Basic Sanitation Company of the State of Sao Paulo SABESP

SWB:SAJA

Earnings Call Transcript 2022-Q2

[Luiz Tiberio, executive]

[Interpreted] Well, good morning, everyone and welcome to SABESP's audio conference to discuss Q2 results for 2022. My name is Luiz Roberto Tiberio. I am resources fund responsible and IR Officer. Today with us, we have Dr. Benedito Braga, SABESP CEO; Dr. Osvaldo Garcia, Economic Director and CFO; Marcelo Miyagui, Accounting Manager.

Before moving on and giving the floor over to Dr. Braga, I'd like to convey information and instructions. This video conference is being recorded and has simultaneous translation into English. The respective slide deck will be available for download at the company's IR website. Once again, questions will be answered. We'll be receiving writing through our chat facility. Our conference will have some time at the end for Q&A for analysts and investors, and another 15 minutes for journalists.

To conclude the initial instructions, I'd like to say that possible forward-looking statements made during this conference concerning the company's business outlook, operating and financial targets are based on beliefs and assumptions on the part of the company's management and also on information currently available. Forward-looking statements are no guarantee of performance. They involve risks, uncertainties and assumptions and therefore depend on circumstances that may or may not materialize. Investors should have in mind that general economic conditions, industry conditions and other operating factors might affect the future results of SABESP and thus lead to results that will differ considerably from those expressed in these forward-looking statements.

Having said that, I would like now to turn the floor over to Dr. Braga, who will give us his opening remarks. Over to you, Dr. Braga.

[Benedito Pinto Braga, executive]

[Interpreted] Thank you, Tiberio. I would like to salute everyone, and thank you for participating, and also thank you for your interest on the part of our investors, journalists and the public as a whole who are now watching us for this results announcement call for Q2 2022.

But before we share the highlights of Q2, I'd like to make a brief and general comment about 2022 up to now. This has been, without a doubt, a very challenging year for all sectors of the economy in our country, and the sanitation sector is no exception. We had the start of a war in Europe which brought in its wake inflation and a high level of insecurity to our suppliers with a subsequent increase in costs in the products that we buy to treat water and sewage. It was a drier summer with a consequent increase in energy tariffs, both in the free market and as in the regulated market, which brought costs beyond what was expected. Service costs, which account for another important component in our cost increase, have also spiked, driven by contract readjustments and also because of higher activities across different fronts.

Another important issue arising from that worsening of the economy is that the population got poorer. And that is reflected in our estimated losses with credits of doubtful settlement, an increase of 75.5% and a worsening in our default indexes. That situation is not exclusive to SABESP, but it's something that can be observed across several utility companies across different sectors of the Brazilian economy. We are implementing actions to hold off that default, and our CFO, Dr. Osvaldo Garcia, will go into detail those actions.

As a highlight for the quarter, we readjusted by 12.8% as of May 10, with a positive impact on revenues. The impact is still partial because the tariffs applied to consumers' bills in May have not levied across all collections in the period, which will only happen in the third quarter of the year. Also important to remind you that this readjustment, which was approved by the regulating agency, contemplated all devices defined during the tariff review, which ensures us on the regulatory front that we can go on with our operation, and it also brings confidence to our shareholders and creditors.

As for the volume builds, we saw a growth of 1.8% when compared to the same period of last year, especially in the commercial and public categories. This growth in volume happened despite the drop in average temperatures in the period, which has a strong and direct impact on consumption from our clients, despite the important effort on our part to reduce foreign exchange exposure. In other words, we brought the percentage of our debt in foreign exchange currency from 55% down to 15%, 1-5, and still, in this quarter, we still suffered with a negative foreign exchange variation, which impacted our net income.

As for the water situation, we saw affluents which are slightly higher than last year's. And it's important to highlight that even though we have identified, throughout the last decade, outflows, which were lower than average, especially in the Cantareira system, we didn't have supply problems for potable water in the São Paulo greater area. Early in August last year, the total stored volume by the systems of the metropolitan area was 47%. This year, the number is 49%. The Cantareira system calls the attention of communication media because its volume is lower than last year.

But it's important to reinforce that the systems are interconnected and they are less dependent on the individual situation of Cantareira. We are more resilient today than we were in the precrisis period, 2014, 2015. We have faced this period very well and we continue to go down this dry winter until we start having rains again in October. We're going to go through this period in a very smooth way.

In July, we also saw the signature -- the signing, rather, of 2 new funding contracts, BRL 466 million with the BID Invest, which will be allocated to the Projeto Tietê, and BRL 760 million with IFC, investments which will be allocated to the Novo Rio Pinheiros Project, which has started 3 years recently with above-expected results. Also an investment of BRL 1.2 billion in the quarter, out of which BRL 588 million in water and water security and loss control; and BRL 652 million in sewage and also expanding the collection and treatment of collected sewage.

We're also celebrating the results reached towards depolluting the River Pinheiros with the real impact on the quality of life of the population in the surrounding neighborhoods, which make up the Pinheiros basin, very populated and deteriorated neighborhoods, economically speaking. 3.3 million people, 2.4x the population of the city of Guarulhos. As for the new Rio Pinheiros Project, I'd like to highlight 2 actions: number one, this acceleration of phase #4 of the Tietê Project to collect and treat sewage at the basin of this very important affluent of the Tietê River, I'm talking about the Pinheiros River. We were very innovative in terms of contracting based on performance with payment based on results and not simply by implementing tubes and pipings.

The performance indicator is quality of the water at the stream level, which leads to Pinheiros, as measured by the DBO (sic) [ BOD ] concentration, biochemical oxygen demand, which should sit below 30 milligrams per liter that allowed us to deliver results before the expected time and with a very favorable financial flow for the company, 16 contracts, which anticipated the connection of 533,000 households to the sewage system. We exceeded by 22% that target 3 months before the deadline. Today, we have 650,000 households, which means 1.7 million people connected to the sewage network and over 2,800 liters per second of sewage being geared towards treatment at the treatment station of Barueri. Until the end of next month, our expectation is to reach 660,000 connected households. The disbursement until now of 38% of the total contracted amount also shows the advantage -- the financial advantage of that innovation in terms of contracting sanitation works.

The second main action involves technological innovation in terms of engineering. We are doing direct intervention at the stream level with the construction in places where there is no urbanization of 5 units to recover the quality of the water in rivers, the so-called UR, which are structures put in place to treat the remaining sewage at the streams which are affluent to Pinheiros, coming from areas which are irregularly occupied where it's not feasible to install sewage collection systems.

Several measurement points already show satisfactory water quality with BOD concentration below 30 milligrams per liter. A Pinheiros River with fish without bad smell and pleasant for cyclists. At the margins, the number of cyclists went from 17,000 a month in 2019 when we arrived, the SABESP, to 170,000 per month today, in 3 years. That's the result of the integrated work with SABESP teams and this innovative contracting system.

All right. Ladies and gentlemen, I would like now to turn the floor over to our CFO, who will give you a broad overview of our financial numbers for Q2 2022. So Osvaldo, over to you.

[Osvaldo Garcia, executive]

[Interpreted] Good morning, Dr. Braga. Good morning, everyone, and thank you very much for participating in our results call relative to Q2 2022. The slide being -- starting on Slide #3, please. We can see an increase in the volume of the total water billed of 1.4% of water and [ 2.4% ] of sewage year-on-year. In terms of water, the nonresidential segments contributed for that elevation. Commercial with an increase of 16.8% and the industrial segment with 1.2% and the public segment with 41%, offsetting drops in the residential segment of 0.5% and the wholesale of 3.2%.

And sewage, the residential segment remained stable as other segments showed an increase, i.e., 17.9% in commercial, 2.2% in industrial and 36.5% in the public segment and 10.8% in wholesale. So showing an improvement in our volume mix with a reflex in the tariffs in the period, as mentioned by Dr. Braga. It's worth remembering that this has been a very low temperature quarter, but still, volumes grew and there was an improvement in the mix.

Next slide, please. Let me talk about the financial highlights. We have revenue from sanitation services, net of taxes, saw a growth of 15% in the period, moving from BRL 3.6 billion in Q2 2021 to BRL 4.1 billion in Q2 2022. In addition to improving the mix, the readjustment over the tariff table of 12.8% as of May 10 has contributed to that increase. The readjustment will reach its total in the next quarter or will reach all the accounts by Q3. EBITDA increased by 3.9%, going from BRL 1.45 billion in Q2 2021 to BRL 1.5 billion in Q2 2022, driven by an increase in revenue and also impacted by inflationary pressures on costs and expenses.

Net income has dropped 45.4% and I will go into more detail on that on the next slide, so if you could move on to the next slide, please. We start from a net income of BRL 773 million in Q2 2021. We had a positive variation in revenues from net sanitation, net of taxes, of BRL 537 million by the more favorable mix and by the application of the tariff readjustment as mentioned just now. Costs and expenses grew by BRL 530 million when compared to the previous year as we will see after that in more detail.

The net financial result saw a negative variation, which can be explained by the foreign exchange variation on loans and financing and foreign currency leading to a delta of BRL 573 million, which will be explained further in a moment. Income tax and social contribution saw a positive variation of BRL 208 million due to an increase in costs and expenses. And that led to a negative result for Q2 2022. As a result, we had a net income of BRL 422 million in the quarter, as you can see on the right-hand side of the slide.

Moving on to the next slide, please. We will be able to see costs and expenses in more detail. In comparison with the same period of last year, costs and expenses increased by 19.6%, not considering construction costs, moving from BRL 2.7 billion in Q2 2021 to BRL 3.2 billion in Q2 2022. There was an increase in costs when compared to the previous year, very much linked to the hike in inflation. Even though today, our personnel is, on average, 2.3% smaller than we had in the same period of 2021, personnel expenses grew 14.4%, especially due to inflationary readjustment of wages and salaries, which were -- was applied in May to the tune of 12.9%. That readjustment impacts not only salaries but also the balance of labor provisions, such as 13th salary and paid vacation time, which in this quarter are higher when compared to the same period of 2021.

Expenses with materials, both general and for treatment, saw an increase of 40.4% and 73.1%, respectively, both because of a raise in prices and also because of its higher use. Expenses with services saw a hike of 24.8% due to contract readjustments and also the higher intensity of activities across different fronts. In the period, we performed more maintenance works at the water and sewage systems, which implies more expenses in [indiscernible] and implementation of the new commercial system also demanded more hours in technical services for IT. We have increased our surveillance contracts and have reinforced our channels with customer relationship.

We also intensified our field activities. And therefore, in addition to the increase in prices, there was an acceleration of activities which were pent up in the previous year, where we had a scenario with higher restriction because of the pandemic. Electric energy costs also increased by 10.4% or BRL 35 million, mostly driven by an increase in average costs, both in the free environment of 6.6% but also in the regulated environment at 28.8%. We saw a reduction in consumption for both environments related to a lower need of pumping in 2022.

The focus on containing consumption was geared towards the regulated markets where we saw a much higher reduction in consumption at 20% when compared to a drop of 3.7% in the free environment. The idea is to reach a consumption mix across all markets to minimize costs, meeting technical restrictions, which had emerged. Estimated losses with doubtful credits, the so-called PCLD, doubtful credits, saw an increase of 75.5%, reflecting a worsening in the default indexes observed in the economy across the board. In this context of high inflation and high SELIC rate and of a drop in income of families, clients prioritize paying bills, even though they pay higher interest rates. We are performing actions to contain default levels, such as cutting off water supply, resend notifications and alerts to those who are in default in arrears, and we also make it easier for them to access virtual agencies to print bills and also pay outstanding bills in installments.

Next, please. Now moving on to the next slide, financial expenses and debt. We see a worsening in the financial results at BRL 573 million, a very drastic variation in the quarter, quarter-on-quarter once we moved from a financial result, which was positive at BRL 249 million in Q2 2021 to a negative figure of BRL 324 million in Q2 2022. That was driven by an appreciation of the U.S. dollar in the second quarter of 2022 when compared to a depreciation of the U.S. dollar and of the yen in the second quarter of 2021.

To minimize impacts related to foreign exchange fluctuations, SABESP has been gradually implementing a guideline to reduce exposure in foreign currency. For example, funding resources coming from BID Invest and IFC are already coming in, in Brazilian reals in July, and that shows that we are reinforcing this commitment. Today, we have 15% of our debt pegged to foreign currency.

Still on new contracts, I'd like to add that the contract with BID Invest to the tune of BRL 466 million has a term of 14 years and a grace period of 1 year. The contract signed with IFC to the tune of BRL 760 million has a term of 10 years and a grace period of 1 year as well. And it's the first partnership for a blue loan in Latin America, an innovative instrument by which resources are monitored to ensure that they were allocated to sustainable projects.

So those were our initial comments. We'd now like to move to the Q&A session. And I give the floor back to Dr. Braga.

[Benedito Pinto Braga, executive]

[Interpreted] I apologize, my mic was muted. Once again, I apologize. Tiberio, so if you could please move on to the questions we have to address, if you will, please, so that we can answer questions which were sent.

[Luiz Tiberio, executive]

[Interpreted] Okay. Thank you, Dr. Braga. So let's move on to the Q&A session. We'll dedicate a portion of this segment to answer questions from analysts and investors, and then we'll address questions coming from journalists if there are any. We already have 2 questions, one coming from [ Eduardo Lazzaretti ], where he says or he asks, "Good morning, everyone. Recently, we saw headlines about potential studies by SABESP to reach out to private partners to manage solid residue. Could you comment a little bit more on that?"

[Benedito Pinto Braga, executive]

[Interpreted] I'll ask Dr. Osvaldo to go into detail on the topic, but broadly speaking, I could offer the following contribution. The company is interested, of course, in working on that. But especially with the final phase of the solid waste process within a circular economic concept, in other words, instead of discarding residue in sanitary landfills, we would recycle it. And the remaining, we would either mass burn it or produce biogas and then methane to generate energy.

So we wouldn't simply going into the collection and transportation phases of the solid residue process, but we would be acting on which is more technological and more environmentally important. But Dr. Garcia is working on it on the new businesses front, and we also will have the participation of the private sector.

[Osvaldo Garcia, executive]

[Interpreted] As President Braga said, we are now working to follow our new business policy as approved by our Board in July last year. And that policy sets as a guideline the participation in the final destination of solid residue, especially focusing on energy generation. So along those lines, we have this MOU with one of the landfills in the São Paulo area in the region of Mauá. And we are now developing a plant to burn solid residue and generation of electric energy. We are studying other partnerships on that front. And as soon as we have news on that front, we will announce to the market. But as Dr. Braga said, it is part of our policy, and we are interested, of course, in participating in the circular economy, turning the destination of solid residue a priority for the company.

[Luiz Tiberio, executive]

[Interpreted] Okay, moving on. We have 2 questions from [ Michelle Moran ]. I'll ask the first one. She asks, "What are the main risks for SABESP in terms of water flow and water inputs?"

[Benedito Pinto Braga, executive]

Should I respond in English because she made the question in English just to facilitate our translator?

No. We have a very small risk in terms of water inflows to our production systems. SABESP has worked a very long way in increasing its resilience with regards to adaptation to climate change. Since 2014, '15, when we had a tremendous crisis in the metropolitan region, we've used the concept of redundant infrastructure and we've built some interbasin transfers to our reservoirs in the metropolitan region, giving us more resilience.

So as I mentioned in my speech, we have been suffering with inflows below average in the last decade. Nevertheless, due to this infrastructure that we have put in place, we have had no problems and we do not see any problems in the near future. Thank you.

[Luiz Tiberio, executive]

[Interpreted] Okay, thank you, Dr. Braga. I have another question from [ Michelle ] again. She would like to thank you and ask for the presentation for the great results. And she asks if we could go into a little more detail on what you can expect in terms of revenue for the next fiscal year. Thank you.

Dr. Braga. I think the answer -- you can speak in Portuguese, provided we have a translation. You can speak in Portuguese if you feel like it. And I trust our translator, so please carry on.

[Benedito Pinto Braga, executive]

Okay. [Interpreted] I just wanted to be sure to get all the details right. But moving on to Michelle's question now, I think Dr. Osvaldo would be the right person to address that question, coming from Michelle at this point. So over to you, Osvaldo, if you could, please.

[Osvaldo Garcia, executive]

[Interpreted] [ Michelle ], well, the estimated revenue for the following year, in other words, next fiscal year, January through December 2023, we work with the numbers set for the third tariff review. In other words, [ BRL 18.35 million ], at February prices of 2021. There is a possible variation of [ 2.5 up or 2.5 down ] around that number, as set by the tariff review, as I said. Thank you.

[Luiz Tiberio, executive]

[Interpreted] Okay. Thank you, Osvaldo. [Operator Instructions] I'll stand by a couple of minutes more, if somebody wants to make a final comment. [Operator Instructions] Thank you.

We have received 1 more question from [ Eduardo Lazzaretti ] and he -- his question is the following, "If you could please also comment on how you see the evolution of provision levels and default levels for the remaining of the year, that would be helpful."

[Osvaldo Garcia, executive]

[Interpreted] Default for the remaining of the year with default levels or delinquency rates for the remainder of the year. Well, Eduardo, I'm not going to comment on internal data, of course. But what I can say is the following. What we saw last quarter, especially in April, early in the half of the year, were way above our historical average.

Since we closed data for April, we have been very careful in terms of bringing those numbers down, and those measures have already made a change -- have already changed our doubtful credit down, right, to lower levels in April. So those measures, they are basically, as I said before, we are cutting off water supply at a higher level. We are now reaching levels which are prepandemic levels.

Also, we also make available for customers a second copy of their water bills. And have already started collecting bills digitally. We expect that delinquency for the rest of the year to be lower than that peak which we have reached in April. And that's already happening, as you can see, from May and June numbers.

[Luiz Tiberio, executive]

[Interpreted] Thank you, Osvaldo. [Operator Instructions] Well, Dr. Osvaldo, Dr. Braga -- I have 1 more question from [ Michelle Moran ] once more. And the question is the following. "In the past years, we've seen SABESP increase rates. Could you comment what is the process of rate raising and typical feedback you get from those raises." She's just rephrasing the sentence once again. So the question is on tariff increase from SABESP and what kind of feedback we got from clients when we raise rates?

[Benedito Pinto Braga, executive]

[Interpreted] Well, [ Michelle ], nobody likes to see their bill going up, of course. But we have not had -- to be sure, we have not had any, I'd say, negative repercussion on that respect, in other words, concerning readjustments defined by the regulating agents, that's important to understand as well.

So those defining the rate are not in the company, right? That is done by the regulating agency. And the agency, of course, has in mind different interests, the government, the utility company and the customers' interest as well. So the increase which was implemented did not have a significant impact on repercussion, as I said, on feedback. Maybe Osvaldo would like to comment or to complement that answer, but no major repercussion just to be sure, [ Michelle ].

[Osvaldo Garcia, executive]

[Interpreted] Well, tariff readjustments or tariff increases, they were all -- they have been planned, as I said, as of the third tariff review. Those increases were announced back then, so that readjustment is not the cause for an increase in delinquency. No, not really. We put together a work group to analyze that. And our conclusion, if I may, is that the delinquency levels, which increased especially in April, that was driven mainly by an economic deterioration in April. That readjustment was not in place, the 12.8% was not in place yet. So it was more a question of economic deterioration than anything else.

[Luiz Tiberio, executive]

[Interpreted] Okay, Osvaldo, thank you. Dr. Braga, we have 1 more question from [ Maria Carneiro ]. "Good morning. Cost performance, even excluding PCLD in Q2, was a lot higher than that seen in Q1. Was there any nonrecurring factor or seasonal factor to explain that? Also, as for tariffs, can you anticipate discussions with the regulating agency about the new tariff structures and potential impact for companies in the coming years?" So Dr. Osvaldo, please.

[Osvaldo Garcia, executive]

[Interpreted] As for an increase in costs in Q2 when compared to Q1, 3 main drivers were there for that cost increase: our own labor costs because of the inflation correction of wages; material costs for water treatment and also general expenses, which saw brutal increase, some of those costs doubled because of the war in Europe; and electric energy costs, even though we decreased consumption, those tariffs went up at a higher level than we expected for early in the year.

As for the seasonality of those costs, we expect we won't see an increase in addition to what we've seen, at least not significantly above that in the second half. We are monitoring that. And inflation was sitting at a higher level than we expected for the year. But let's wait and see how things will unfold in the second half.

As for the rules, what we anticipate in terms of negotiations with the regulating agency, they're all in line. We expect that for the coming year, the agency will put in place the new tariff structure. That new tariff structure, based on our studies, will probably contemplate all cost increase we are estimating.

And we have a guarantee from the standpoint of company, which is the assured revenue -- revenue assured by the agency, as we have a revenue within that estimated revenue of [ BRL 18.35 billion ] for the next year, as I said, based on February 2021. And we also had a possible variation of up to [ 97.5 negative and 102.5 positive ]. So anything within that window, that 5% window, will be supported by the company. Anything in addition to that window will be absorbed or complemented at the following tariff by the regulating agency.

[Luiz Tiberio, executive]

[Interpreted] Okay. Thank you, Osvaldo. So those were the questions that we have received. [Operator Instructions] But otherwise, we'll move on to the Q&A session for journalists who are following us as well. A question from [ Guilherme Hefe ], "Could you give us an update on the new tariff structure?" That has been answered already. Yes. That has been answered, yes.

In that case, from now on, we'll also take questions from journalists. Otherwise, our IR team also remains available for questions you still may have. But now the floor is open for journalists as well. Please feel free to ask your questions if you have any. We have 1 more question from Juliana Estigarríbia, "Could you please give us more detail on the measures to mitigate the effects of high interest rates and also high costs?" Osvaldo, over to you.

[Osvaldo Garcia, executive]

[Interpreted] Well, high interest rates, it's not really something I know how I could mitigate. That's an external factor, external to the company. But what we have prioritized in our investment plan is to take all possible measures to optimize costs. That can be done via innovation. In other words, automation of stations, also the use of alternative technologies as well.

As for costs and -- or interest rates rather, the way to avoid them right now is to generate our own cash. So we have a clear project to generate our own cash by which we expect that most of the money that we need to keep our investment plans alive, which is quite bold, will come from company's revenues. And that's what is contemplated in that number I mentioned for 2022, which was already forecast for 2022, which is also the regulatory limits.

[Luiz Tiberio, executive]

[Interpreted] Thank you, Osvaldo. [Operator Instructions] Well, Dr. Braga, Osvaldo, Miyagui, no more questions for today. So I'd like to turn the floor back over to you. Should we wait a little more or would you like to move on to your closing remarks?

[Benedito Pinto Braga, executive]

[Interpreted] Are there journalists waiting as well?

[Luiz Tiberio, executive]

[Interpreted] No, the floor is open to them as well, Dr. Braga.

[Benedito Pinto Braga, executive]

[Interpreted] Okay. Osvaldo, would you like to wrap this up?

[Osvaldo Garcia, executive]

[Interpreted] Mr. President, we remain hopeful that we will be able to materialize our investment plan for the year and all possible measures to reduce costs and to reduce delinquency having put in place by the company. Most of the costs are endogenous or -- and the root causes for delinquency are coming from an economic deterioration in the economy, the Brazilian economy. That's a direct reflection.

But whatever it can do from the standpoint of preserving its revenue, the company is doing it and keeping our costs within budget. We're doing all that. That's what I had, Mr. President.

[Benedito Pinto Braga, executive]

[Interpreted] Okay, very well. So I'd like to ensure our investors and all of those listening to us here today, analysts and others, the public, that the company is paying close attention to this very, very peculiar situation we're going through right now. As I mentioned early on today, a situation where we have high inflation, inflation that reached levels nobody could have expected, of course, because of a world crisis, no doubt.

But still, as Dr. Osvaldo said and said it well, what is endogenous is being taken care by the company. What can be done internally is being done to mitigate those effects. And of course, exogenous or external factors, of course, there's not much we can do. But you can be -- you can rest assured that wherever and whenever we can interfere and intervene, be it to preserve water security, which is our main input, water, of course, we are doing that and we're doing that well. We are ensuring that water security so that we can have our work delivered.

The investments, as they were mentioned, they will be concluded, as Osvaldo said, and I am an optimistic by nature and will always be. I am sure this is transitory. This will all pass. I think inflation will gradually slow down and things will fall back into track once again. So for our next earnings call, I am sure we will have very satisfactory positive results to all of you.

So thank you very much once again for participating in this call, and we remain available for questions or comments you may have. The whole executive team, IRO, the IR team is always ready to service you, Tiberio as well, Miyagui as well, the executive team remains at your disposal. Thank you very much.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]