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Sao Paulo, Brazil-based Companhia de Saneamento Basico do Estado de Sao Paulo, or SABESP’s (SBS - Analyst Report) net income for the second quarter 2011 improved 50.1% year over year and more than doubled sequentially to R$479.6 million (US$301.6 million), or R$2.11 per share (US$2.65 per ADR). Earnings per ADR also surpassed the Zacks Consensus Estimate of US$1.91 per ADR by a wide margin.

SABESP’s impressive earnings performance was due primarily to lower operating and financial expenses in the quarter.

Revenue

In the second quarter, consolidated net revenue improved 3% year over year to R$2,341.6 million (US$1,472.7 million) and fared better than the Zacks Consensus Estimate of US$1,416 million.

Billed water and sewage volume in the quarter went up by 3.1% year over year to 874.5 million cubic meters. Of the total volume reported, roughly 57.9% represented water variation and 42.1% of sewage. The increase in billed water and sewage volume was due to higher number of connections and acceleration in consumption.

Water loss rate in the second quarter was stable year over year at 26%. Water volume produced in the quarter went up 2.5% year over year; water connections increased 2.5% and sewage connections rose by 3.7%.

Margins

SABESP’s cost of sales and services, as a percentage of revenue, soared to 61.5% from 57.3% in the year-ago quarter, thus hitting the gross margin by 4.2%. Operating expenses, including selling, administrative and other expenses, improved in the quarter and settled at 10.9% of total revenue versus 16.2% in the year-ago comparable quarter.

EBITDA in the quarter was around R$775.7 million (US$487.9 million), up 3.1% year over year with a margin of 33.1%. 

Balance Sheet

Exiting the second quarter, SABESP had cash and cash equivalents of roughly R$2,174.5 million (US$1,385.0 million) versus R$2,399.8 million (US$1,463.3 million) in the previous quarter.  Loans and financing, net of current portion plummeted 1.4% sequentially to R$7,105.9 million compared with R$7,207.1 million in the previous quarter.

Cash Flow

In the second quarter, net cash flow from operating activities jumped by 51.4% year over year to R$801.6 million (US$504.2 million). Capital spending on property, plant and equipment together with intangible assets were R$483.6 million (US$304.2 million), reflecting an 11.1% year-over- year increase.

Following its second quarter 2011 earnings announcement, SABESP keeps up its position as the largest water and sewage services provider in the world, serving roughly 23.8 million customers for water and 20.2 million for sewage.

The company faces stiff competition from Veolia Environnement S.A. (VE), a privately held Thames Water Holdings plc, and GDF Suez. We currently maintain an Underperform recommendation on the stock.

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