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We have recently downgraded Companhia de Saneamento Basico do Estado de Sao Paulo, or SABESP (SBS - Analyst Report) from Outperform to a Neutral recommendation, anticipating its performance to be in line with the broader market.

Why the Downgrade?

SABESP is a renowned water and sewage service provider in Brazil and offers water and sewage services to roughly 24.3 million and 21.1 million people, respectively. The company has an ambitious long-term target to achieve roughly 1.3 million new water connections and 1.7 million new sewage connections by 2019.

Moreover, investments worth R$9.9 billion have been planned over 2013-2016 to improve the company’s water supply coverage, sewage collection and treatment of collected sewage services. SABESP also spent approximately R$362 million in 2012 on its Water Loss Reduction program.

Despite the company having a promising future, we have downgraded SABESP due to the near-term concerns that surround the stock. Rising debts is a major concern for the financial health of the company. Moreover, risks from increase in expenses as well as political interference pose potential threats to growth.

A glimpse into the recently reported first quarter 2013 results justifies all our concerns. Loans and financings grew by 6% sequentially to R$8.0 billion at the end of the first quarter of 2013 while expenses soared as cost of sales and services grew 2.7% and operating expenses registered a 1% increase.

The Zacks Consensus Estimate for SABESP has gone down by a cent to $1.23 for 2013 and increased by 3 cents for 2014.    

Other Stocks to Consider

SABESP currently has an $8.7 billion market capitalization. Other stocks to watch out for in the industry are American States Water Company (AWR - Snapshot Report), Consolidated Water Co. Ltd. (CWCO - Snapshot Report) and Middlesex Water Co. (MSEX - Snapshot Report), each with a Zacks Rank #2 (Buy).

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