Companhia De Saneamento Basico Do Estado De Sao Paulo-Sabesp Q2 FY2020 Earnings Call

Good afternoon everybody. Welcome to SABESP's videoconference to discuss the results for the Second Quarter of 2020. My name is Mario Sampaio, and I am the Head of Capital Markets and Investor Relations. Please note that this videoconference is being recorded. The presentation with the accompanying slides is being broadcast on the Internet through the company's website and the MZiQ platform. You will be able to download the presentation and earnings release from the same portal. Questions addressed to the speakers will only be accepted through the video cast platform. Before we proceed, I want to note that forward-looking statements are being made under the Safe Harbor of the Securities Litigation Reform Act of 1996. These statements are based on the beliefs and assumptions of SABESP's management and on information currently available to the company. They are not guarantees of performance and involve risks, uncertainties, and assumptions since they relate to future events that depend on circumstances that may or may not happen. Investors should be aware that general economic conditions, industry conditions, and other operational factors might also impact SABESP's future results and could cause those results to differ significantly from the forward-looking statements made. Now, let's introduce our team. We have with us Mr. Rui Affonso, Chief Financial Officer and Investor Relations Officer. Also joining us are Mr. Agnaldo Pacheco, the Company Controller, Mr. Marcelo Miyagui, Head of Accounting, and Mr. [indiscernible], Head of Costs and Tariffs. Now I will present the highlights for the second quarter, starting with some initial highlights. Let's start by saying that this was a typical quarter with the most intense month of social isolation due to the pandemic, which, aggravated by the economic context, brought adverse effects for the company. The effect of exchange rate evaluation on foreign currency debt had a relevant impact on the result. The consumption of commercial, industrial, and public customer categories, which have a higher tariff, decreased and delinquency increased. These facts, added to the bill payment exemption for customers and the residential, social, and residential favela categories, along with the postponement of the tariff adjustment, made this scenario even more challenging for us. We did stand still during this time and kept things moving. On the operational side, we reduced costs, secured markets by signing contracts with 13 municipalities in the quarter, and concluded the important negotiation with the municipality of Mauá, which was previously served on a wholesale basis and which had a historic bad debt with SABESP. From a financial point of view, we concluded the 25th and 26th debenture local bond issues, adding up to close to $2.5 billion in capital raising. We also reduced from the previous quarter to this quarter our effects exposure from 55% to 34%. And we have advanced in negotiations with other institutions that can provide funding for the company's strategic projects and debt refinancing. So let's go now to the numbers, starting on Slide 3. We will begin on Slide 3, where you can see a 2% reduction in total billed volume, 2.1% in water, and 2% in sewage, excluding the volumes in the recently included municipality of Mauá and Santo André, as well as the volume from the wholesale and customers in the residential, social, and residential favela categories. However, as expected, the consumption mix among the categories changed; volume in the residential category increased by 0.7%, while the commercial, industrial, and public categories were strongly impacted by the new dynamics arising from the COVID-19 crisis. Volumes fell by 18.4% in the commercial category, 16.7% in the industrial category, and 24.5% in the public category when compared to the second quarter of '19. The migration of consumption from the categories with higher tariffs, the commercial, industrial, and public impacts directly affects the average tariff prices and consequently our financial results. Let's move down to Slide 4. Here, let’s discuss the financial highlights. Income reached BRL378.2 million in the second quarter of 2020, down from BRL454.4 million in the second quarter of 2019. Despite being significantly affected by the COVID crisis and the global economic downturn, the cost-saving measures taken in the first quarter, along with the agreements made with the municipality of Mauá, resulted in a positive bottom line for the period. Adjusted EBITDA rose by 28.4%, increasing from BRL1.23 billion in the second quarter of 2019 to BRL1.58 billion last quarter. Net operating revenue improved by 10.9%, from BRL4 billion in the second quarter of 2019 to BRL4.43 billion in the second quarter of 2020. The agreement with the municipality of Mauá led to some technical difficulties. Costs, including administrative, selling expenses, and construction costs, saw a 4.9% increase; however, when excluding construction costs, expenses actually decreased by 6.6%, which helped boost the operating margin. The adjusted EBITDA margin was 35.7%, up from 30.8% in 2019. The adjusted EBITDA margin for the past 12 months was 42%. Including the write-offs of revenue and construction costs, the adjusted EBITDA margin was 45.7% in the second quarter of 2020, compared to 36.7% in the second quarter of 2019 and 8.2% over the last 12 months. Now, let's go to Slide 5. Here we will analyze costs. Compared to the previous year, administrative and selling expenses, along with construction costs, increased by BRL157.6 million, or 4.9%. However, excluding construction costs, overall costs and expenses decreased by 6.6% from BRL2.52 billion to BRL2.36 billion compared to last year, with nearly all expenses declining. Significant reductions included BRL113.3 million or 14.7% in salaries, payroll charges, and pension plan obligations, primarily due to lower medical expenses, agreements with retirees, and the absence of salary adjustments this year. The decrease in general expenses also played a substantial role, dropping by BRL134.7 million or 39.7% due to reduced provisions for loss payments, closure of losses with the municipality of São Paulo in the second quarter of 2019 through settled agreements, and a decrease in transfers to the municipality's fund as its revenues fell during the period. It is important to mention that there was a 45% or BRL36.4 million year-over-year increase in expenses related to allowance for technical difficulty, although this amount was still lower than what we had actually provisioned in the first quarter of this year. Let's quickly then go to Slide 6. Let's analyze the changes in the results. Net income fell by BRL76.2 million, net operating revenue decreased by BRL434.6 million, and costs and expenses, including construction costs, grew by BRL157.6 million. Other operating expenses were positive by BRL111 million, while results fell due to the turn of the real against the dollar and the yen. Finally, income tax and social contributions fell by BRL55.5 million because of lower taxable income recorded in the quarter compared to the same period in 2019. Let's now move to Slide 7. In this slide, we will provide an update on the company's initiative to ensure the execution of investments and refinancing of debts during this year. As noted in the first quarter call of 2020, BNDES launched a program that allows for the suspension of debt service for up to six months. We successfully suspended the debt service for five months, which amounts to a total of BRL130 million that will not need to be paid this year. This amount will be added to the principal of the debt, which will be repaid in the remaining terms of the contract, making it quite appealing. Additionally, with BNDES, we secured an advance that has been reflected in our cash flow since July. We have also requested a similar program for suspending debt services involving cash economic assets at other social banks and are currently awaiting a response from them. Regarding the IDB and the World Bank, we have requested advances and adjustments to projects that, if approved, could potentially lead to an early disbursement of nearly BRL500 million. We are now waiting for feedback on their evaluations and what is feasible for us to progress with this year. We anticipate having some information soon but want to clarify the extent of what we can expect this year. On July 10, we issued our 26th debenture amounting to BRL1.045 billion. This debenture was structured in accordance with Law 12,421 and is classified as an incentive or infrastructure debenture, as reflected in the terms we secured. The first series of the debenture was for BRL600 million, with interest rates at IPCA plus 4%, maturing in five to seven years. The second series was for BRL445 million with interest of a specified rate plus 95 for ten years, organized in the 8th, 9th, and 10th years. Additionally, the company has mandated IDB Invest for a loan in reais of up to BRL600 million. The structuring process is well advanced, and once completed, it will enhance liquidity and support expense reductions. Overall, we believe we have secured enough funding to enable us to redeem our main debts due by December of this year ahead of schedule. Let’s now move to the next slide for discussions on regulation. Recently, on July 15th, SABESP released resolution 1021, which authorizes a tariff adjustment index of 3.4026%. This includes an annual adjustment of 2.4924% and a compensatory adjustment of 0.888%. The latter pertains specifically to compensation for delaying the application of this index, as the exemption for residential favela categories will be addressed together with the third tariff review discussions. In terms of residential social and residential favela clients, SABESP published resolution 1038 on the 14th, extending the exemption under the same conditions as before, now valid until September 15. Concerning the tariff review, we have completed a public consultation on methodology and operations. SABESP accepted significant contributions on both matters. We believe the process is proceeding in a technical, transparent, and balanced manner. Some key points from the feedback include: consideration of COVID-19’s impact on consumption history and the proposed level of regulatory laws being unrealistic compared to existing ones. This topic will be further examined in public forums. The discussion regarding exemptions from residential tariffs will be addressed specifically. Regarding the regulatory asset-based inclusion of investments as of December 2020, an earlier request from the company has opened the door to evaluate exclusions made during the first tariff review expected for the latter half of 2020. Furthermore, the new tariff structure, which is currently being developed, is expected to be finalized by December. Key issues are related to the walk, where the final result reached 8.9%, indicating an increase of 72 basis points over the preliminary figure of 738%. Additionally, the cost of equity was notably higher than the initial proposal and current levels. Let's finalize with our comments. Final remark on July 15, 2020, Law 1,426 was sanctioned by the President, which extinguishes the figure of the program contract, increasing compensation and competition in the sanitation sector. In addition, it imposes transparency in setting the service targets, encouraging operators to act more efficiently. Additionally, it creates conditions for the National Water and Basic Sanitation agency to establish guidelines for the performance of state and municipal regulatory agencies. The law minimizes regulatory uncertainties, creating an attractive environment for investments in the sector. However, the final assessments of the changes introduced in the Brazilian sanitation will only be possible after deliberation and approval by the National Congress on the maintenance of the 11 presidential vetoes which Law 1,426 was enacted. The company understands it has competitive advantages in this scenario, as its contracts already encompass goals that meet or even anticipate those contained in the new regulatory framework, or due to its access to public and private capital in the financing of its projects, or due to its high level of governance. The great exposure to the market that has characterized its performance in recent decades shows the company is prepared to compete in expanding its participation in the sector. These are our comments. Now let's move to the Q&A session. So let me see here. If we have questions, do we have questions?

Thank you all for joining us in this conference call. I believe the quiet on your end reflects the strong participation we've had this morning; however, we are available 24/7. Please feel free to reach out with any concerns you may have. I'm certain there are questions, and we can continue our discussion whenever you'd like. Thank you again for your participation, and I look forward to connecting with you next quarter. Thank you.