[Mario Arruda Sampaio, executive]

Picked? I'm sorry.

[Lawrence Tedeschi, analyst]

Why was she hired?

[Mario Arruda Sampaio, executive]

Great, great. Hired. Okay. Give me a second.

[Rui Affonso, executive]

Hi, it's Rui speaking. First of all, to make it very clear, the appointments and the election of any member of the board of officers of SABESP is faculty of our major shareholders. And so, I cannot answer on behalf of the government, of course. But -- so the first answer, I cannot unfortunately answer because I'm not mandated of the governors of the State of São Paulo to talk on behalf of them. So they may -- it's a legal faculty of the governor of the State of São Paulo to appoint any officer of the Board of SABESP. That's the point. But what we can talk, I mean, we can reiterate is that, the change is from Mr. Kelman to Ms. Karla is a change that does not change the way or the route that SABESP has been working all of those years since we opened the capitals and we made our IPO, and then the secondary offer and so on and so forth. So it's the same route. Ms. Karla was -- before that was working as Undersecretary of the Government of the state -- the Secretary of Government of State of São Paulo. So she was actually working with us in the project of creating a holdco for SABESP, we remember, and capitalize SABESP. So if there is any kind of discontinuity in general orientation of the company, that's the point I can make it.

[Operator]

Your next question is a follow-up from Snehal Amin with WindAcre.

[Snehal Amin, analyst]

I had a question on the dividend policy. After ARSESP put out its result, I think you guys formalized your dividend policy at 25% of net income. And I know that's what you've been paying in recent years. So it's basically the same as the past few years. But in light of ARSESP's decision, why doesn't it make sense to return more of the cash to shareholders via dividend, especially because if ARSESP is not going to treat you fairly, why is it safer to have the cash in the company as opposed to distributed out to shareholders, right, the excess cash you need after the CapEx? So why did you formalize it at 25% instead of just returning all the excess to shareholders?

[Mario Arruda Sampaio, executive]

Okay, just a second.

It's Mario. Look, first, there's no relationship between effective decision and we, the company, formalizing our dividend policy. They're just coincidence in time. The dividend policy -- formal dividend policy is a request under a legal obligation under the state, the federal laws that rules how mixed capital companies' governance should hold. So there are other and you will see other policies -- like the related-party transaction policies, there are other policies you will see us formalizing. All this has to be done latest by last day of June. So it's basically a coincidence, in fact. Nothing changes for us. As you mentioned, it's exactly what we have said and exactly what we have done. No relationship with ARSESP. As for what you mentioned in terms of distribution of dividend increase, I think that falls to the last question -- to your last question. And I think we have to still do the next steps before we change anything in the way we deal with dividends and the company, okay? So I think that answers.

[Snehal Amin, analyst]

Yes. I get that the timing -- basically what you are saying that the timing was a coincidence?

[Mario Arruda Sampaio, executive]

Yes.

[Snehal Amin, analyst]

I think my point is these -- maybe these should be connected, right. So maybe the right thing for the company to do is to change its dividend policy in light of ARSESP's decision. And so I think what you're saying is maybe that in the future it's still an alternative, right, as one of the things that you can do, if you don't in the end, it's just the matter of ARSESP's decision.

[Mario Arruda Sampaio, executive]

So, what we're saying is -- we understand what you said. But we're saying that we will -- it's not the time to revisit as you're putting it. Let's do the next step and then let's see what happens and to see if there is room or anything to revisit, okay. That's what we're saying, right? Okay?

[Snehal Amin, analyst]

When is the timing of these next -- like, when will we know whether these next steps have worked or not?

[Mario Arruda Sampaio, executive]

No, you will see this anytime soon. We are now appraising exactly the timing and -- we know, but now we are fine-tuning, as now we do have a result from the regulator. And based on that, we will take action. So the timing is something that and the steps is something that we don't have with us right now. But obviously, we will make everybody knowledgeable, and there is a window time to be happening, and we have to be in compliance with that window. We're just finally appraising from an administrative perspective how that happens and eventually even from a legal perspective, right?

[Snehal Amin, analyst]

Okay. So we'll see something soon though in terms of your next steps?

[Mario Arruda Sampaio, executive]

Okay. Sorry?

[Snehal Amin, analyst]

Well, we'll see something soon in terms of the next steps you're going to take?

[Mario Arruda Sampaio, executive]

Yes, yes.

[Operator]

The next question comes from Lilyanna Yang with HSBC.

[Lilyanna Yang, analyst]

I have a follow-up question from my other questions.

[Mario Arruda Sampaio, executive]

Lilyanna, a little bit higher, please. Speak a little bit higher, Lilyanna.

[Lilyanna Yang, analyst]

Sorry. A follow-up from my question in the other call. So on the service contract with the São Paulo City, who are the people or the officers who have to sign off potential renegotiation? Would it entail the signature, for instance, of Water Resource Secretary, the Board or just the top management team of SABESP? That's one question, right. If you can clarify for me, that will be great. And number two is, where do you think you might have room for OpEx savings for this year and next?

[Mario Arruda Sampaio, executive]

Lilyanna, can you repeat the first question that we had a hard time taking note of it.

[Lilyanna Yang, analyst]

Yes, it's regarding the service contract with the São Paulo municipality. You've signed some 5 years ago, and it did entail the payment of SABESP to the City of 7.5% of the revenues. So for that potential renegotiation, albeit, I know you said that you're not planning on it. But if you were to renegotiate, you push for 5% instead. I would like to know if it requires the legal signature or the blessings of the top management team, CEO, CFO, anybody else, if it requires the signature of the Chairman, for instance, or the Water Resources Secretary of the State and plus, let's say, the Mayor of São Paulo. So who would be the people who would be backing up a potential renegotiation of this contract?

[Mario Arruda Sampaio, executive]

A second, Lilyanna.

[Rui Affonso, executive]

Lilyanna, it's Rui. First question is with -- the reason that we don't intend to start negotiation the contract of São Paulo City is that it's a very complex task. It requires us to go through the legislative body in electoral year and put it in risk our major contract by far, about 55% of our total revenue depends on this contract. So we don't think that it's a good idea to start renegotiating anything of the contract with the City of São Paulo. We have few [ room ] and that's our intention to go through the administrative measures with the regulatory body. So we go to that. At the end of the day, maybe we still have no other possibilities to the courts. But to renegotiate the contract of São Paulo City is out of our considerations because of the reasons I have told before. Second, if there is a room to lower our OpEx, we believe, of course, that in the long term, yes, we always work on that. When we started in here some of people, but we particularly in 2003, our headcount was more than 18,000 people. Now we are under 14,000. So in the long term, yes, it is room to lower down the OpEx, but not in 4 years' time. So that's the point. Second, we believe that ARSESP is taking a standpoint that's not correct because as you follow very closely, during 2014, 2015 and the budget we established for 2016, was very, very low due to the coincidence of the water crisis, the devaluation of real that put pressure on our covenants. So it's not a good standpoint to make any projection of our OpEx. That's the point. So it's most impractical. It's not feasible to lower the OpEx down in the short term. That's the point. If we're talking about 10 years, that's fine. We have plans to lower our OpEx in 10, 20 years, but not for one cycle, that's the point.

[Operator]

[Operator Instructions] We do have a follow-up question from [ Julianna Diaz ] with UBS.

[Marcelo Sá, analyst]

Marcelo, here again. Just -- I'm just curious and wondering if the government of São Paulo is aware that if the best outcome doesn't change, it's going to be very complicated to find a private partner that will be willing to buy a minority stake in a holding company controlled by the Government of São Paulo? Because for me and the [ investors ] this disappointed tariff -- disappointing tariff reset results, it's going to be very complicated to find a partner given all the uncertainties and all the fears of the regulator?

[Rui Affonso, executive]

Marcelo, this is Rui. First of all, it's my -- I have to oblige to say that one thing is the governor of São Paulo State and the other one is the regulatory body. They are appointed by, but are not connected, remember. Several directors were indicated by the former governor. Some others will be indicated by the new one. So they're not [indiscernible] connected between the governor and the Board of Directors of ARSESP. We are, of course, concerned of implications over the company and over our future plans among others. Main one probably in the short term is the capitalization of SABESP with the creation of the holdco. So we agree with you, but we don't think that a connection between the São Paulo State's view and the ability or disability of ARSESP to deal with this situation.

[Operator]

At this time, there appears to be no further questions. So I would like to turn the conference back over to SABESP for their final remarks.

[Mario Arruda Sampaio, executive]

Okay, this is Mario. Thank you for your time. We will certainly be back in August. And in the meantime, please call us. We are available, myself, Angela and the team. Thanks a lot. Bye-bye.

[Operator]

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