Basic Sanitation Company of the State of Sao Paulo SABESP

SWB:SAJA

Earnings Call Transcript 2019-Q3

[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 third quarter of 2019. The audio for this conference is being broadcast simultaneously through the Internet on the website, www.sabesp.com.br, where you can also find the 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, CEO; Rui Affonso, Chief Financial Officer and Investor Relations Officer; Adriano Stringhini, Corporate Management Officer; Mario Arruda Sampaio, Head of Capital Market and Investor Relations; and Marcelo Miyagui, Head of Accounting.

Now I will turn the conference over to Benedito Braga, CEO. Sir, you may begin your conference.

[Benedito Pinto Braga, executive]

Thank you. Good morning, everyone. It is a great pleasure to be in this conference with our directors and superintendent to discuss the results of the third quarter. We are extremely happy with the results. You will appreciate the results. Mario Sampaio will, in a very detailed fashion, present the results for you.

And what I would like to say is that the administration of this company is looking forward to bring in more and more consumers, and we're very successful in bringing in Guarulhos and Santo André that is now producing the earlier results of the assumption of these municipalities. We were very successful in Guarulhos to stop water rationing, and more than 1 million people that were going through rationing are not any longer in that situation.

Also, the intermittency of water distribution in Santo André will be improved, and we already started some civil works that is going to be very beneficial to the population of Santo André during the summertime -- approaching summertime in December, January and February.

So in a nutshell, things are moving smoothly. We are very determined to clean up one of our items in São Paulo, the Pinheiros River, by 2022. And this involves a lot of investment in sewage collection and treatment, but we are prepared for that. We are now using innovative contracting processes that will accelerate results in the area of sewage treatment. This is very important for the image of our company and the interest of our shareholders in these results.

So without further ado, I will give the floor to Mario Sampaio to present to you in detail the financial results. Thank you.

[Mario Sampaio, executive]

Thank you, Mr. Braga. So let's start. Let's start on Slide 3. Including the services now being provided to Guarulhos and Santo André, we can see that our total build volume increased by 2.8%, of which $2.4 million was for water services and 3.4% was for sewage services when you compare to third quarter '18. If we consider Guarulhos and Santo André, the total build volume rose to 3.8%.

Now on Slide 4. Here, we will discuss our financial results. The third quarter of '19, our net income was BRL 1.2 billion compared to third quarter '18 net income of BRL 565 million, resulting in a bottom line growth of 113.9%. This variation is mainly driven on the positive side to the BRL 1.3 billion impact due to the recognition of extraordinary revenues from the signing of the agreement with the municipality of São Paulo. If you recall, this is to provide sanitation services directly to the agencies.

On the unfavorable side, the increase in financial expenses resulting from the devaluation of the Brazilian payout against the dollar and the Japanese Yen was the main event.

Net operating revenues was BRL 5.4 billion,against BRL 3.8 billion in third quarter '18, resulting in an increase of 42%. Including the services in Santo André, net operating revenue was BRL 4.1 billion, which corresponds to an increase of 8.5%.

As for costs, administrative and selling expenses and construction costs, we had an increase of 5.5%, mainly due to services, electricity and general expenses.

On the other hand, we had a 25% reduction in salaries, charges, benefits and pension obligations accounts, largely due to the reversal of a provision referring to an agreement signed with the Public Prosecutor Office of São Paulo regarding the gradual dismissal of retired employees, which the company fully complied with the requirements that were established by the state prosecutor. We will further explain this point in the next slide.

Adjusted EBITDA reached BRL 3 billion in the third quarter '19 increased by 109% or BRL 1.6 billion against the BRL 1.4 billion in the same period of 2018. The adjusted EBITDA margin in the quarter was 55.6% versus 37.6% in the same period last year, with a margin of 44.6% in the last 12 months. If we exclude the effects from construction revenue and construction costs, the adjusted EBITDA margin in this quarter would be 64% versus a margin of 46% last quarter '18. As for the last 12 months' margin, this quarter, we reached 52% compared to 45% in the same period 2018.

I'll move on to Slide 5. On this slide, we will highlight the key variations that impacted results in this quarter. Starting with Santo André. In July '19, the company entered into an agreement with the municipality for the operation -- the beginning of operations in August. Initial impact of this agreement in third quarter '19 was an increase of BRL 1.3 billion on operating revenues and a BRL 41.7 million decrease in expenses with a net effect before income tax and social contribution of BRL 1.3 billion. Next event refers to the operation in the city of Guarulhos, which had a positive impact this quarter on this quarter results, with the recognition of BRL 116 million in operating revenues,and BRL 37 million in costs and expenses, and this excludes revenue and construction costs. Results is a net income before income tax and social contribution of BRL 78 million in the period. These same accounts for second quarter '19 were operating revenue of BRL 90.6 million, costs and expenses, again, excluding revenue and construction costs of BRL 66.5 million and net income before income taxes and social contribution of BRL 24 million, all of which expresses an improvement with the operation of Guarulhos.

Moving on, this next -- this quarter, we've reversed a provision in the amount of BRL 173 million in the salaries, charges and benefits of social security obligations account due to the termination of the retirement conduct adjustment term, what we call here the TAC.

Just going back on October 11, 2019, the state prosecutor responsible for the proceeding recognized that the company complied entirely with the requirements and thus concluded the proceeding.

Recall this matter. All the way back on February 20, 2009, SABESP and the state prosecutor signed a conduct agreement, the SAC, which I mentioned, in which case, the company pledged to promote the gradual dismissal of employees already retired. Due to this, the company constituted a provision for the dismissal of these employees. Remembering, at the time, the number of employees involved totaled 2,250.

Next Point. Expenses with the partial start of the services rendered by the São Lourenço production system in the third quarter of 2018 had an impact of BRL 19.2 million. In the third quarter of '19, the operation was in full capacity resulting in an expense of BRL 53.6 million, thus generating an impact of BRL 34.4 million in the period in our results.

Moving forward, as the last quarter, the company has also advanced in the process of adjusting its contracts with municipalities. We operated in a contractually precarious manner. In this sense, the company entered in agreement with the municipality of Guarujá, in which it formalized the contract for the rendering of sanitation services for a period of 30 years. And at the same time, closed outstanding lawsuits recognizing them as a nonrecurring expense in the amount of BRL 46.4 million in the third quarter of '19.

Finally, we highlight the signing of the adhesion agreement with the CETESB foundation as we have been observing our health care plan managed by Sabesprev was imbalanced due to increasing health care costs and demanding thus timely contribution by SABESP in order to maintain the financial solvency and margin requirements established by the National Health Care Agency, known as ANS.

In August '19, a new health plan managed by FUNCESP came into force replacing the previous plan. With the signing of this new health care plan, no additional contributions were required, and thus, the company recorded savings of BRL 39.1 million in health care expenses this quarter when compared to third quarter '18.

Let's move now to Slide 6. Here, we will highlight the key variations that impacted our cost in the third quarter of '19. As already mentioned on the previous slide, when compared to the same period of last year, costs, administrative, selling and construction costs increased by BRL 148.4 million or 5.5%. Including construction costs, the cost in the administrative and selling expenses increased by BRL 172 million or 8.6%. The main increases were BRL 141.9 million or 65.5% in general expenses, BRL 83.4 million or 22.8% in services and BRL 41 million or 17% in electricity expenses. Services, several factors contributed with the increase in expenses such as in highlighting expansion of services related to meter readings and delivery of bills and the increase in network maintenance and paving services.

Additionally, we can highlight the costs resulting from the agreement with Santo André related to the permanence of approximately 1,000 employees for 6 months. This represented a BRL 6.7 million increase in cost incurred for only one month that is September '19. It's important to remember that the number of employees assigned will drop to 400 starting in the seventh month of the contract signature.

General expenses were impacted by nonrecurring events, such as the termination of losses within the municipality of Guarulhos, the result of the agreement we entered into, as mentioned in the previous slide. We also had an increase in electricity consumption compared to last year third quarter. This is due to the new Guarulhos operations and the start-up of 2 very important investments, the Jaguari-Atibainha interconnection and the before mentioned São Lourenço Production System. On the other hand, we highlight the reversal of provisions for the retirees in the amount of BRL 173 million, positively impacting the salaries, charges, benefits and pension obligation accounts.

Well for a breakdown of these and other charges, costs, please refer to our earnings release.

Let's quickly go on to Slide 7. Here, we summarize the variations that affected the company's net income in the third quarter, always compared to second quarter -- sorry, third quarter '18. Net income, as already mentioned, reached BRL 1.2 billion. Net operating revenue increased BRL 1.6 billion. Costs and expenses, including construction costs, increased BRL 148 million. Other operating income and expenses, including equity income, had a negative variation of BRL 19 million. Financial results had a negative variation of BRL 457 million. And finally, income tax and social contribution increased BRL 331 million due to the higher taxable results in the third quarter of '19.

Let's move on. In case, we should be looking at Slides 8, 9 and 10. Starting, we would like to share with you a brief analysis of 3 management performance indicators namely, gross revenue per cubic meter, operating expenses per cubic meter and EBITDA per cubic meter built. This analysis, we took a historical series since 2014, using quarterly accounting data disclosed by the company. Additionally, we made some adjustments to isolate some extraordinary and relevant events that would distort the results. Additionally, to look at the performance for the period in the same basis, we brought all values at average prices for the third quarter of '19, updated by the EPCA (sic) [ IPCA ], which is the index used to adjust our inflation on yearly basis.

Our goal with this approach is to look at the company's performance through indicators over a longer period of time, and on the same price basis than in nominal terms on a quarter-over-quarter basis where specific events may lead to comparison basis problem as well as imposed difficulties in analyzing -- better analyzing the company's evolution and performance over time.

As you can see from these 3 slides, gross revenue shows a favorable and consistent evolution regarding operating expenses. It's clear that it evolves in a controlled manner and compatible with the expansion of our operations in the period, as a result of disciplined cost management. Lastly, largely as a result of the behavior of the gross revenue and operating expenses, we see a very consistent growth in EBITDA per cubic meter.

Now let's comment 3 points that we'd like obviously to highlight. So one of them this quarter was the beginning of operations on an emergency basis of Guarulhos sewage treatment services on August 22, following the breach of the agreement between the municipality of Guarulhos with the PPP [ Mongaguá ] operator. September with the objective of assuming 100% of the provision of public sanitation services.

In the municipality of Guarulhos, we signed a commitment letter for the preparation of an amendment for the main water and sewage public service agreement with the municipality of Guarulhos, which we signed on December 12, 2018.

In summary, we want to include the sewage treatment service in the main contract. This amendment should be done anytime soon. And at the time, we will obviously make it public, and we will communicate to the market.

Let me remind you that operating 100% of Guarulhos sewage services added with the provision of the same service in Santo André both will be a major step in the process of depollution of the Tietê water basin at the Tietê River.

Let's also comment on the tariff structure. As you may be aware, in May this year, ARSESP approved the Resolution No 865, which establishes the schedule of events to be observed in the revision of the company's tariff structure. As part of the schedule, just now, on November 15, the company submitted to ARSESP, our proposed tariff structure along with implementation plan. Next step will be the public consultation process, scheduled by ARSESP for April 2020, when the regulators should disclose more details in this matter.

Last point we would also like to comment refers to our debt in foreign currency. Today, 49.2% of the company's total debt is exposed to the exchange rate variation of the Brazil real against the U.S. dollar and the Japanese yen. This is due to the outstanding loans with multilateral banks, basically, IDB and IDB -- IBRD, the official Bank of Japan, we called it JICA. But just remember that these funding offer very long-term and low costs. And again, we also count with other funding instruments used in the capital and credit markets in our overall debt structure. Considering the current international and national macroeconomic conditions and their impact on interests and exchange rates, and in particularly, the significant reduction in the differential between internal and external interest rate, the company should, whenever possible, contemplate actions to capture opportunities that will result in a decrease in its foreign exchange exposure. In the case of debt with the multilateral and official banks, some of our current contracts already have currency exchange clauses that may be amended to include this option. In such, that there will be no need for the use of market currency hedging instruments for the execution of any debt currency exchange.

For other debt of the company in foreign markets, whether a private credit or a public financing that do not have currency exchange clauses, the company may resort to market currency hedging instruments to reduce the exposure. Company continues to prioritize assets and increasingly diversified credit sources, both internal and external, to support its investments, its cash and refinancing needs. And in this sense, we always evaluate the opportunity to carry out currency hedging operations based on conditions and cost offered by the market.

Well this concludes our comments, our highlights, and now we pass on to the Q&A session.

[Operator]

[Operator Instructions] There appears to be no questions in the question queue, and I would now like to turn the conference back over to SABESP's for their final remarks.

[Mario Sampaio, executive]

Okay. Thank you, everybody, for your time. We will definitely be back here soon for the fourth quarter results. So once more thanks. Bye-bye.

[Operator]

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