Fitch Affirms Sabesp's IDR at 'BB+'; Outlook Revised to Negative
RIO DE JANEIRO -- May 23, 2014
Fitch Ratings has affirmed Companhia de Saneamento Basico do Estado de Sao
Paulo's (Sabesp) foreign currency and local currency Issuer Default Rating
(IDR) at 'BB+' and its National long-term rating at 'AA(bra)'. The Rating
Outlook has been revised to Negative from Stable. A full list of rating
actions follows at the end of this release.
Key Rating Drivers
The revision of the Rating Outlook reflects Sabesp's challenging scenario
which makes it uncertain that the company can report credit metrics in line
with the current ratings in 2014 and 2015. Fitch estimates a relevant
reduction in Sabesp's cash flow generation at least in 2014 as a result of a
severe rainfall shortage coupled with the company's decision to postpone to
December 2014 the 5.4% tariff increase implementation as approved by the
regulator on the conclusion of tariff revision. The tariff increase has been
authorized as in effect since May 1, 2014. The deteriorated financial profile
should improve as soon as hydrological conditions return to normal standards.
Sabesp faces a stressed operating environment given the prolonged low levels
of rainfall in the Sistema Cantareira reservoir region, which is responsible
for producing nearly one-third of the total volume of water produced by the
company and for the supply of its main region of service. Sabesp has taken
measures to avoid water rationing, which includes an incentive program to
reduce water consumption in the metropolitan region of Sao Paulo effective
until December 2014. Under this scheme, the company is to grant a 30% tariff
discount for clients that reduce by 20% the volume of water consumed.
Sabesp's ratings are supported by its historical growing demand for its
services and predictable cash flow generation under a regular hydrological
environment. The company benefits from high EBITDA margins compared to its
peer group, an extended debt maturity profile and robust liquidity position,
which should partially mitigate the current operational concerns. The ratings
incorporate the company's near monopolistic position in its business area, as
well as the economies of scale obtained as the largest basic sanitation
company in the Americas by number of customers.
The analysis considered the risks associated with Sabesp's high percentage of
foreign currency debt on its balance sheet and the still-new regulatory
environment for the company. Fitch also factored in the political risk
inherent with its control by the State of Sao Paulo, with the potential for
changes in management and strategy after each election. Cash flow generation
can be jeopardized due to political decisions.
Severe Drought Pressures Leverage
Fitch's current projections assume that Sabesp's net leverage should grow to
above 4x in 2014, which is high for its rating category and compares
unfavorably with the 2.4x achieved in the last 12 months (LTM) ended March
2014. The projected deterioration in leverage is due to the estimated negative
impact on the company's operational cash flow caused by very low rainfalls in
Sabesp's main water reservoir area. The company's initiatives to decrease
water consumption, which include a tariff discount of 30% if a 20% reduction
is reached, should lower volumes billed and revenues. The postponement of the
tariff increase in 2014 adds pressure on Sabesp's credit profile. Sabesp's net
leverage may recover to a level aligned with the current ratings as soon as
hydrologic conditions return to a normal pattern and the company lifts its
water reduction incentive program. Historically, the company has been
efficient in sustaining reduced financial leverage for its operating segment.
Fitch estimates that the company may breach few of its convenants, which
should be waived during the challenging operating scenario. Sabesp is
currently subject to leverage/EBITDA below 3.65x and EBITDA margin above 38%
High and Predictable Cash Generation Weakened in 2014
Sabesp's decision to postpone the tariff increase implementation up to
December 2014 weakens its cash generation, particularly under such a stressed
operating scenario, and places further pressure on its ratings. The decision
also highlights the political influences the company is subject to given its
majority ownership by the state of Sao Paulo and considering 2014 is a state
government election year. Fitch estimates the company's net revenue decrease
of around 16% (net of construction revenues) during 2014, which should be
partially mitigated by the tariff adjustment of December 2013 (3.15%) and the
volume growth of around 2.5% out of the affected region. Fitch also considered
Sabesp's EBITDA margin deterioration to 33% in 2014 versus the 44% EBITDA
margin during the last four years as average.
In recent years, Sabesp's operational cash generation has been robust,
supported by the consistent growth of its activities. Excluding construction
revenue, the company's net revenue of BRL9 billion during the LTM ended March
2014 grew 7% against LTM ended March 2013, benefitting from tariff rebalancing
of 2.35% in March 2013 and tariff adjustments of 3.15% in December 2013 and
5.15% in September 2012. The company has also reported a higher volume of
water and sewage billed of around 2.8%. During the same period, Sabesp
reported EBITDA of BRL4.1 billion, with a 45% margin (excluding the
construction revenue), which is strong for the industry and reflects the
company's capacity to maintain its operating efficiency.
Investments Pressure Free Cash Flow
Fitch believes that Sabesp should continue to report negative free cash flow
(FCF) in view of the high annual investments foreseen, around BRL2
billion-BRL2.5 billion, mainly focused on the expansion of sewage collection
and treatment services. Lower cash flow from operations (CFFO) in 2014 should
bring FCF to a more negative result this year of around BRL800 million. During
the LTM ended March 2014, Sabesp reported strong CFFO of BRL2.8 billion, which
compares favorably to BRL2.3 billion in 2012. The FCF was negative at BRL57
million, pressured by these aggressive investments, which amounted to BRL2.3
billion, coupled with the dividend distribution of BRL499 million in the same
High Liquidity Mitigates Refinancing Risks
The maintenance of substantially more robust liquidity positions since 2010
reduces Sabesp's debt refinancing risk and should benefit the company within
the current deteriorated operating environment. The company's proven access to
debt markets and manageable indebtedness maturity profile should also
contribute to its financial flexibility. As of March 31, 2014, Sabesp's cash
and marketable securities position was sound at BRL2 billion. The BRL622
million in short-term debt resulted in a comfortable coverage ratio by
liquidity of 3.2x, 1.4x when including total payments maturing until 2015. In
the same period, Sabesp's total adjusted debt was BRL11.7 billion, with a
significant portion (BRL3.7 billion, or 31% of total debt) exposed to exchange
rate fluctuations. The company does not carry any hedging instruments, which
could generate negative pressures on the company's credit metrics and
financial covenants in the event of a significant devaluation of the Real.
The Negative Outlook could result in a downgrade if Sabesp's challenging
operating scenario persists for a longer time or the company fails to return
its credit metrics to previous levels, with a net leverage remaining
consistently above 4.0x.
A Rating upgrade is unlikely in the short term. In the medium- to long-term
upgrades may result from lower operational cash generation committed to
investments or cash generation growth above Fitch's expectations, combined
with net leverage below 2.0x. Lower FX debt exposure and reliance on frequent
debt rollovers should also benefit future assessments.
Fitch has taken the following rating actions.
--Local currency long-term Issuer Default Rating (IDR) affirmed at 'BB+';
--Foreign currency long-term IDR at affirmed at 'BB+';
--USD140 million notes affirmed at 'BB+';
--USD350 million notes affirmed at 'BB+';
--National long-term rating affirmed at 'AA(bra)'.
The Rating Outlook for the corporate rating has been revised to Negative, from
Applicable Criteria and Related Research:
--'Corporate Rating Methodology', including 'Parent and Subsidiary Rating
Linkage', dated Aug. 5, 2013.
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and
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