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We recently downgraded our recommendation on Saneamento Basico do Estado de São Paulo or SABESP (SBS - Analyst Report) from Outperform to Neutral, anticipating the company’s performance to be in line with the broader market, going forward.

The company is considered to be one of the largest water and sewage service providers in Brazil. It primarily serves the State of São Paulo, the industrial and economic hub of the Brazilian economy that solely accounts for about one third of Brazil’s GDP.

The company’s non-cyclical and regulated utility business positions it well for the long term. It is making constant endeavors to improve its services and reach 1.3 million new water connections and 1.7 million sewage connections by 2019. An amount equal to R$7.9 billion has been allocated, setting aside roughly 40% for Sewage collection, 32% for Water supply and 28% for Collected sewage treatment for the 2012-2015 time frame.
Despite these long-term positive aspects, we have some near-term concerns that override our positive sentiments for the stock. Financial performance for the third quarter 2012 was below our expectation with earnings per ADR of US$1.59; falling short of the Zacks Consensus Estimate of US$2.13.

Moreover, headwinds emanating from escalating cost of sales and services (roughly 59% of total revenue), political interference, mounting debt levels and risk of foreign exchange losses cannot be ignored.

Hence, we preferred to remain on the sidelines on the stock. The current Zacks Consensus Estimate for the fourth quarter of 2012 is $2.73, representing a year-over-year increase of 15.2%. Estimates for 2012 and 2013 are $8.40 and $9.26, reflecting annual growth of 42.4% and 10.1%, respectively.

The stock currently has a Zacks #3 Rank, implying a short-term (1-3 months) Hold rating while its nearest competitor Veolia Environnement S.A. also bears the same Zacks #3 (Hold) Rank.

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