SBS

Business Context and Reporting Period

Company: Companhia de Saneamento Básico do Estado de São Paulo (SABESP)
Reporting Period: Year ended December 31, 2004
Operations: SABESP is Latin America's largest basic sanitation company, providing water and sewage services to 368 municipalities in the State of São Paulo. In 2004, the company expanded its retail operations by acquiring the water and sewage system of São Bernardo do Campo (January 2004) and assuming operations in Itapira (March 2004). The year was significantly impacted by a prolonged drought in the São Paulo Metropolitan Region, necessitating a "Water Consumption Reduction Incentive Program" to avoid rationing.

Key Financial Metrics

Cash Flow: Net cash provided by operating activities was R$ 1,436 million. Net cash used in investing activities was R$ 671 million, primarily for property, plant, and equipment. Net cash used in financing activities was R$ 941 million.

Material Changes vs. Prior Period

• Revenue Growth: Net revenue increased 6.4% to R$ 4.397 billion, driven by tariff adjustments (18.95% in Aug 2003 and 6.78% in Aug 2004) and the inclusion of São Bernardo do Campo retail operations.
• Volume Decline: Invoiced water volume dropped 4.1% due to the drought and the successful consumption reduction program. However, sewage collection volume grew 2.9%.
• Profitability Decline: Net income fell 38.4% to R$ 513 million. This was primarily due to increased bad debt expenses (R$ 242 million vs. R$ 38 million in 2003), higher operating costs related to drought mitigation campaigns, and a reduction in financial income due to the appreciation of the Brazilian Real against the US Dollar.
• Debt Structure: The short-term debt ratio increased to 21.2% due to a Eurobond maturity in July 2005. The company issued R$ 600 million in new debentures in September 2004 to refinance liabilities.

Guidance, Outlook, and Risks

• Dividends: The Board proposed paying R$ 153 million in interest on shareholders' equity (substituting mandatory dividends), representing a 3.4% yield. An additional R$ 439 million was proposed for transfer to the investment reserve.
• Outlook: Management expects no water rationing in 2005 based on current reservoir levels. Tariff restructuring studies are underway, with completion expected by October 2005.
• Key Risks:
  • Drought: Continued low rainfall could impact reservoir levels and revenue volumes.
  • Currency Risk: Significant exposure to foreign currency debt (US$ and Euro). The appreciation of the Real in 2004 reduced financial expenses, but volatility remains a risk.
  • Legal/Contingencies: Ongoing negotiations with the State of São Paulo regarding the reimbursement of pension benefits and water services (GESP Agreement). The outcome and timing of recovery are uncertain. Significant provisions exist for customer, contractor, and environmental claims.
  • Debt Maturity: Significant debt maturities in 2005 require refinancing or payment from own funds.

Investor Verification Checklist

• Bad Debt Provisioning: Verify the adequacy of the R$ 242 million bad debt expense, particularly regarding receivables from municipal authorities and the State Government.
• State Government Receivables: Monitor the status of negotiations for the GESP Agreement and the recovery of R$ 822 million in receivables from the State of São Paulo.
• Debt Refinancing: Confirm the execution of refinancing plans for the R$ 950 million in foreign currency debt maturing in 2005.
• Drought Impact: Assess the long-term impact of water conservation programs on future revenue volumes versus the cost of infrastructure investments to mitigate scarcity.
• Environmental Liabilities: Review the status of environmental lawsuits and the potential for additional fines or remediation costs.