We have recently upgraded our recommendation on Companhia de Saneamento Basico do Estado de Sao Paulo, or SABESP (SBS) from Underperform to Neutral, anticipating the company to perform in-line with the broader market.
Why the Upgrade?
In Brazil, industries like tourism, steel, electricity, among others offer promising growth especially as the country is gearing up to host the upcoming 2014 Soccer World Cup and 2016 Olympics sporting events. The Brazilian government, under its Growth Acceleration Program or PAC – phase II, has major investments planned for development of ports, railroads, airports, wind farms and roads. Other areas of focus are sanitation, energy, logistics etc.
SABESP is a well renowned water and sewage service provider in Brazil operating in the State of São Paulo. At the end of the second quarter of 2013, the company’s water and sewage connections were approximately 7.8 million and 6.2 million, respectively.
For the long-term, SABESP is making earnest efforts and investments to achieve both targets of over 1.3 million new water connections and 1.7 million new sewage connections by 2019. Further to service improvement, the company has allocated approximately R$9.9 billion to finance its capital investment plans for the 2013-2016 timeframe. Recently, the company signed an agreement to control the water and sewage services of Diadema for the next 30 years.
Talking of SABESP’s financial performance, second quarter 2013 results were quite impressive. Earnings per ADR at US$0.26 registered 18.2% increase and revenue grew 13.0% on higher water supply, sewage collection and treatment in the quarter.
All the above discussions were the prime reason for the recommendation upgrade for SABESP. The upgrade has been restricted to a neutral view due to near-term concerns arising out of factors such as rising cost of sales and services as well as operating expenses, debt levels and political interference among others. In the second quarter 2013, cost of sales and services increased 10.5%, operating expenses rose by 30.8% and loans and financings reflected 3.4% sequential increase.
Other Stocks to Consider
SABESP currently has a $6.9 billion market capitalization. Other companies to watch out for in the industry are Connecticut Water Service Inc. (CTWS) and Consolidated Water Co. Ltd. (CWCO), each with Zacks Rank #1 (Strong Buy) while SJW Corp. (SJW) has a Zacks Rank #2 (Buy).