Regulator Snaps Sabesp Stock Rally on Rate Recommendation

Shares of Cia. de Saneamento Basico do Estado de Sao Paulo snapped a rally after a state regulator recommended a water-rate increase that was less than investors expected.

Water regulator Arsesp, in a statement on its website, proposed a maximum rate increase of 4.66 percent. The proposal didn’t include a surcharge to recover royalties that is “a key risk factor,” Citibank analyst Marcelo Britto said in a report today. It was also based on a lower asset valuation than that estimated by Sabesp, he said.

Investors had been betting that the utility -- which says its rates are the lowest among 24 water utilities in Brazil -- would win a bigger increase, according to Henrique Kleine, head analyst at Sao Paulo-based brokerage firm Magliano SA. Arsesp is accepting public comment and will announce a final decision on April 10.

Shareholders “are disappointed,” Kleine said in a phone interview. “Now Sabesp will make its case to the regulator and could still get a higher raise by the end of the negotiations.”

Sabesp fell 3.8 percent to 22.36 reais at 1:50 p.m. in Sao Paulo. The stock had rallied 12 percent through yesterday since falling to a 2014 low on Feb. 5, topping the 3.4 percent gain for the benchmark Ibovespa index. The company traded at 7.5 times estimated 2014 earnings yesterday, compared with an average of 18.9 times for global utilities, according to data compiled by Bloomberg. Of 14 analysts rating the stock, eight say buy and six say hold.

‘Black Hole’

Sabesp won approval in November to increase rates for water and sewage services by 3.14 percent, effective in December, according to a regulatory filing. The changes have been set by Sao Paulo state on an annual basis, and will now be regulated by Arsesp, said Michael Gaugler, senior vice president for equity research at Brean Capital LLC.

“The profitability of the company is pretty much a black hole,” he said. “You don’t know what it’s going to be until they finalize the tariff.”

Sabesp’s reservoir supplying 10 million people in greater Sao Paulo fell to an all-time low of 18.8 percent of capacity after the hottest January on record. That spurred Sabesp, as the company is known, to offer 30 percent discounts to clients who cut usage, a step that Moody’s Investors Service estimates may pare earnings by as much as 11 percent.

Brazilians more accustomed to floods than dry spells have rarely given a second thought to turning off the water while doing dishes or shampooing, said Giuliano Dragone, president of the water and sewage industry group Sindcon. Conservation awareness is low compared with places like California, where residents also face a statewide drought.

Loudspeaker Vans

Sabesp is sending vans with bullhorns into neighborhoods urging residents to stop hosing down sidewalks and instead sweep up with brooms. Telemarketers are also calling with tips such as not using the toilet as a flushable ashtray.

“The intensity of the heat this year is off the charts,” Dragone said in a telephone interview from Sao Paulo. “People use water with no consciousness at all.”

A lack of investment and poor management by state companies has hindered development of Brazil’s water and sewage services, Dragone said, and the necessary upgrades will cost 270 billion reais ($111 billion).

Dragone estimates leaking pipes, broken meters and other defects contribute to water losses of 40 percent nationwide. Losses totaled 25 percent for Sabesp as of 2013’s third quarter, compared with less than 10 percent in Japan and the U.K.

City Rationing

The cities of Guarulhos, Sao Caetano do Sul and Diadema said in separate statements that Sabesp has reduced water supplies by as much as a third in response to the drought. Guarulhos, where Sao Paulo’s international airport is located, said Feb. 10 it is rationing in six neighborhoods.

Sabesp denies cutting water to any municipality and says there’s no rationing, according to an e-mail sent Feb. 10.

The company last offered discounts of as much as 20 percent in 2004 when reservoir levels were low, said Gustavo Mueller, an analyst at Fitch Ratings. He expects revenue to drop by up to 7 percent in 2014 because of the current plan for lower rates for customers who cut usage by 20 percent. Moody’s projects an 11 percent drop in earnings before interest, taxes, depreciation and amortization, analyst Jose Soares said Feb. 9.

Rain Coming

Some areas of Brazil may get relief from the drought as rains resume later this week, Somar weather analyst Gustavo Verardo said by phone from Sao Paulo. A cold front will ease dryness in the south and southeast, and rainfall may increase in the second half of February. Still, it won’t be enough to recover adequate humidity in soil or refill reservoirs, he said.

“It’s been years since the last rationing -- but then again we haven’t seen this kind of heat in 71 years,” Joao Simanke, a hydrologist who spent 28 years at Sabesp and is a board member at a trade group for groundwater interests, said by phone from Peruibe in Sao Paulo state. “We won’t ever be able to recoup what we lost in January.”

(Corrects spelling of Fitch analyst name in 16th paragraph. Story was originally published Feb. 13.)
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