SBS

Business Context and Reporting Period

Company: Companhia de Saneamento Básico do Estado de São Paulo - SABESP
Filing Type: Form 6-K (ITR - Quarterly Information Form)
Reporting Period: Nine months ended September 30, 2014 (3Q14)
Business Overview: SABESP is a mixed-capital company controlled by the São Paulo State Government, providing water and sewage services in 364 municipalities within the state. Operations are heavily concentrated in the São Paulo metropolitan region, which accounted for 50% of gross revenues.

Key Financial Metrics (YTD 9M 2014)

Material Changes vs. Prior Period

• Revenue: Net operating revenue increased 1.9% to R$8.37 billion. However, gross operating revenue from water and sewage services (excluding construction) dropped 9.5% due to a 3.5% decrease in billed volume and a R$127.2 million impact from the Water Consumption Reduction Incentive Program. Construction revenue rose 18.0% to R$2.01 billion.
• Profitability: Net income fell 34.6% to R$871.5 million. Adjusted EBITDA declined 15.8% to R$2.42 billion. EBIT dropped 25.5% to R$1.69 billion.
• Costs: Total costs and expenses increased 10.2% to R$4.71 billion. Key drivers included a 17.4% rise in electric power costs (due to tariff increases) and a 9.6% increase in payroll and benefits.
• Financial Result: Net financial expenses worsened by 10.6% to R$331.8 million. This was primarily driven by a R$226.2 million increase in foreign exchange losses due to the appreciation of the US Dollar and Yen against the Brazilian Real.
• Capital Structure: Paid-in capital increased from R$6.2 billion to R$10.0 billion following a capitalization of reserves. The leverage ratio increased slightly from 37% to 38%.

Outlook, Risks, and Management Commentary

• Water Shortage Crisis: Operations are significantly impacted by record heat and the lowest rainfall in 84 years at the Cantareira System reservoirs. The company is implementing water rationing, transposing water between reservoirs, and utilizing technical reserves to maintain supply for approximately 8.8 million people.
• Consumption Incentive Program: To mitigate the shortage, SABESP expanded a bonus program offering discounts (up to 30%) to customers who reduce consumption by at least 20%. This program negatively impacted revenue by R$226.1 million YTD.
• Foreign Exchange Risk: The company holds significant debt denominated in US Dollars and Yen (approx. R$3.95 billion). Management does not use derivative hedges. A 10% depreciation of the Real would result in a pre-tax loss of approximately R$396.5 million.
• Legal and Regulatory: 54 concession agreements have expired and are under negotiation. The company faces lawsuits regarding tariffs from wholesale customers (municipalities) and environmental claims. Provisions for lawsuits totaled R$1.51 billion.
• Capital Expenditures: SABESP invested R$971.6 million in 3Q14, totaling R$2.3 billion for the first nine months of 2014.

Investor Verification Checklist

• Water Reservoir Levels: Monitor the status of the Cantareira System and the effectiveness of water rationing measures on future billed volumes.
• Exchange Rate Exposure: Assess the impact of continued Real depreciation on financial expenses, given the lack of hedging strategies.
• Concession Renewals: Track the progress of negotiations for the 54 expired concession agreements, which represent 24% of intangible assets.
• Wholesale Receivables: Review the allowance for doubtful accounts regarding municipal governments challenging tariffs, which has increased significantly.
• Regulatory Tariff Adjustments: Verify the approval and implementation of the requested tariff recalculation for December 2014 to offset cost increases.