Earnings Call Transcript - SBS Q4 2022

Operator, Operator

The results conference call for 2022. Today, we have with us Mr. Andre Salcedo, Ms. Catia Pereira, Finance Director and Investor Relations Director, and Mr. Marcelo Miyagui, Accounting Manager. And before I turn it over to Andre Salcedo, I would like to share some information and instructions. This video conference is being recorded and has simultaneous translation into English. The presentation and recording will be available at the IR website of SABESP. I would also remind you that questions will only be taken in writing in the chat of this platform. Our conference shall last about one hour and 30 minutes. We are going to save 45 minutes for Q&A from analysts and then journalists. To conclude, I would like to clarify that any statements made during this conference regarding the company's businesses and projections for the future are only projections based on the assumptions of the company, as well as the information currently available to the company and do not constitute any results. They involve risks, uncertainties, and premises because they refer to future events, and therefore, these circumstances may vary or not. Investors should consider general operational factors and the industry, noting that their results may change materially in future projections. And now, I would like to turn it over to Mr. Andre Salcedo, who will start the conference.

Andre Salcedo, President

Good morning. Thank you very much. I thank everyone who has been with us in these early months of our new management. I think investors, journalists, and analysts for their presence, as well as the general public. For those who do not know me personally, I am Andre Salcedo. I was appointed as President last year and officially took over on January 13. Since then, we have been learning about the company's performance, getting to know the team of managers, allowing us to have a more extensive view of what the aspirations for SABESP truly are. I was given a mandate to turn the company into a more modern, innovative, and inclusive one. This mission is what we will implement throughout this management. To give you an idea of the work we will perform, we have already defined the new composition of the Board to align SABESP’s management with this strategic view—a vision of modernity with better relationships with regulators and our clients as well as the end users. We aim for a more integrated company that utilizes its resources—human and financial—rationally. A management style that is closer to people, both internally and externally, pursuing full openness with all stakeholders, regulators, shareholders, and investors to understand what can be improved and how we can improve. We will strive for as much transparency as possible. I am very happy to be here at the company right now. We are at a moment of turning a page. We will pursue new businesses, aim to grow, and also want to provide better services to the population in terms of investment adequacy. We will begin planning for the next four years focusing on organizational transformation and work in autonomous clusters that are integrated in terms of processes. We will review our methods for both the Board of Directors and the company, ensuring they reflect what we understand to be necessary for better efficiency in decision-making processes. As I mentioned, our focus will be on generating value for all stakeholders; we understand the importance of the environment and the ESG agenda, which will be prioritized in our management. Additionally, we will separate clients into two tiers: the owners of the sanitation service that authorize our work and the actual end users. For this transformation and new vision, we will pay special attention to our employees, training them and developing their knowledge based on our investment demands. We want to create a more competitive company that can grow and compete in new markets. We see opportunities in optimizing our workforce and in developing activities we currently do not pursue. Later, we will allocate activities to different functions that can generate more value. Cost reduction is also one of our targets, and we will demand our managers meet our objectives. We are proposing new programs for engaging our employees to reach our goals. Before moving to the next slide, I want to highlight that last year was challenging. Despite the difficulties, we achieved a record net profit in the company’s history. We will continue pursuing growth, and it’s important to note that last year’s growth did not account for the tariff gap we had in December. We hope that in upcoming cycles, this will be incorporated in the annual review we will have, resulting in a more appropriate revenue structure for operations. Speaking more specifically about the new challenges for the company and moving to the next slide, what will SABESP look like in the next cycle? It will have a clear vision of what needs to be pursued. As you have noticed, our proposal for this year includes changes in our bylaws to modernize the company. We have specific attributions, but we want to be flexible in how we allocate roles as the company evolves. With a fresh perspective for each Board member, we will focus on areas like legal affairs and strategic planning. Sabrina has substantial management experience, having joined the company in February and doing excellent work. As our CFO, we are confident in her capabilities. She has been working with investors and, in addition to her typical financial and investor relations responsibilities, is handling our shared service centers. From her previous role, we are leveraging her expertise in corporate shared centers to ensure that water production, distribution, and sewage management are integrated into corporate governance, guaranteeing that the company has the necessary resources when needed. This updated regulatory and new business model will not rest solely on financial and investor relations but will also involve Bruno D’Abadia managing our relationships with regulatory agencies and municipalities as we combine opportunities for new businesses, whether through concessions or otherwise. The organization will focus on engineering, which will be divided into two areas: one that addresses CapEx and long-term investment alongside environmental management, led by Paula Violante. The intent is for all CapEx to flow through Paula, prioritized according to demands, beginning with environmental investments necessary to ensure the safety of our employees and meet contract requirements. We will also adapt our metropolitan and regional departments into a new structure, already managed by Roberval, who has extensive experience with the company. He has been here for many years and is now integrating these two departments for unified management, ensuring that best practices are adopted across the organization. With this, we expect to see improvements in operational costs. Another innovation will be the creation of a new department under the Board called Clients, to maintain close relationships with clients, ensuring their cycle receives all necessary attention. We aim to adjust everything to SABESP’s needs strategically, focusing on stronger communication that will report directly to me. This is vital for information exchange with the market, providing access to mayors and regulatory agencies through our website. We also aim for total transparency in our digital transformation—leveraging data collected from our operations and client information to create significant value. We will set up a digital transformation unit to ensure that data management and decision-making based on data form the company's backbone. The strategic view remains the CEO’s responsibility, honestly assessing opportunities for improvement and ensuring alignment with our ESG agenda, which will be extremely important for our corporate goals. Within a few months, we anticipate being able to complete ESG targets and communicate these to the market. The entire Board is optimistic and feels fortunate to have the right people to face the challenges ahead. This will be a productive cycle with substantial transformation, improving operational goals and client perceptions. I will conclude now by emphasizing your support is crucial. SABESP has an open-door policy for feedback and criticism; our objective is to become the best company possible. We look forward to your cooperation, and I appreciate your attention. Tiberio, I turn it back to you.

Operator, Operator

Thank you, Andre. Now actually, I think it is Catia's turn to present the results.

Catia Pereira, Finance Director

Good morning, everyone. Thank you, Andre, for the inspiring introduction. First of all, I am Catia Pereira. I started working in the company in early March. I am very new here, but I am pleased to be part of this team and contribute to the financial area, helping to turn the company into an efficient organization with integrated processes so that the finance department permeates all other company areas. As Andre mentioned, we will focus on operational delivery, making processes more integrated, faster, and efficient. This is our objective, aligned with shared services, and it will be our journey for 2023. Moving on to the next slide, I will begin discussing volume. In 2022, we saw an increase of 0.2 in terms of water volume. Essentially, we observed a decrease in residential areas, but an uptick in the commercial and industrial sectors. This reflects a return to normalcy post-pandemic, indicating we are resuming our standard routines. The same trend was evident in sewage, with a 1.7 increase, predominantly driven by activities in the commercial and industrial domains. This increase was notably higher in sewage due to our intensified focus in this area, which has yielded positive results. Overall, we are seeing growth around 0.9 in volume, and advantageous changes in tariff mix and clientele shift to commercial and industrial categories positively influence our revenue, representing a significant factor when considering our volume impact. Next slide, please. Now, reviewing the financial highlights, we can see an overall growth of 13.7. As Andre mentioned, part of this is attributable to the tariff readjustment we had in 2022, which accounted for 12.9%. This also relates to the volume mix and changes in the consumption profile, resulting in revenue of 17.2. I want to emphasize that this is related to sanitation and separate from construction profits. Examining adjusted EBITDA, we see an increase of 11.2%, rising from R$6.6 billion to almost R$7 billion, while net income surged by 35.4%, moving from R$2.3 billion to R$3.1 billion in 2022. I will elaborate more on our performance later. Next, turning to financial performance, we started with a net profit of R$2.3 billion, prompting an increment in revenue of R$2 billion. We made calculations comprising revenue variations from construction, hitting around 2.3%, in line with all our metrics. We encountered an impact on costs and expenses amounting to R$1.6 billion. Additional revenues totaled about R$33 million—nothing particularly significant. In terms of net revenue, we note a positive monetary adjustment resulting from the GESP agreement, recorded in the third quarter, represented here within the R$555 million, along with other effects from exchange rate variations tied to our foreign currency-linked debt, particularly showing a favorable valuation of the BRL against the yen, which moreover contributed positively to our net financial results. Later, I will provide more details on these items. Taxation, including income tax and social contributions, increased due to the performance we experienced throughout 2022. Now moving to the next slide, I want to draw attention to costs and expenses—this is very telling. We witnessed a growth of 12.8 in personnel costs, resulting from inflation around 12.9, and we also recorded a 1% rise in salaries across various positions alongside a mean employee count of 12.8, concluding with 2,300 employees at the end of 2022. The increase in personnel expenses correlates with inflationary adjustments. Regarding materials, we also experienced a significant jump of 20%. This increase largely relates to maintenance systems, treatment supplies, and fuels, particularly now that we are resuming operations post-pandemic. When comparing this to 2021, behavioral changes influenced by pandemic-related limitations have appeared. Material costs comprise the primary impact. Despite volume increases, external market pricing dynamics fundamentally shaped these costs; many materials we utilize are raw commodities, significantly affected by international pricing fluctuations and the war in Ukraine. Regarding services, we saw a 13.3% surge, with highlights on IT expenses focusing on enhancements to our invoicing system—launched in October 2021. Throughout 2022, we invested in system improvements to help stabilize our operations focusing on our Service Level Descriptions (SLD). Moreover, we allocated investments to our communication channels with clients to aim for recovery and reach pre-pandemic levels. As for the allowance for doubtful accounts, we are now concentrated on ensuring robust revenue. Electricity costs jumped by 2.4%; we find a 8.7% rise in the regulated market versus 6.3% in the free contracting; when contrasting with 2021, our reservoir consumption levels diminished, impacting overall pumping energy costs favorably. We benefited from better energy pricing due to elevated reservoir levels, with the end of the red flag in December contributing positively to our operations, manifesting a 2.4 rise in costs. In general expenses, we saw an increase of 22%, which relates to R$270 billion in total expenses. We faced two significant elements affecting our costs: provisions for lawsuits as part of our contingency monitoring, where we acknowledged R$190 million at the close of December; additionally, expenses payable to various municipalities rose in proportional relationship to our revenue increases, driving up overall general expenses. Broadly, in terms of asset increases, we mobilized resources anticipating depreciation impacts due to planned activations and this needs to be considered in the context of depreciation and amortization shifts. Comparing these allowances against our net revenue, we shifted from 4.3 to 4.5 regarding doubtful accounts, indicating our goal of reducing such allowances to previous lower levels. This aligns closely with what our CEO emphasized concerning our focus on client engagement—striving to enhance client relations and ensuring timely payment collections. This was an initial priority I took when assuming the financial department, underscoring the topic's critical nature in terms of revenue. As for taxes, we align with our 2021 position—no substantial changes there. Now, moving to the next slide, discussing our financial results, we've seen notable improvements when comparing 2021 to 2022. We recorded gains from exchange rate variance alongside the GESP agreement, noting the correction of these assets has a recurring impact. Additionally, we also capitalized from the BRL appreciation against the dollar and yen. Notably, one-third of our net exposure is in yens and the remainder in dollars. When assessing net expenses, our debt composition transitioned from 19% in '21 to 15% in '22 in regard to our low-loan position. We successfully captured funding from bid investments in BRLs, further reducing our currency exposure from 19% to 15%. On the lower left side of our documentation is depicted the debt increase, from R$17.7 billion to almost R$19 billion, which supports investment actions targeting universalization processes. Distribution of this debt indicates 16% in IPCA, 8% in PGLP, 9% in TR, and 10% in foreign fixed rate. The majority of our debt corresponds directly to the DI, totaling 50%. Therefore, we experience an effect with respect to financial expenses if we convert our dollar debt to BRLs, always referencing the DI. Proceeding to the next slide, I've concluded my financial presentation and will hand it over to Tiberio for our Q&A session.

Operator, Operator

I'm going to ask the first question on behalf of Carolina Carneiro. Good morning. Our question is regarding costs. Another quarter where the company had a relevant increase in manageable costs, exceeding expectations, especially concerning PDD. Firstly, with the new management, do you have a mapped strategy for reducing these inefficiencies? Secondly, when do you plan to announce this detailed plan? Thirdly, how long do you expect it will take to achieve more adequate cost levels? Who will respond, Andre or Catia?

Andre Salcedo, President

I can answer this question. Carolina had asked this prior to Catia's presentation, but perhaps we could revert to Catia's slides where she addressed individual costs. Doing this might provide some clarity on what she shared. Carolina and those following this presentation, we've achieved a lot within 2.5 months. We implemented a new company strategy and a new Board of Directors with fresh proposals and strategies that are currently ongoing. We aim to have our assembly to implement every initiative. Based on the screen you see, management changes, process reviews, and a strategic overhaul will significantly influence resource allocation and roles we currently occupy. We've put forth a plan that is undergoing analysis; we will share details with you once everything is finalized. Specifically examining supplies, treatment materials, and overall services are pertinent within our process review framework. We formed two centers: the CST, overseeing contracts, continuous requirement hiring, and the bidding model for major projects. The responsible department will submit investment and maintenance demands through CapEx modeling, which will guide us through bidding and hiring processes. This ensures standard hiring protocols and unified contracts to facilitate scale negotiations, resulting in lower hiring costs. We expect reductions across these four factors. For electricity, there’s an ambitious process underway focused on distributed generation. We anticipate seeing results regarding electricity. The self-production model will be ready in the next quarter, and we aim to hire within the market this year. We are particularly concerned about the allowance for doubtful accounts and have dedicated resources to evaluating this area. Although we can't currently determine what an adequate provision level is, with our focused oversight, once approved by the Board, we will commence our action plan. Meanwhile, we've secured external assistance to evaluate efficiency and revenue utilization opportunities. We are collaborating with various consultancies and expect to launch our value capture vision for all areas within two to three months. We don't possess that information just yet.

Operator, Operator

Thank you, Andre. Now let's move on to the next question.

Marcelo Gonsalves, Analyst

What is the review process for the tariff? Will the resulting fees from this review be made along with the annual adjustments? Does SABESP have an estimate of the total increase in the tariff for '23?

Operator, Operator

Tiberio, can you answer this one? Yes, I can. In practice, the regulator for public consultation already addressed this, and we have not assigned a percentage value yet. However, it will be published by April 8 alongside extraordinary adjustments due to inflation, and the new tariffs will likely take effect after May 10. We anticipate a range around 10% to 12%, more or less.

Carolina Carneiro, Analyst

Could you elaborate on the regulatory model? What are the expectations for the extraordinary review? Do you plan to change the base model and cost structure to a fixed tariff in light of potential privatization negotiations?

Andre Salcedo, President

Aa previously indicated, this is a public matter the governor and secretary have commented on: the IMC is assessing the privatization model. To my understanding, there is a regulatory model review underway, and we will await the outcomes. We presently lack information regarding desires or future paths. I know that the model is feasible, but I cannot predict if this will be the chosen model.

Thiago Patricio, Analyst

Hello, thank you for the call. I have two questions. Could you provide some guidance on default projections? Do you believe that PDD has peaked? Could you explain why there was a significant increase in legal deposit expenses? Is it possible to estimate the normalized provision level?

Andre Salcedo, President

I can address this question. Looking at legal implications, we’ve seen a distinct impact this year compared to previous years. We do not regard this as a recurring effect, though we monitor contingencies proactively. We do not see the current situation as a norm, expecting improvements even if it's premature to declare we've reached a peak. The pandemic, which significantly diminished consumption power, alongside invoicing system alterations led to noticeable changes but we see positive trends in 2022, such as a decrease in unemployment. With this backdrop, we maintain a hopeful outlook for recovery in 2023, although it remains too soon to project tangible outcomes. These observations tie to having team members focused on client relations.

Gustavo Fabricio, Analyst

The results reveal that cost pressures are emerging compared to other sector companies, compounded by a PDD rate exceeding the average. Furthermore, in Q4'22, we observed that the principal tariff not meeting expectations within the volume mix. Considering the new management, what can we look forward to regarding operational costs, improved tariff management, and overall capital profitability? Do you plan to present a strategic plan to investors?

Andre Salcedo, President

I believe this question was raised before we had the chance to elucidate. We have introduced a new strategic approach that will influence costs, and specific quantifications will be provided once the consultancies and internal reviews yield results concerning personnel and other costs.

Gabriel Caruso, Analyst

Andre and team, I wish you success in your new management. Is SABESP considering revising the company's pricing? For investors, it is reassuring to know that the company is exploring investments for new returns. As an end client, do you foresee cost reductions or considerations for the consumption cost price affecting SABESP’s performance?

Andre Salcedo, President

Thank you very much! We are genuinely enthusiastic regarding the challenges and opportunities identified to date. Our aim is to convert SABESP into the most efficiently operated company possible. We will pursue possible avenues for optimizing human resource management and CapEx, ensuring environmental compliance and aligning with stipulated programs. We see the structure of tariff costs reflecting in current operations, where an annual review occurs every four years—anticipating our next review in 2025.

Antonio, Analyst

Could you comment on the privatization aspect and the agreements made with municipalities?

Andre Salcedo, President

Antonio, thank you for your question. We can only provide insight once the IFC completes its analysis. The regulatory framework comprises components concerning potential contract changes. Existing deadlines pre-stipulated notify municipalities, granting them 60 days for response. I recognize everyone’s interests considering its impact on company valuation, but before the state government’s studies conclude, revealing results becomes challenging. Our interest is to facilitate a process that upholds transparency; it’s vital for stakeholders, society, and government. We strive to align interests, as the governor and secretary have noted regarding investment and environmental sustainability, meaning privatization makes sense only if it benefits society.

Antonio, Analyst

What will be the investment plan for the next years? Would any major changes occur?

Andre Salcedo, President

We anticipate changes. Being aware, we published an R$27 billion investment plan for the next five years. Following the principles I outlined earlier, closely observing regulatory compliance and environmental mandates, this aligns with ongoing processes. We're yet to conclude the reprioritization of current investments, but we will soon.

Operator, Operator

Let’s now move on to the journalists’ Q&A. If no additional questions emerge from the investors, we can open the floor for journalists.

Juliana Rocha, Journalist

Hello, I would like to ask about the investment plan. The report indicates that the plan for '23 would require an investment of R$5 billion, a decrease compared to R$5.39 billion in '22. What explains this deceleration? Will the new management revise this? Also, is there an ongoing discussion regarding the new federal sanitation decree? What impacts could these changes have on the sector?

Andre Salcedo, President

Regarding the investment plan, we have not modified it yet; the ongoing review is tied to investment capacities, and we anticipate decisions soon. This figure was established by previous management, and we are presently assessing its alignment with our priority initiatives. Pertaining to your second question, I have not examined the decree's particulars but read a report today. The regulatory framework continually presents opportunities for improvement, and governmental perspectives seek enhancements. This decree is meant to rectify gaps that existed under prior management, which could consequently benefit the sector.

Alberto Alerigi, Jr., Journalist

Will SABESP consider reopening any voluntary resignation plans as a means for cost reduction?

Andre Salcedo, President

Yes, we can assess this post-structuring; if opportunities for cost reductions arise, the company may opt for incentivizing voluntary resignations for those considering that path. This subject has been raised by unions and associations, and ongoing discussions are in progress, yet no final decisions have been made.

Gabriel Caruso, Analyst

Do you find anything concerning with the new management?

Andre Salcedo, President

No, the transition process from the prior management to this one has been very smooth. No significant issues were flagged by internal or external audits nor by the accounting processes. The management has been responsible, regardless of the current and previous administration. Our priority lies in delivering results; we recognize the urgency in implementing value-driven changes expeditiously while respecting the broader governmental decision-making processes.

Thiago Patricio, Analyst

Considering ESG principles as they apply directly to operations, do you believe SABESP could enhance efforts to reduce water loss, recycle wastewater, engage in composting, and produce bio-methane? Based on these technologies and techniques for optimization, which ones will be prioritized in forthcoming years?

Andre Salcedo, President

Thank you, Thiago, for your question. We recognize that sanitation companies like SABESP represent perhaps the highest ESG triggers. We presently align with circular economy practices in our treatment facilities, implementing pilot initiatives for producing biogas and bio-fertilizers while crafting ceramic products for construction from mud. We are one of South America’s most significant recycled water providers, and we value our commitment to environmental sustainability, ensuring we efficiently manage resources. We have ample insights to share about our ESG strategies, but time constraints this discussion today. I appreciate your inquiry.

Juliana Rocha, Journalist

When will the strategic plan be concluded and introduced? Additionally, does SABESP plan to access the market for funding through debt issuance, debentures, or bilateral arrangements?

Andre Salcedo, President

The strategic view has been defined within our current structure, with aims of efficiency and regulatory alignment. We are prioritizing client relations, ensuring ESG perspectives lead toward sustainable activities that harmonize interactions with the environment, lowering impacts. Our strategic outlook reflects a newly formed Board of Directors' composition and attributed responsibilities. Regarding funding for investments, SABESP's history encompasses smart market engagements. We’ve observed strong market capital accesses over the last few years, which have been favorable. Simultaneously, we maintain robust relationships with institutions for multilaterally secured capital, leveraging support from the Japanese market, IBD, World Bank, BRICS, and Development Bank. Consequently, we anticipate sufficient funding for investments in 2023 and beyond.

Alberto Alerigi, Jr., Journalist

Could you update the status of the Pinheiros River de-pollution program concerning investments already made and what will be made? The prior management claimed ahead-of-schedule activities; however, recent reports indicate high pollution levels. When will the river be accessible to the public?

Andre Salcedo, President

I don't currently possess updated figures on the volume of investments made, but we have indeed made significant advancements regarding water recovery. However, it's essential to recognize that this is a multifactorial process involving not only SABESP but also municipalities and agencies managing rivers. There is a decrease in the flow of the Pinheiros River due to issues related to upstream reservoirs. Ongoing investments cover various operational fronts, and we are committing to seeing this agenda through. We also aim to apply the insights derived from the Pinheiros River improvement processes to our initiatives concerning the Tiete River.

Operator, Operator

If time permits, could you provide more specifics regarding the Tiete River activities?

Andre Salcedo, President

If you can provide me a couple of days, I’ll offer details soon—we’re coordinating with the environment department for an official launch message this upcoming Friday.

Operator, Operator

Thank you, let’s wrap this up. Andre, perhaps you’d like to make some closing remarks.

Andre Salcedo, President

Thank you all for attending today. We appreciate your trust and are committed to transforming SABESP into a model of effective management. Our door remains open for feedback and communication, facilitating our evolution as both a company and society. I encourage investors to attend our assembly; it is vital to align on modern visions for what we achieve together. Thank you all for being here as we usher in a new phase—one filled with promise and positive change, where inclusivity remains a key driving principle. Our Board's composition reflects this dedication as well; it marks a historic first for SABESP with three women in key roles, reinforcing our commitment to diversity and robust decision-making processes. Thank you once more for your time, Tiberio. I believe we're in a strong position to conclude.

Operator, Operator

We look forward to seeing you all again in the next earnings call.