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We have recently downgraded Companhia de Saneamento Basico do Estado de Sao Paulo, or SABESP (SBS - Analyst Report) from Neutral to an Underperform recommendation, anticipating its performance to lag behind the broader market.

Why the Downgrade?

SABESP is one of the leading water and sewage service providers in Brazil. The company is constantly making earnest efforts to improve its services and investing to enhance growth and achieve its targets of serving roughly 1.3 million new water connections and 1.7 million new sewage connections by 2019.

Despite these endeavors of the company, we have currently downgraded SABESP anticipating lack of share driving catalysts. Year-to-date return of negative 15.9% also supports our revised recommendation along with the reasons mentioned below:

SABESP’s loans and financings, ending the first quarter 2013, stand at a staggering R$8.0 billion, reflecting a 6% sequential increase. Also, expenses are on the rise for SABESP as is evident from a 3% increase in cost of sales and 1% hike in operating expenses registered in the first quarter 2013. Further increases in long-term debt and expenses will put pressure on the company’s financials and thus, impact profitability.

Moreover, risks arising from increased political interference pose potential threats to growth. The government of São Paulo owns part of SABESP’s outstanding shares, which gives it the power to control the election of the majority of the members of the board of directors and the senior management. Under such circumstances, the possibility of regulatory uncertainty or delay by the government to make important decisions remains a major hindrance.

The Zacks Consensus Estimate for SABESP has gone down by 13% to $1.07 for 2013 and decreased by 11.4% to $1.55 for 2014, in the last 60 days.    

Other Stocks to Consider

SABESP currently has an $7.4 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 Aqua America Inc. (WTR - Snapshot Report).

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