Companhia de Saneamento Básico do Estado de São Paulo - SABESP
Q2 2017 Earnings Call Transcript

Published: 16 Aug 2017

[Operator:]

Good day. Ladies and gentlemen, at this time, we would like to welcome everyone to SABESP’s Conference Call to discuss its results for the Second Quarter of 2017. The audio for this conference is being broadcast simultaneously through the Internet on the website, www.sabesp.com.br, and on the MZiQ platform, where you can also find a slide show presentation available for download. We inform that all participants will be able to listen to the conference during the Company’s presentation. After the Company’s remarks are over, there will be a Q&A period. At that time, further instructions will be given. [Operator Instructions] Before proceeding, let me mention that forward-looking statements are being made under the Safe Harbor of the Securities Litigation Reform Act of 1996. Forward-looking statements are based on the beliefs and assumptions of SABESP’s management and on information currently available to the company. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions because they relate to future events and, therefore, depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of SABESP and could cause results to differ materially from those expressed in such forward-looking statements. Today, with us, we have Jerson Kelman, CEO; Rui Affonso, Chief Financial Officer and Investor Relations Officer; Mario Arruda Sampaio, Head of Capital Market and Investor Relations; Silvio Xavier, Head of Costs and Tariffs; and Marcelo Miyagui, Head of Accounting. Please note, this event is being recorded. Now, I turn the conference over to Mr. Arruda Sampaio. Sir, you may begin your conference.

[Mario Arruda Sampaio:]

Okay. Thank you. Good day, everybody. Let’s start our conference call. We have some new slides in our presentation. And as usual, at the end, we – let’s open for question and answers. Let’s start on Slide 3. Here, we show the Company’s billed water and sewage volumes. It was up 2.7% in the second quarter of 2015, with an increase of 2.9% in water and 2.4% in sewage compared with the same period of 2016. On this slide, you can also see billed water volume, which has been increasing since the third quarter of 2015 when the water situation began to improve. Quickly now to Slide 4. Let’s go through very briefly through our financial results. Gross operating revenue increased 6.5% over the second quarter of 2016 due to

[Operator:]

[Operator Instructions] The first question comes from Marcelo Sa with UBS. Please go ahead.

[Marcelo Sa:]

Good afternoon, everyone. So I have one question following up the past conference call that you guys did. It’s regarding the average tariff, on the current average tariff of the company. So one of the questions was that regarding the tariffs that the company charges for the wholesale. And the company charges a tariff that is slightly – actually, not slightly but below the maximum tariffs approved by the regulator. So what we tried to do here is that we did an exercise in order to assume that what would be the effective current tariffs if the company charged the maximum tariff for the wholesale? If that’s the case, we get to an average tariff of BRL 3.3 instead of BRL 3.23. So there will still be a huge gap to the BRL 3.47 per cubic meter calculated by the regulator. So I think, the problem with the most of the difference could come from the tariff structure. And then, I would like to see if you guys have done any analogies where they said if this is – the main difference comes from that structure and not from the discount in the wholesale? Thank you.

[Operator:]

The next question comes from Humberto Medina with C&S.

[Mario Arruda Sampaio:]

Just a second.

[Operator:]

Okay.

[Mario Arruda Sampaio:]

We are just working our way to answer the question. Just one more second.

[Jerson Kelman:]

Marcelo, this is Kelman. Look, we are also puzzled by how the ARSESP has done the calculation. We don’t know. So to begin the answer is, we don’t know. But we don’t think that, say, the tariff structure would answer the question. We are thinking, but we have no confirmation from the technical notes issued by ARSESP. We’re not sure. But we are just wondering that maybe they are considering different volumes and different consumptions according with the consumption classes. So it seems to us that possible explanation for this mystery is that they are not considering the same consumption volume for 2017, the year of reference in the numerator and denominator. I don’t know if you follow, my English is so bad. Did you understand what I’m trying to explain?

[Marcelo Sa:]

Yes, sure. But I did another exercise that maybe it would help, is that instead of, for example, dividing the revenues by the billed volumes, if you divide the revenues by the produced volumes minus water losses, and then you’re going to get the effective volume that was delivered, I get to exactly the 3.47. So my question here is probably is that, I think that the company, because of tariff structure, if you consume less than 10 cubic meters per month, the billed volume is 10. I think that the regulator, instead of considering the 10, they’re considering the effective volume that was delivered, maybe 7, 6, and therefore, they get to a higher average tariffs maybe. That could be one of the reasons. So the volume is actually different than what the regulator is considering in what is actually the volume that SABESP is billing the consumers.

[Jerson Kelman:]

Well, yes, these are several hypotheses what the regulator is doing. This perhaps is one of them. And of course, in our overall cost, we have to consider also the production of water for wholesale. And of course, the regulator is already considering that the corresponding revenues will get there. So if he’s considering that the default by the CDs that are not being asked should not be paid by the order consumers of our CDs, then the corresponding course of producing this water should also be considered. But okay, it just are – we see, it’s very difficult to, at this stage – you are doing some exercise trying to explain. We are doing the same. And I don’t think that during this kind of call, we are going to reach a conclusion. And as Mario said in the beginning, we are going to study the issue and say, we are – since we understand what the regulator has done, and probably, we will agree with. At this stage, we think that we disagree. Then, of course, we are going to make our point very clearly to the regulator. Okay?

[Marcelo Sa:]

Okay. Thank you very much.

[Operator:]

The next question comes from Humberto Medina with C&S. Please go ahead.

[Humberto Medina:]

Yes, thank you. Good afternoon. I realize that at this point, you guys don’t want to comment ahead of your formal filing on the preliminary tariff that is obvious to anybody that has been looking at the process that this is grossly insufficient. And we hope, as investors, that you guys will try to forcefully make that clear. Ultimately, what would make the expected offering to a private investor or through existing shareholders of a minority stake would be the same regulatory process. If this regulatory process does not fully, or at least close some of that regulatory gap that you have, then there would be a lot of credibility issues going forward. This is the time to do it. I think, you guys understand then, and I hope that the process reflect some of these issues. More specifically, I wanted to ask you on the cost side. Obviously, the regulatory EBITDA seems to be, not the first, still below what you guys should be getting given your actual investment. But even if we use our regulatory EBITDA with the preliminary rate adjustments, you would not be earning that allowed EBITDA because of your disallowed cost. Can you talk about the cost that are being disallowed by this preliminary tariff methodology? And what can you do so the regulator understands that those costs should be included in your tariff? Thank you.

[Mario Arruda Sampaio:]

Humberto, just a second, please. Thank you.

[Jerson Kelman:]

Humberto, this is Kelman. First, let me tell you that we are fully aware of our responsibilities in terms of defending the interest of the company towards what the regulator is doing. So we are – this is why we are cautious at this stage. We don’t want to issue anything that we are not completely sure. So we are going to defend the interest of the company before clarity of the – ask more clarity and transparency from the regulator when we know exactly what we are claiming. At the moment, the technical note issued by the regulator is as what it was said in the beginning. Much, much better than in the first cycle, but still has too many dark, dark or no transparency parts. So one of the parts that is particularly obscure is what the regulator has done with our detailed plan of OpEx. There is a very large discrepancy between what we had asked for OpEx, which detailed information year by year, and what the regulator has accepted in the technical note. And the technical notes, as I mentioned, does not bring what was the methodology that the regulator has used to disagree with us. So we are going to ask more transparency from the regulator on this particular issue, which is OpEx. Several others, but in this in particular, we are also concerned. I don’t think our, say – we are restraining at this stage. Don’t think this is something that we are afraid of asking the regulator to be more clear and confronting the regulator when we think that they are not right. But as we said in the beginning, what the regulator has done in this particular – the technical note this time is much better than the first revision.

[Humberto Medina:]

Okay. Thank you for that clarification and comment. My second question is regarding the RAB, and this goes to the discussion during the Portuguese call. And personally, my Portuguese is not great. Can you clarify what was said in terms of potentially arguing for the incorporation of the disallowed investments. I think, it was mentioned, the BRL 6 billion for example, that you and others have pointed to, investments that you should be given credit for and you’re currently not being given credit. Just talk about why do you think it was not included? Are you going to try to push for that to be included? Why not, if that’s not the case? Thank you.

[Jerson Kelman:]

Okay. This is Kelman again. There is important move forward that was not noticed so far. In the first revision, as you said, the regulator did not accept something like BRL 6 billion, and there was no clear explanation for that. What the regulator has promised us is now to give before 2018, which is the closing of this revision process, they will provide us with a clear report of what – why they have, how to say, excluded some of the items. This is the first piece of information. The second piece of information is that those – all those assets that were excluded in the first revision, summing up some BRL 6 billion currency at the time, BRL 1 billion, they have now changed their minds. This is related to iron pipes that, in the first revision, they excluded the cost of these iron pipes from the base – the revenue base because they thought that iron pipes would not be used currently. This will be something from the 19th century. But we could prove to them that in some circumstances, iron pipes are actually needed and cannot be replaced by other material. So they changed their minds and they accepted from something that are nowadays, the current prices would be some – of the order of BRL 1 billion.

[Humberto Medina:]

Okay, thank you. My last comment, I guess, is – and I think you guys fully understand this, but perhaps, it might be worth just emphasizing that with the regulator. I think, here, the perfect maybe enemy of the good, meaning that I understand that there might be willingness that over time, that regulator would address all the claims that you have, but I think, it’s very important for the market to gain confidence in what you guys are doing and, ultimately, confidence that might enable for you guys to finance this large investment plan that is going to be ultimately beneficial for consumers is for a good outcome hearing in terms of a clear demonstration that the regulator is addressing the issues and the regulatory lag and we’re moving in the right direction. If we continue to see major postponements in some of these issues and there’s not a substantial rate increase that allows you to earn closer to your allowed returns or you’re not even close, that might be very, very detrimental long-term. And I know you guys understand that, but I just wanted to emphasize that. As an investor, I’m happy to share that if you think it has any value even in the hearing process. Thank you, guys.

[Jerson Kelman:]

Thank you, Humberto.

[Operator:]

The next question comes from Vinicius Tsubone with HSBC. Please go ahead.

[Vinicius Tsubone:]

Hi, thank you for the call. My question is regarding the pass-through, the tariffs of the contributions to the environmental and infrastructure fund of the Sao Paulo City. When does the company plan to start this discussion again? And could we expect that the [indiscernible] to be published in April next year will include this pass-through? Thank you.

[Rui Affonso:]

Hi, it’s Rui speaking. This issue has been under discussion for many years, not only [indiscernible] continually SABESP and the regulator, but also, it’s related to our consensual powers in the case of Sao Paulo City as it resides in the Metropolitan region, concerning to the municipality of Sao Paulo and also to the State of Sao Paulo. Remember, for several times, there have been this clarification of this issue and implementation of this pass-through cost from our opinion, and also from ARSESP has been suspended by the intervenience request of the both sides of the consensual power. I mean, the municipality and state level. The last decision that ARSESP provide to the public was that the 7.5% was to be addressed at the end of the revision process. What happened is that in the middle of the road, we have a preliminary revision process. At that time, it doesn’t exist at the time. So we – the timeframe for the decision of the 7.5% is to be concluded at the end of the tariff revision process that ended, finally, at April 2018. That’s the point that we are.

[Vinicius Tsubone:]

Okay, thank you. So just to clarify, only after April, right?

[Rui Affonso:]

The last decision of ARSESP insist – motivated by the request of both municipal level and state-level governments was that, that should be decided, finally, at the end of the tariff revision process that ended in April 2018.

[Vinicius Tsubone:]

Okay, thank you.

[Operator:]

The next question comes from Snehal Amin with WindAcre. Please go ahead.

[Snehal Amin:]

Hi, thanks. I have two questions and a comment. One, given there’s a bunch of discrepancies in this ARSESP note between the 4.3% tariff increase, the P0 number of BRL 3.63 in the required revenue, which number should we focus on as being the most significant and the one that SABESP will eventually actually achieve? I mean, will you only put through the percentage increase? Or will you achieve the required revenue, irrespective of what percentage increase or what P0 comes out of that because that’s the required revenue is what you actually need to generate a return. But can confront to us which number really matters?

[Jerson Kelman:]

The required revenue is the relevant number. All the calculations done to find what is required revenue, and then the P0 is just the division of required revenue by the volume. So the required revenue is what really matters. The percentage of increase is exactly what we are not understanding and this will be a matter we are going to ask the regulatory agency to clarify this because we are also not understanding what they have done essentially. We don’t understand what was the previous tariff that they are using. So long answer to – very simple, the required revenue which is really matters. Okay?

[Snehal Amin:]

Okay. And then – so if that’s the case, then does it matter in the end – if ARSESP uses a volume number that SABESP does not agree with, because ARSESP wants to just use something, its own calculation, but it’s not the real billed volume that you sell, right, the actual build volume. If there’s a discrepancy there, does it matter or not? Because you say, fine, ARSESP, you can use that volume, I’m going to use a different volume number, which is the actual billed volume, and I’m going to charge the tariff I need to charge on the billed – on my actual billed volume so I can get to the regulatory revenue that we both agree, right? So is that the way it works?

[Jerson Kelman:]

Look, there is no discrepancy between us and the regulator in terms of what is the volume target for 2017, 2018, 2019, 2020, so we agree with the regulator on the volumes that we sell. And we also – don’t agree, but the regulator has said what is the required revenue. So this doesn’t – this means that we have to discuss with regulator what is the adjustment in tariff. We cannot just apply the percentage that you think is correct. We have to clarify to regulator. And what you’re saying is probably right. This one hypothesis, maybe the regulator is not considering our actual sales of water. If it’s the case, he has to adjust to what really is happening. But we have to discuss with regulator.

[Snehal Amin:]

Okay, okay. I think, I understand. And then, the second question, there’s been a lot of delays in this process, right? I think, my understanding with the original rate review should have been effective, I think, April 2017, if I’m not mistaken. So if the final one is only going to happen in April 2018, there’s a lot of lost value and lost revenue. Is there a regulatory asset that’s going to build up? Or something that will compensate the shareholders for this delay?

[Jerson Kelman:]

Yes. The regulator, in April 2018, when it finishes the whole process, it will calculate all the rights you have, given the fact that there was a postponement of the revision. So in his technical note, it has made it clear that in April 2018, he will do all the calculations back to adjust the whole thing as if – in terms of economic terms of course, to make it even with the fact that the revisions should be done on April 2017 and not April 2018. Okay?

[Snehal Amin:]

Okay. So there will be compensation. Okay.

[Jerson Kelman:]

Yes, yes.

[Snehal Amin:]

Okay. Great. And then, just one comment, as I was thinking about the previous question, the 7.5% Sao Paulo fee, I mean, it seems very clear, right, that this fee needs to be passed through and there’s really no economic argument, I think, that anyone can make that says the shareholders should suffer the cost of this and as a result, the business shouldn’t earn its required cost of capital. So I know you agree with that. But if the regulator, for some reason, doesn’t pass this through, I think, they should understand, it’s an extremely damning situation because it smells of politics, right, which is exactly what the company is trying to free itself from. So – I mean, you can always debate to some extent what the right RAB is and get very technical, but there really is no debate that this fee is not a fee that the shareholders should pay, right? It’s a fee that the – the shareholders are entitled to get the required return and this fee needs to be put through in the tariff. So hopefully, the regulator understands, and the other various – I realize the city and the state and the municipality, but they’re all going to suffer if this decision ends up being a political decision. And they’ll end up suffering an amount that are much larger than the 7.5% fee if people can’t trust that something that’s state-owned is going to get treated fairly. So I just wanted to reiterate that, not so much to you, but hopefully, to the government and the regulators, that they understand the significance of this.

[Jerson Kelman:]

Well, look, this is a regulatory issue. There is a conflict of understanding between the two concession entities here. As you know, in the metropolitan areas, there are two entities that – the concession Sao Paulo, the state and the municipality. And in this case, there is a conflict between the attorneys of the state and attorneys of the municipality. The attorneys of the municipality think and have put this on written that this payment is not passed through to the consumer, it’s something that the company is paying to the – to have the right to serve the city for which we take more than 50% of our revenues. The state attorneys think just the opposite. And what we are trying to do is to make the two political entities, the two governmental entities to reach an agreement. It’s not an issue that the regulator can solve by himself.

[Snehal Amin:]

Yes, I understand that. I guess, my concern is this issue has been going on for years now, right? And in some ways, there’s really not much of an incentive for them to resolve it, right, because politically, they may not – no one wants to see the tariff go up, politically, right? The people that really care are the shareholders of SABESP who are paying this fee every year and as a result, not earning the fair return on the RAB, right? So that’s my concern. And the longer it goes on, I think, the more damning it is that the company isn’t getting treated as it should get treated, right, as a regulated business that’s entitled to earn its rate of return. It can never earn it so long as the fee exist, right? It’s never going to get close to earning it.

[Jerson Kelman:]

You see, this payment is OpEx, and we are not getting back this OpEx. Our thinking is that we should get this and we are working hard on this and the issue is very delicate. The scenarios that we have is not all, well, either we go, for example, go to court and fight municipality. If you do that, we’ll have the risk of losing the concession that is more than half percent – half of our revenues. So it’s not a simple issue. It’s not a simple issue. And what I can say is that the administration is doing the most we can to put the two concession entities together and come to our – attorneys on one side and attorneys on the other side, they should come to some kind of agreement, and this what we are working hard to do. What I want to stress is that in the interest of the shareholders, we cannot be adventurous in the interest of the shareholders because we cannot enter in a dispute with the municipality that we don’t know exactly what would be the exit points. So we are being cautious and trying to get the 7.5% as OpEx, convincing the attorneys of the municipality that is the right thing that is written in the conference, this is what we believe and this is exactly what we are – the point of view that we are defending.

[Snehal Amin:]

Understood, okay.

[Operator:]

The next question comes from Lilyanna Yang with HSBC. Please go ahead.

[Lilyanna Yang:]

Hi, thank you for taking the call and the questions. One thing, right, on the tariff and equity issuance plan. You know that the tariff is going to be given to you in October, and it’s preliminary, and the final one is only in April. And if we check the past history of all the rate reviews and the dialogue with the regulator, the reality has actually disappointed expectations. So I wonder, what are the chances that SABESP and the Sao Paulo state postpones the equity issuance plans to until after the April 2018 rate review process? And my second question related to this is what is the ideal level of investments that you believe you can execute going forward? Or how much more CapEx you ideally will like to have SABESP carry on? Would it be a 40%, 50%, 60% increase over the current levels? And I have actually a third question that goes back to this discussion about the Sao Paulo city fee. I understand that despite the six years of having this payment not pass through SABESP whilst you cautiously continue to make this payment, right? So at least I would like to know what are the checking points to see if the Sao Paulo City is spending the money well that is actually going to cause us related to water and sewage, environmental issues so that it can have an indirect benefit for SABESP in terms of even avoiding other CapEx, for instance? Thank you.

[Mario Arruda Sampaio:]

Okay. Just a second Lily.

[Lilyanna Yang:]

Thank you, Mario.

[Rui Affonso:]

Hi Lilyanna, it’s Rui. Concerning your first question, we – our strategy regarding the tariff revision process, including the preliminary and the final one, and the proposal, the deal sent to the state assembly to allow us – to allow the state to create a holding and capitalize, after that, SABESP, our strategy is to improve and to put pressure on the results of the tariff revision. I mean, what has been done and we wanted to speed up is to have a better tariff revision process, both, of course, on the final result, but also related, as Kelman has said before, to the process of this. So we don’t think, nor us, neither the state, and we don’t count is the possibility is not in our [indiscernible] it’s not in our plans to postpone by any chance, the plans for the capitalization of SABESP. So it’s the other side to improve the tariff revision process, we believe that this is the way to deal with those two process. We know that it generates several uncertainty, but at the beginning of the process, we’re starting this process knowing very well that we have to deal with uncertainty. So this is the first point. Second one, we have no precise number, but we have working hard in order to define it, which – not just the amount, but which projects we can add to our CapEx immediately if you have, again, the opportunity to count with more entity, resources on equity to spend our CapEx. And what we have said is that we have several projects ready to grow with very good returns and capable to increase our CapEx in a short-term. That’s the issue. The important thing is if you can get this project ready then at the beginning of 2018, we’ll be able to speed up our CapEx in a very short time way. That’s the second point. The third point, I’ll send it to my colleague, that’s the Head of Regulation here in SABESP, Mr. Marcelo. Okay?

[Lilyanna Yang:]

Thank you, Rui.

[Marcelo Miyagui:]

Hi Lilyanna, good afternoon. Well, about the answers that he said that SABESP makes every three months to the municipality of Sao Paulo, they have [indiscernible] rule to follow, okay? So they cannot use the money to do anything they want. There is a municipal law regarding this, and there are strictly permitted objects and they have to publish it all over the Internet. So if you go to the housing department in the website of Sao Paulo’s municipality, we will find all these things we’re talking about, okay?

[Jerson Kelman:]

But let me complete this. They have to apply this money in things related – in investments related to sanitation. In other words, it’s something that we could not provide a service unless they do their part. Typically, if you have to install a pipe where there is a slum, you are not allowed to this. And then, the municipality, with the money that we pay, they go there and take this part of slum out in order that they can pay us with the part as an example. Okay?

[Lilyanna Yang:]

Yes, okay. Perfect. And if I can follow-up on this Sao Paulo City fee controversy, I’m puzzled because Sao Paulo City, in my view, doesn’t seem to have any other service provider other than SABESP, right? At the same time that SABESP, of course, needs Sao Paulo City as half of the revenue contributor. I would say that, and argue, that the Sao Paulo City also have no other choice. And if not mistaken, SABESP do owns the assets used to provide service to the city, is that correct? Or am I missing something? Could there be any potential competitor or another service provider for the city instead of SABESP?

[Jerson Kelman:]

Lilyanna, from the legal point of view, the service provider to the municipality of Sao Paulo should be some entity which is agreed by the state government and municipal government. And there is no [indiscernible] that SABESP would lose these contracts, not at all. What I said before is that we don’t want to disturb a [indiscernible] very well with something that is not agreed by the attorneys, and they need some work on convincing the attorneys of municipality that what we think is the right thing to do. Okay?

[Lilyanna Yang:]

Okay. Okay, thank you. Thank you so much for the answers.

[Jerson Kelman:]

Welcome.

[Operator:]

The next question comes from Vinicius Canheu with Credit Suisse. Please go ahead.

[Vinicius Canheu:]

Hi guys, good afternoon. I would like to come back to the issue of the tariff regulatory proposal. When we read the regulator’s note, specifically on Page 8, it says that at the end of the process in April, it will be set the compensation adjustment relative to the fact that it’s ending right now including those related to the extraordinary tariff review of 2015. I’d like to know if you could share with us what kind of expectations you have related to this item because beginning in 2015, the extraordinary review that was granted to the company was not a fully [indiscernible] at that time and then there was this issue about our future compensation and apparently, here, the regulator is reaffirming the fact that it’s things about the compensation. I’d like to know what kind of expectation you have and if you could share with us that? Thank you.

[Rui Affonso:]

Well, Vinicius, if we understood the question, what he’s saying that in April, he would do compensation adjustment of extraordinary tariff review we asked in 2015. So what he’s saying is that at the time, the required increase to compensate for volume was not fully given to us. So what he’s going to do is he’s going to rebalance that cycle based on the actual volume that happened and compensate us for any differences between the business plan original and the difference we obtained in the extraordinary tariff. That’s what he’s saying. He’s going to rebalance not only the first cycle, he’s going to rebalance, I’m sorry, the volume on the first cycle. That’s the way we understood it.

[Vinicius Canheu:]

Okay. So we can have an expectation that it’s very likely that like this further compensation will be part of your tariff at the end of this process?

[Rui Affonso:]

Yes.

[Vinicius Canheu:]

Okay, thank you.

[Operator:]

[Operator Instructions] It appears to be no further questions. Now, I’ll turn the conference back over to SABESP for their final remarks.

[Mario Arruda Sampaio:]

Okay. Everybody, thank you very much. And as we mentioned in the first Portuguese call, we are available for what we – you need in terms of our contributions and answers. And see you soon in the next quarter. Bye-bye.

[Operator:]

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.