Companhia de Saneamento Basico do Estado de Sao Paulo - SABESP (SBS) 2017 Q1 法說會逐字稿

Good morning, 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 2017. The audio for this conference is being broadcast simultaneously through the Internet on the website, www.sabesp.com.br, and on the Engage-X platform, where you can also find a 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 and Exchange Commission Private 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 Mr. Benedito Braga, Chairman; Mr. Jerson Kelman, CEO; Mr. Rui Affonso, Chief Financial Officer; Mr. Marcelo Miyagui, Head of Accounting; Mr. Mario Arruda Sampaio, Head of Capital Market and Investor Relations, and Mr. [Silvio Xavier], Head of Costs and Tariffs.

Now I'll turn the conference over to Mr. Arruda Sampaio. Sir, you may begin your conference.

Okay. Good morning, everybody, and thank you for attending this conference call. Here, we will discuss the results for the first quarter of '17, talk a little bit about tariff revision and the material fact on the approval by the state for us to initiate studies on a possible capitalization of SABESP.

So we have here, specifically in terms of Slide 4, so let's move on those, and afterwards, we're going to have a Q&A question.

Also, starting on Slide 3, we show the company's billed water volume and sewage volume, which was up 6% in the first quarter of '17, with an increase of 6.1% in water and 5.9% in sewage. On the slide, you can also see billed water volume behavior, which has been increasing and improving since the third quarter of 2015 when the water situation began to improve. In this quarter, billed water and sewage volume was equivalent to the billed volume in the third quarter of '13, so we're picking up a very hot period right before the beginning of the water crisis, okay?

Let's move to Slide 4. Let's talk very quickly on the financial results. Net operating revenue increased 17.5% over the first quarter of '16, chiefly due to the 8.4% tariff increase since May '16. The 6% increase in total billed volume, 6.1% of which in water and 5.9% in sewage. And the granting of bonus, totaling BRL 153 million in the first quarter of '16, which is not present anymore. And at the time, this was part of the crisis demand control. So again, this ended on April, not affected -- not present now.

It is worth also noting that the increase costs by these factors we have just mentioned was partially offset by the end of the contingency tariff also, which totaled BRL 160 million in the first quarter of '16.

Costs and selling and administrative and construction expenses increased 5.5% or BRL 132 million in the period.

Adjusted EBITDA totaled BRL 1.4 billion, 49.1% higher than the BRL 907 million recorded in the same period last year. The adjusted EBITDA margin came to 38% in the first quarter of '17 against 30% in the first quarter of '16. If we exclude the construction revenue and construction costs, the adjusted EBITDA margin was 47.2% in the first quarter of '17 against 37.2% in the same period last year. Quick note, 47% is higher than the average we had pre-crisis.

Net income totaled BRL 674 million against BRL 628 million in the first quarter of '16.

Let's move to Slide 5. Let's discuss the main variations in costs in the first quarter. In comparison with the first quarter of '16, costs, expenses, including construction costs increased 5.5%. Excluding these construction costs, costs and expenses climbed by 2.1% from year-to-year. Costs and expenses represented 71.3% of net revenue in the first quarter of '17 versus 79.5% in the same period last year. This increase was mainly led by 53.5% upturn in estimated losses with doubtful accounts. And it's worth noting that decline in 16.9% in electricity and 6.9% in general expenses.

Again, for more details, please refer to our press release and earnings release. You'll get the detail there.

But still, let's move to Slide 6. Let's present the main variations between the first quarter '16 with the first quarter '17 and the items that affected our net income, which totaled BRL 674 million.

Net operating revenue increased BRL 531 million or 17.5%. Costs and expenses, including construction costs, grew BRL 132 million or 5.5%. Other operating revenues and expenses were BRL 4.8 million.

Net monetary exchange rate variations and financial expenses had a negative variation of BRL 336 million. This was mainly due to the lower dollar depreciation and the appreciation of the yen against the real in the first quarter of '17, basically 2.8% and negative and positive 1.9%, respectively, compared with the devaluation of these currencies in the first quarter of '16, which was negative 8.9% and negative 2.4%, respectively.

Finally, on this slide, income tax and social contribution moved up BRL 21.4 million. This was mainly due to the increase in operating revenues. These upturns were partly offset by the worst financial result in the period, impacted by exchange rate fluctuations.

Now let's comment on the tariff, which we mentioned in the beginning. On May 9, we issued a material fact requesting ARSESP to postpone the stage -- the preliminary stage of the tariff process in 30 days. And the next day, ARSESP published the authorization 722 that granted the postponement. The reason that we asked for this postponement is our understanding that the profit is complex and needs further improvement as we move. In this sense, we have to make a choice between time line or the quality of the regulatory process. We chose the quality.

The specific point that drove our decision refers to the exclusion of networks from the asset base in the first cycle. If you remember, the nominal value at that time was BRL 6 billion, so we want to work on that. Considering that we concluded our studies to present to the regulator on this subject, we saw that no need for this discussion to be left for the final stage of the tariff review in April 2018. For this reason, and considering that we understand that ARSESP will need more time to review this document, we asked for the postponement.

To this point, it's worth remembering that ARSESP faced a hard time undertaking the bidding process to hire the needed consultants for the implementation of the tariff review. This is mostly due to the complexity of the process. But the good news is that they just overcame this problem and are now in a better position to run this process.

Last, as mentioned before, the Tariff Revision Process requires processing a large amount of information and details. So with more time for this for us to provide information and the regulator to analyze, again, we think this is going to be more precise and the results would be better.

Let's move now to the next subject, which is the capitalization of SABESP. Last Friday, we published a material fact making reference to the approval of the State of São Paulo public sector reduction program that authorized hiring consultants to undertake studies that will make possible SABESP to capitalize itself. This initiative is driven by the demand from society for us to accelerate investments and reach full penetration on a shorter period of time. Considering that the company find itself in a prudent indebtedness level and the initiatives to do this will be through credit, this is loans and debt issuance, and we'll take it -- and this will take it to a debt level undesirable. So the only way to do this is capitalizing the company.

Now considering that the government of São Paulo is at the limit of dilution of its control, the only way we could do this is with equity from the private sector. But how to do this? But before talking about this, let's outline the basic assumptions that will guide this process.

First and foremost, it needs to maintain the state government control, so there will be no privatization. It needs to secure all concession contracts and our relationships with the municipalities, so we would not put at risk our concession base, which means our revenue. Maintain our access to multilateral, important, long-term and low-cost cost funding. Obviously, respect and deal with the best governments and transparency possible, SABESP minority shareholders. Very important, maintain the company listed in the Novo Mercado in BOVESPA. And the capitalization of SABESP will be made, if made, will be made through a public offering. In this way, what is being done now, and that's important, and was approved are studies to find the best way to achieve this objective.

Also important to highlight is that all this process will have to go back to the state government public sector reduction program, the same that just approved the beginning of the studies, as much as it needs and will need approval from the state legislative branch.

So this finalizes this presentation. Now we will move into the Q&A questions.

(Operator Instructions) Our first question is from Michael Gaugler with Janney.

Maybe you could just give us a little more color on what -- how you would be using the proceeds from this potential public offering? What the thoughts are around that?

Okay, Michael, a second.

Michael, it's Rui. The use of proceeds of this potential capitalization of SABESP, the intention here is to improve our CapEx expansion capacity without any compromise with our sustainability in our financial index. So the proposal is expansion and with the same good results we have been able to prove to you, our investors. That's the point.

Okay. I guess, what I was thinking about was more, is it just simply to pay down debt? Avoid debt? Or perhaps make acquisitions outside of your core geographic region?

As we used to say, the main goal of SABESP and the low-hanging fruits are in São Paulo. Inside São Paulo, inside our operation base, there's lots of growth opportunities already. If you go outside, outside, I mean, outside São Paulo or outside our main field operations should be something very close what we have already done. I mean, some other businesses, very tightly connected with water and sanitation, like waste-to-energy, like reused water, and so on and so forth.

Our next question comes from Lilyanna Yang with HSBC.

You mentioned in the earlier call in Portuguese that the capital increase idea is in its initial stages that it could take up to 12 months to have it, and the goal would be to actually have better governance standards by bringing investors at the holding company level. We're fine with that. Actually, I do see the benefits there. I was just wondering if you could give a little bit more color on the potential capital increase of SABESP, right? Sorry to insist on the question, but I wonder what is the best targeted net debt-to-EBITDA level for the company that if you think you should go below the 2x net debt, which we think is maybe not ideal, especially when taking into account that the latest interest rates in Brazil are coming down and faster than anticipated. And I'm wondering if you could also give us a little bit more of color on what you expect to achieve in the rate review negotiation on a preliminary basis for this year in June, actually now in July? If you think that you have good chances of having the regulator assume in the tariff the BRL 7 billion in regulatory asset base that have been disputed since 2012.

Lilyanna, it's Mario. On your first question, the objective is to stay on the net-debt and total debt levels that we are today. We're not going to deleverage, and we don't want to leverage. The entire objective is to increase and accelerate investments without further increasing indebtedness. On the other hand, it's not to pay down debt. It's not to pay dividends. It's essentially to run the business in a more speed and higher-level investment rate. I think that's it. I'll pass the word for the second to Rui. Just a second.

Lilyanna, it's Rui. As you probably agree, we don't have the ability to know how ARSESP will consider from our request. This pending BRL 7-point-something spending from the first cycle, we are working on that. We present to them several detailed field research that we have made, so we've tried to get the moves. But we have no idea that the result at the end of the day how part of percentage of this request they will, at the end of the day, consider.

Yes, so it's more likely they will consider this year? Or do you think that the outcome might still come out only next year or later?

Well, the proposal of our -- the postpone of until 30 days was to give them time on elements to consider at least part of this BRL 6 billion to BRL 7 billion left behind from the first cycle. That's the proposal. But we will realize how much they can be able to analyze first, and then second, to consider.

Our next question is from Humberto Medina with CNS.

I had two questions. The first one is, I want to make sure, going back to what Lilyanna talked about, that under no circumstances, the capital raise would come ahead of the rate -- pending rate increase that was just delayed. And then the second question is, I want to clarify, would the State of São Paulo sell part of their ownership? Or the dilution would come just by raising additional capital and then just obviously, by São Paulo not really selling but getting diluted?

Okay, Humberto, just a second please. Look, Humberto, on the second question, the government has to keep control, in any case, as much as he has today. So there is a vehicle, which will be used, he has to keep control on that. Now if he's going to be diluting or not, it's not what we're in discussion here. The discussion here is how can we bring additional capital, raise capital to -- in such that we can issue shares at SABESP and increase equity in SABESP. So that's what...

Yes, I understand that. I guess, the question I had is, would the State of São Paulo sell a portion of their stake as part of this process? Or would they not sell and just raise additional capital, and therefore, through raising the capital, they would get diluted?

No, the point, Humberto, is that we will undertake studies. We have enough information that we think it's something worth going after. Now what and how it's going to work and whatever comes out does or does not open the door for the government to dilute itself without losing control, that's really of their decision. This is not the discussion. That was not the decision that was made by the government at this point, and this is -- and what we're announcing here, having a discussion with you. In any case and whatever happens, there's only one thing we all know. The state is not going to lose control, okay?

Okay, we can follow up on that. And what about the timing of this? You mentioned that, obviously, it's early stages. Is there any scenario under which the capital raise could come ahead of the rate increase that is pending?

Just a second. Humberto, Rui is going to answer.

So, Humberto, despite the fact that the two process are interconnected, I mean, the tariff revision and the capitalization of SABESP, they are different in a sense that we can -- we meet and we count with a robust tariff revision as including -- as inclusive, as part, as a support of the capitalization. What I'm trying to say, that there's no trade-off between one thing and the other. We are trying to move fast and get a robust tariff revision, the provisory one and the final one at the beginning of 2018, and to get the conclusion of the process of capitalization of SABESP in front, I believe, at the end of the -- this year. In the first call, we said that it's very important to conclude it, the capitalization of SABESP, before 2018 in order to avoid some contamination of this very technical process with political agenda in 2018. So despite the fact that our connections, you are right, we have tried to treat those actions to induce movements separate.

This concludes our question-and-answer session. I would like to turn the conference back to SABESP for their closing remarks.

Well, I'd first thank everybody for participating and I think to take advantage to comment that today, SABESP's management is in New York at the New York Stock Exchange. We are celebrating 15 years of our ADR program. So hope to see you next quarter and in 5 years for the 20 years. Thank you very much. Bye-bye.

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