Earnings Call Transcript - SBS Q1 2020

Operator, Operator

Good afternoon, ladies and gentlemen. At this time, we’d like to welcome everybody to SABESP Conference Call to discuss its results of First Quarter of 2020. The audio for this conference is being broadcast simultaneously through the Internet on the website, https://www.sabesp.com.br, where you can also find the slideshow presentation available for download. We inform that all the participants will only 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. 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 Rui Affonso, Chief Financial Officer and Investor Relations Officer; Mario Sampaio, Head of Capital Markets and Investor Relations and Marcelo Miyagui, Head of Accounting. Now, I will turn the conference over to Mario Sampaio. Sir, you may begin the conference call.

Mario Sampaio, Head of Capital Markets and Investor Relations

Thank you, everyone, for joining us for our first-quarter 2020 conference call. As usual, we have some slides to review, after which we will open the floor for questions. Let's begin with Slide 3. In this slide, we report a 2.6% growth in our total billed volume of water and sewage for the first quarter of the year. The total billed volume rose by 2.2%, with water increasing by 2% and sewage by 2.5%, compared to the first quarter of 2019, excluding the municipality of Santo Andre. This growth is primarily attributed to the residential category, which increased by 2.7%, particularly in the metropolitan region of Sao Paulo, highlighting the balance in Sao Paulo and its neighboring areas. Regarding Santo Andre, we transitioned from wholesale service until the first quarter of 2019 to retail service starting in August 2019. The initial drop in billed water volume is typical during the early stages of retail operations, as losses in distribution systems are not recorded by SABESP. On a positive note, we saw a considerable increase in the volume of sewage treatment in Santo Andre, which we had not operated before our takeover. Additionally, we observed growth in the residential category across nearly all municipalities we operate in, along with a notable increase in satellite savings in regional centers both inland and along the coast. While we did not see significant impacts on volumes this quarter due to isolation measures implemented at the end of March, we did notice a decline in billed volumes in the industrial and public categories, showing reductions of 2.2% and 1%, respectively. This lack of significance is because only accounts read at the end of March captured this event. Moving on to Slide 4, let's review our financial outcomes. We reported a loss of R$657 million in the first quarter of 2020, compared to a profit of R$647 million during the same period in 2019. The current loss is mainly due to a R$1.8 billion expense resulting from exchange rate fluctuations on yen-denominated borrowings and financing. Although the negative effect of exchange rate variations on our debt servicing and cash was minor at R$42 million, the overall net loss reported this quarter was offset by positive earnings before taxes and financial results amounting to R$1 billion, although this figure is R$138 million lower than the previous year's. This decrease stems primarily from a R$149 million rise in our allowance for doubtful accounts. Adjusted EBITDA for the first quarter was R$1.48 billion, down from R$1.54 billion in Q1 2019, reflecting a 3.9% decrease. Net operating revenue rose by R$163 million, or 4.2%, from R$3.88 billion to R$4.04 billion, resulting from a R$268 million uplift in gross revenue, countering a R$2.1 million drop in construction revenues. However, our administrative and selling expenses, along with construction costs, saw an increase of R$299 million, or 10.9%. Excluding construction costs, this rise amounted to 17.6%, or R$380 million. The adjusted EBITDA margin was 36.7%, down from 39.8% in Q1 2019, and for the trailing twelve months, the margin stood at 41.1%. Excluding the effects of revenue and construction costs, the adjusted EBITDA margins dropped to 41.8% in Q1 2020 compared to 46.8% in Q1 2019. On the next slide, we delve into cost variations. As previously discussed, costs relating to administrative and selling expenses increased by R$299 million, or 10.9%, in Q1 2020, totaling R$3.04 billion compared to R$2.75 billion in Q1 2019. Excluding construction costs, administrative and selling expenses increased by R$380 million, or 17.6%. Key increases included allowances for doubtful accounts by R$149 million, general expenses of R$100 million, depreciation and amortization of R$72 million, and electricity costs of R$43 million. Notably, delinquency rose by approximately R$100 million in Q1 2020 compared to December 2019. We also anticipate that expected losses may grow due to the economic instability exacerbated by the COVID-19 crisis. For a detailed breakdown of these and other cost changes, please consult our press release. Moving on to Slide 6, we summarize the major changes affecting the company's net income in Q1 2020 compared to Q1 2019. The net loss was R$657 million, while net operating revenues increased by R$163 million; costs and expenses, including construction costs, rose by R$299 million. Other operating income and expenses amounted to R$3.2 million, and the financial results suffered a negative impact of R$1.8 billion. Conversely, income tax and social contributions improved positively by R$633 million, primarily due to the tax losses reported in Q1 2020 linked to our financial performance deterioration. Let’s move to Slide 7, where we discuss certain social measures implemented by SABESP in response to the COVID-19 pandemic. We are executing various initiatives, focusing on our fundamental role in basic sanitation during this health crisis. Our first initiative involved installing water systems in field hospitals. Moreover, starting March 24, we undertook cleaning operations in numerous health facilities and public areas, employing reuse water with an extra chlorine dosage. In the metropolitan region of Sao Paulo alone, around 2,000 cleaning activities were executed, extended to over 290 municipalities where we operate, totaling nearly 9,000 cleanings. We were able to conduct these activities thanks to donations of adequate chlorine supplies. Additionally, we distributed water tanks in communities with residents lacking local reservoirs. We delivered a total of 4,500 tanks, with 3,800 already provided, and about 3,000 units were donated by manufacturers, with SABESP organizing the distribution. Another effort includes the installation of washbasins and drinking fountains across the state to promote hand washing and ensure access to quality drinking water. Sixty-five cities in the interior and coastal regions benefit from this program, with plans for 100 washbasins in vulnerable communities in Sao Paulo, where SABESP is responsible for the hydraulic installation. Over 60 washbasins have already been set up in the metro area, plus an extra 160 in the interior and coastal areas. Lastly, SABESP is participating in a volunteer program, having collected and distributed 35 tons of food and 70 tons of hygiene product kits to support those in need. Turning to the next slide, we will discuss our initiatives to guarantee the execution of our investments, along with refinancing debt due this year and reducing foreign exchange exposure. The company has established a well-known debt program allowing for a six-month suspension of debt services, with the suspended amounts added to the overall remaining debt for contracted financing entities. This is already under negotiation with banks to access these benefits. We are also negotiating with BNDES to expand financing disbursements and postpone deadlines for reporting expenditure, alongside discussions with CEF to defer debt service payments as authorized by the FGTS Management Council. Regarding multilateral agencies, we are actively working to support sanitation programs limited to state-controlled companies like SABESP. We recently entered into a $250 million financing agreement with the World Bank and are negotiating for advanced resource disbursement and emergency support actions for additional work outside the original contract scope. In similar discussions with the IDB, we signed a $350 million agreement that also offers support akin to the World Bank’s commitment. Both of these contracts include provisions for currency exchange from dollars to reals, potentially managing foreign exchange exposure during disbursement, although it may be premature to predict the exact funds from this initiative; it’s expected to be significant for CapEx execution and liquidity. Next, let's address our debt management strategy in light of the year's sharp market changes, especially impacted by the devaluation of the real. We successfully completed our 25th debenture issuance on April 27, raising R$1.45 billion with a rate of CDI plus 3.6% for 18 months, maturing principal and interest. Initially intended to raise R$1 billion, due to market constraints following the crisis, we managed to increase this amount by R$450 million, aligning with our planned funding and refinancing schedule. On fundraising, the company has mandated IBRD for a R$600 million loan and received federal approval to issue up to R$1 billion in infrastructure bonds. While we have not yet made any announcements regarding an infrastructure bond, we include this authorization as part of our strategy for future issuance. It's also noteworthy that the company has secured substantial public financing for investments set to be disbursed this year, expecting to disburse R$1.1 billion. Combining this with our recent debenture and the mandated IBRD operation, the total available mounts to R$3.15 billion. If we also factor in the potential infrastructure bonds, these funds could surpass our billing. In terms of reducing foreign exchange exposure, on April 27, the company converted $495 million of debt from the IDB to reals, changing from a dollar-based loan to a cost of the CDI rate plus 0.06% per year, with maturity unaffected. This conversion represents an estimated reduction in our FX exposure from 55% to 38%. We also need to monitor the upcoming foreign currency debt maturing in December 2020 to determine the optimal strategy for redemption. Next, we'll discuss the economic crisis's impacts on SABESP and the measures we've adopted to maintain liquidity and positive financial performance. It's crucial to acknowledge that the economy was already exhibiting signs of weakness before the COVID-19 pandemic was designated as such. COVID-19 has intertwined with existing economic challenges, intensifying their effects over time, leading to reduced economic activity across all sectors and downward revisions in GDP growth estimates. In this recessionary period, there's a visible decline in revenues and an increase in delinquency, despite 84% of our billed volume being in the residential sector. Furthermore, currency volatility presents risks to our financial expenses. However, as a key provider of public water and sewage services, SABESP plays an essential role in combatting the pandemic. To this end, we waived water and sewage bills for residential social and favela categories for 90 days on bills issued after April 1. Notably, despite the economic downturn, we recorded revenue growth from residential customers, aside from those categories, and postponed 50% of the regulatory fee payment to January 2020. In light of these challenges, we initiated various measures to enhance liquidity and maintain our positive financial trajectory. These include cutting R$360 million in expenses and postponing R$300 million of planned CapEx for 2020, as well as reducing our workforce through a voluntary incentive dismissal program initiated in 2018, which will see about 998 employees depart by year-end. We've also replaced judicial deposits with surety bonds to ease cash flow pressure. Before wrapping up, we want to remind you that on April 1, we issued a notice regarding our Resolution 974 concerning the timetable for this year's ordinary tariff review. Following that, on April 14, we published our Resolution 981 outlining the regulatory agenda for the 2021 biennium. During the regulatory process, we expect public consultation notices regarding tariff calculation methodology and the weighted average cost of capital. The proposed block is set at 7.38%, lower than our current permitted block of 8.11%. We are actively preparing our comments to submit to RSET by the public consultation deadline of July 3. It's also significant to mention that on April 17, our SABESP team issued two resolutions aimed at mitigating the financial impact of the COVID crisis. Resolution 985 temporarily postpones Regulation 3 payments, while Resolution 991 proposes deferring the start of our four-year program for research and technological development for innovation in sanitation and services. These resolutions are expected to provide support as we move forward. That concludes our remarks, and now we will transition into the Q&A session.

Operator, Operator

Our first question is from Lilyanna Yang from HSBC. Go ahead.

Lilyanna Yang, Analyst

Hey, hi. Thank you for that comprehensive presentation. Would you mind please giving us a brief overview of how you see the regulator responding to the crisis together with SABESP? You indicated that they came out with a preliminary walk, which in my personal view seems low at a 7.38%, right? And you have been suffering from higher delinquency. You have a little bit of demand destruction with unknown outcomes on the revenue side for now, right? But you do have a rate review that is as early as May 2021. So, my question is, do you see this potential delay in the rate review process happening in May? And it did happen in the prior rate reviews for SABESP? And if you see any changes recently, for the better or the worse on the regulatory side regarding the approach of the regulator towards the rate review and how they deal with the unprecedented crisis? Any color on that front will be super helpful. Thank you.

Rui Affonso, Chief Financial Officer and Investor Relations Officer

Lily, it's Rui. To begin with, I can provide some insights on that. If he's on the line, I believe so. Looking at the recent technical notes, the intention seems to be to expedite the tariff review process, especially considering potential complications from delays due to COVID and the economic crisis. There are indications that some parts of the process may be simplified to meet the targets to conclude everything by May 2021, but this is just a preliminary approach. We expect them to try their best to meet the timeline despite the challenges we've been facing. Therefore, the aim should be to streamline some processes instead of postponing it, at least for now. I'm not sure if anyone else has further comments or needs more clarification.

Unidentified Company Representative, Unidentified

Yes. Rui, I am on the call and I think you've summarized it quite well. I don't feel like to add anything on that. Other than we are ready to comply with all schedules already provided or by assess. So we are working towards delivering information as required right now in May then it may should be providing assess with some start-up information and now a little wise we should be providing comments on the methodology as well as on our work. So that’s about it at this point in time.

Lilyanna Yang, Analyst

Okay, great. Thank you. And follow-up question. On your regulatory asset base, there’s a certain amount of assets of investment that had not yet been recognized by the regulator in your asset base. Do you think that in May 2021 there would be enough time to get to a review maybe of those assets or the idea is to let them stand apart go and decide about it later when you have more time and then just to make sure that the recent investments of the company are truly reflected in there rather than we discussing what invested pre-second rate review?

Unidentified Company Representative, Unidentified

Go ahead Rui, you want to answer that?

Rui Affonso, Chief Financial Officer and Investor Relations Officer

Yes. It's, well, from our side we are doing our best in order to have those processes concluded by May 2021. I believe that the hope of SABESP and the expectation of SABESP is the same. I cannot see a sort of interference in one process on the other. We have time; we have problems. Of course, to evaluate some assets on the field, for example. But on the other hand, the discussion on the previous cuts in our asset basis is now a known problem. I have to go deep on each; we are working hard to meet and present our points of view to assess and I believe that both sides want to get it solved the sooner possible.

Operator, Operator

Our next question is from an unidentified speaker. Please proceed.

Unidentified Analyst, Analyst

Hey gentlemen, it's Hasan Raza from Robert Asset Management. How are you? Rui, Mario, good to hear your voice. I have a question for Rui. Previously, you mentioned the regulatory developments regarding the assessment calendar and the process of deliberating on improving the targeted tariffs for certain customer classes. Currently, some customer classes are paying significantly higher tariffs while others are paying less, even though they could afford to pay more. There was a regulatory process aimed at better aligning the tariff structure with customers' ability to pay. I'm curious about the current status of that effort to align the tariff structure for different customer classes. If you have any updates on that process, we would love to hear it.

Rui Affonso, Chief Financial Officer and Investor Relations Officer

We are currently in the process of reviewing our tariff structure, and we are making significant progress on several issues simultaneously. We aim to complete this by the end of the year. There are three main components to this review: the ordinary type review, the current tariff structure evaluation, and an important issue involving R$6 billion in costs that we need to address. All three are being handled concurrently, and there is a considerable amount of work ahead. I’m not sure if anyone else would like to provide additional information on the status of the last issue.

Unidentified Company Representative, Unidentified

I want to comment on that. It's important to mention that a recent publication foresees that we should complete this work, as well as the work on the regulatory office, by the end of this year. There should be a few months before the final calculation of the tariff review in May. We have a tight schedule but are working towards meeting the legal requirements. We have had some conversations with the regulator regarding the tariff set, but there is no conclusion or indication on what the outcome might be. We are actively collaborating with them on this matter.

Unidentified Analyst, Analyst

Rui, if I may. Can I ask you one more follow-up question? As you might be aware in the electronic distribution sector, the government is setting up a fund to help with the account receivables that might be a way to alleviate any cash working capital grants for electric distribution companies. I know, I obviously not from your perspective, you are a very well-capitalized company. Your credit metrics are very solid. I was wondering, do you think that kind of a measure that kind of facility might be useful also for the water sector and if it is, any thoughts as to what we've done to have this similar facility set up by the government or by the state for the water sector? So if need be what companies can draw from that kind of facility.

Rui Affonso, Chief Financial Officer and Investor Relations Officer

Are you asking if the federal government could provide funds or special conditions for the water sanitation sector to address the economic crisis caused by the pandemic? Is that correct?

Unidentified Analyst, Analyst

Yes. Specifically how the government is helping the electric distribution sector by setting up a facility which can help companies, if customers are really paying their bills. It's like, almost like a facility to help with working capital, things like that for the electric distribution companies. And I was just wondering if such help could be extended to the water industry.

Rui Affonso, Chief Financial Officer and Investor Relations Officer

Okay, you're comparing us with the electricity sector, correct?

Unidentified Analyst, Analyst

Yes, in terms of the government effort for COVID-19.

Rui Affonso, Chief Financial Officer and Investor Relations Officer

In terms of the government's stance, we see that the electricity sector operates quite differently from the water sanitation sector. In the electricity sector, there is one concession and numerous companies involved in generation, distribution, and transmission. In contrast, our sector consists of about 5,700 concessions along with municipalities and connections to state governments in metropolitan areas. We have a single company responsible for water provision and sewage treatment. Therefore, we do not anticipate a similar approach from the federal government when it comes to providing funds to assist our sector as they announced for the electricity sector. Municipalities and states in poor fiscal situations are unlikely to offer the funds needed to compensate for delinquency and other challenges faced by our companies. However, we are seeing that multilateral banks and private banks, including BNDES, IDB, the World Bank, and IADB, are offering potential solutions to help increase our liquidity during this crisis and providing access to specific financing options focused on water treatment. While we do not have evaluations yet, our negotiations with these banks are ongoing, which will support us during this difficult time. In summary, I do not foresee funds coming from concessions due to their challenging situations, but there is potential assistance from multilateral and some public banks.

Unidentified Analyst, Analyst

That's helpful. And if I can close with one additional question for you, Rui, can you provide an update on the privatization legislation? Obviously, a lot has changed because of the pandemic COVID in the last two to three months. So where do you think the privatization legislation currently stands? And what do you think the timeframe is to potentially revise that legislative process?

Rui Affonso, Chief Financial Officer and Investor Relations Officer

Hasan, you always ask a challenging question. It's difficult to understand how these two crises connect, and we can't accurately predict the extent or development of the situation. Currently, discussions in Europe are focused on the second and third waves of the pandemic. Therefore, we have taken immediate measures to manage our budget and increase liquidity to create a financial cushion for the upcoming period. Predicting beyond this year is tough, and like everyone else, we find forecasting to be challenging. However, we are adjusting our expectations from quarter to quarter based on the reality we face and taking proactive measures in light of our debt obligations. We are expecting a decline in our revenues and increased delinquency, and we are continually adapting to these circumstances each quarter.

Operator, Operator

Our next question is from Lilyanna Yang. Go ahead. Lilyanna?

Lilyanna Yang, Analyst

Hey, sorry, I was on mute. Quick question, please. If cash economic also giving you some better conditions for payment of the loans or is it just mostly BNDES here?

Rui Affonso, Chief Financial Officer and Investor Relations Officer

Mario, I believe that you can answer that question because cash economies we are negotiating with them also. Yes.

Mario Sampaio, Head of Capital Markets and Investor Relations

Yes, Lily, cash is one step back from BNDES. They're both opening the opportunity for companies to waive the debt servicing for six months. Obviously, that the value, the amount will be added to the total debt. So in that sense, we'll be co-funded financed for the period. But we are in our case, working with both to make sure that we fit on the conditions precedent. But overall it is yes, a very supportive measure for those two for the sanitation sector. So yes, there is something out there.

Operator, Operator

At this time, it appears to be no further questions. I'll turn the conference back over to SABESP for their final remarks.

Mario Sampaio, Head of Capital Markets and Investor Relations

Yes, I'm here. Okay. We would like to thank everybody for participating in one more conference call of our results and a very special one. Again, in the middle of a huge crisis and giving you all the information we have, that we are dealing with this crisis. And we are open to questions and to numbers in our IR department, please contact Mario Angela, all the team. We are open 24 hours a day to help you understand better our actions. Thank you very much and see you next quarter. Bye.

Operator, Operator

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