Companhia de Saneamento Básico do Estado de São Paulo - SABESP

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 3/5

Companhia de Saneamento Básico do Estado de São Paulo - SABESP (SBSP) is a Brazilian state-owned water and sewage utility company, providing services in São Paulo.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

SABESP’s core business revolves around providing integrated water and sewage services, serving both residential and industrial customers.

  • Revenue Streams: The company generates revenue primarily from:
    • Water supply and sanitation services: This is the major source of revenue, generated from tariffs charged to customers for providing potable water and sewage services.
    • Construction revenue: This comes from large infrastructure projects related to new and improved systems.
    • Other revenues: These revenues come from minor additional areas of service.
  • Industry Trends: The water and sewage industry in Brazil is undergoing several notable trends:
    • Regulatory Changes: There is a new regulatory framework to create more stability and consistency to increase the amount of private investment. The regulatory landscape is complex and often changes.
    • Infrastructure Needs: There is huge need for investments to update and expand water and sewage systems, as much of the infrastructure is old and not adequate for population growth.
    • Water Security: Scarcity of water resources is becoming increasingly relevant. This may lead to stricter conservation measures and an increased focus on water reuse.
    • Privatization: There has been a debate about privatization of some of SABESP’s areas. While the state has opted against it, the topic could always return.
    • Cost Cutting and Efficiency: Due to high operating costs, companies in the industry are under pressure to increase efficiency and cut costs.
  • Margins: The operating margins of the company show some volatility, due to price controls and changing regulations. There has been some improvement in the company’s EBIT and operating margins in recent years. They do seem to have good gross margins and are able to convert a lot of revenue into gross profit.
  • Competitive Landscape: SABESP is a major player in the state of Sao Paulo and has a near-monopoly because of being a state-owned utility. Because the industry is capital intensive and requires significant regulatory and political approvals, there is very limited new competition in their industry. Competition mainly comes from smaller, municipal owned utilities or local providers of water and sanitation services.
  • What Makes SABESP Different?: The company is a state-controlled water company, that is focused on delivering potable water to the people of São Paulo. That also means that it has the backing of the government, which makes financing easier.

Financials

The company’s financial situation has been improving, and it seems to have come out of financial troubles. They have a stable revenue, and in the latest report there are no more concerns of going concern.

  • Revenue Growth:
    • The consolidated revenue was R$21.2 billion for the year ended December 31, 2023 and R$17.8 billion for the year ended December 31, 2022.
    • The company continues to improve its operational efficiencies as it has continued to reduce its operating costs, and has improved the conversion of revenue into profit.
  • Profitability:
    • Net profit reached R$3.4 billion in 2023, compared to a loss of R$303.9 million in 2022 and a profit of R$1.4 billion in 2021.
    • The company is becoming more profitable. While it has improved, it is quite volatile, because of non recurring items that impact net income.
  • Financial Position:
    • The financial position of the company has improved, and net debt has decreased from R$11.1 billion in December 2021 to R$8.7 billion in December 2022.
    • Despite that improvement, the company still has a significant debt load of R$25.5 billion, mainly from funding projects.
  • Cash Flow:
    • Operating cash flow was a solid positive, with R$5.7 billion generated during 2023.
    • It is important to understand that free cash flow, while positive, is substantially less at R$2.8 billion. This is caused by large capital expenditures.

Moat Analysis

  • SABESP benefits from several moats, though their width is not that high:
  • Regulatory Approvals: The concessions that are required to operate in the Brazilian water/sewage market act as a barrier to entry. These are time-consuming to obtain, and new entrants must clear a regulatory review. However, existing concessions don’t guarantee sustained profits, they only guarantee the monopoly for water provision in a given geographical area.
  • Location: The company is situated in a populous region, with high demand for water and sanitation services. It is difficult for a competitor to move into its market, so proximity gives SABESP a cost and market advantage.
  • Network Density: As SABESP serves large areas, it has a dense and extensive distribution system. Competing companies would have to try to build the same network and incur large upfront capital expenditures.

Risk Factors

  • Regulatory Changes: Future tariffs and regulations could change, negatively affecting the company’s profitability. There is little predictability about pricing in general.
  • Political Intervention: As a state-owned entity, SABESP is exposed to political risks. These risks have historically been very damaging, when governments interfere and change the management.
  • Water Scarcity: The risk of drought and water scarcity will have a huge effect on the business.
  • Debt Load: High levels of debt expose the company to interest rate increases.
  • Recent concerns from the company mention that the proposed concession agreements could reduce the company’s total revenue and profit, if the regulations are not favorable to their business model. The company faces the risk of not being able to pass its cost increases to the customers, if the new regulators limit tariff increases. There are also changes being proposed for how much capital the company needs to have to operate.

Understandability Rating

4 / 5 While the business of providing water and sanitation services is straightforward, understanding the intricacies of the regulatory environment, the capital structure, and the way the company deals with political risk is quite complex. Moreover, financial statements need a lot of analysis, to correctly assess its business and financial performance.

Balance Sheet Health

3 / 5 The company is slowly improving its financial health after a difficult few years. Currently, they have a huge debt, but their cash flows are improving, so the situation should get better.

  • High Debt Load.
  • Positive cash flows.
  • Slowly improving ROIC, profit, and revenues.