We have recently maintained our Underperform recommendation on Companhia de Saneamento Basico do Estado de Sao Paulo, or SABESP (SBS), anticipating its performance to lag behind the broader market.
Why Underperform?
SABESP is among the leading water and sewage service providers in Brazil. Long-term growth prospects are bright for the company, which targets serving roughly 1.3 million new water connections and 1.7 million new sewage connections by 2019. Earnest efforts are being made by the company to improve its services. An amount of $9.9 billion has been allocated for the improvement of water supply coverage, for sewage collection and for treatment of collected sewage during 2013-2016.
Despite these endeavors of the company, we have currently maintained an Underperform recommendation on SABESP. Year-to-date return of negative 39.5% also supports our negative recommendation along with the reasons mentioned below:
Continuous increase in costs and expenses has over time proved detrimental to SABESP’s profitability. Cost of sales and services accounted for 61.9% of total revenue in the second quarter 2013, up from 58% recorded in the first quarter 2013 and representing year-over-year increase of 10.5%. Also operating expenses, including selling, administrative and other expenses, in the quarter increased by 30.8% year over year. Steady rise in costs will impact margins of the company.
Moreover, risks arising from increased political interference pose potential threats to growth. The government of São Paulo owns part of SABESP’s outstanding shares, which gives it the power to control the election of the majority of the members of the board of directors and the senior management. Under such circumstances, the possibility of regulatory uncertainty or delay by the government to make important decisions remains a major hindrance.
The Zacks Consensus Estimate for SABESP is at US$1.38 per ADR for 2013 and US$1.55 for 2014, representing year-over-year decline of 1.9% for 2013 and growth of 12.0% for 2014.
Other Stocks to Consider
SABESP currently has a $5.7 billion market capitalization. Other companies to watch out for in the industry are Connecticut Water Service Inc. (CTWS), with Zacks Rank #1 (Strong Buy) while Consolidated Water Co. Ltd. (CWCO) and SJW Corp. (SJW), each come with a Zacks Rank #2 (Buy).
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