SBS Stays on the Sidelines

We reiterate our Neutral recommendation on Saneamento Basico do Estado de São Paulo or SABESP (SBS - Analyst Report).

Time and again, SABESP has been retaining its position as the largest water and sewage services provider in the world. SABESP’s non-cyclical regulated utility business in the Brazilian emerging market is an attractive and relatively low-risk investment opportunity. We believe the company will continue to make a constant effort to improve its services and in turn, will keep improvising its business portfolio through strategic investments.

However, mention may be made of the adversaries that the company has been facing over the last few quarters. SABESP has been witnessing a steady rise in cost of sales and services, which has been impacting its margins. The company relies heavily on electricity as a source of energy for its pumping stations, which continues to suffer from rising electric power cost. Even the prolonged drought dampens our outlook on the company.

Even under such tender circumstances and operational threats, SABESP has maintained its position as one of the largest players in the industry providing public water and sewage services in the State of São Paulo. The company recorded a rise in billed water and sewage volume during the third quarter primarily driven by higher number of connections and acceleration in consumption. The company’s long-term prospects appear bright as it aims to provide roughly 1.3 million new water connections and 1.7 million new sewage connections by 2019.

Nevertheless, the company’s mounting debt and forex losses remain a cause of concern. Political interference, regulatory uncertainty along with governmental delays also added to the peril. On this backdrop, the company’s debt load from trustworthy national and international credit agencies controlled our anxiety to some extent. Moreover, the company maintains a satisfactory liquidity position, reporting an 18.8% y/y increase in cash flow from operating activities in the third quarter of 2011. The effort looks encouraging and conducive toward further investments.

The company, providing public water and sewage services in the State of SãoPaulo, Brazil, faces stiff competition from its peer Veolia Environnement S.A. (VE - Snapshot Report). Currently, SABESP has a Zacks #4 Rank, implying a short-term (1-3 months) Sell rating.

Read the full analyst report on SBS

Read the full analyst report on VE