Aggressive CapEx Will Lead To Future Valuation Collapse

Key Takeaways

• Aggressive investment and regulatory improvements are boosting expectations of asset and earnings growth, while enhanced cost efficiency is seen driving long-term margin expansion.
  
• Strong credit ratings, low funding costs, and ESG advances are shaping confidence in sustainable financing, elevated valuations, and stable shareholder returns.
  
• Sustained investment in infrastructure, efficiency initiatives, and regulatory modernization position the company for stable earnings, revenue growth, and margin expansion amid strong demand fundamentals.

Catalysts

Plans, designs, performs, expands, remodels, manages, and provides water supply and sewage treatment services in Brazil and internationally.

• The company's significant ramp-up in capital expenditures (R$1.2 billion YTD, targeting R$2.5 billion for the year and an average of R$3.5 billion in coming years) is likely fueling investor expectations of accelerated growth, especially as universalization goals and expanding asset base are explicitly tied to future tariff increases and broader service coverage-suggesting revenue and regulated asset base expansion.
  
• Management highlighted positive regulatory momentum, including the third tariff cycle set to increase allowed WACC from 7.9% to 9.15% and the move to annual asset base recognition; these changes may be driving investor optimism that long-run earnings and margins will rise due to higher returns on an expanding asset base and more predictable, inflation-linked tariffs.
  
• The company's narrative around achieving high operational and cost efficiencies through restructuring, digitization, and advanced analytics may be causing markets to assume long-term sustainable improvements in net margin, embedding future margin expansion in present valuations.
  
• The AAA ratings affirmed by both Moody's and Fitch, coupled with ongoing efforts to lower funding costs through hedges and incentivized credit lines, may be leading to an expectation that future financing for infrastructure expansion will remain cheap-even in a riskier macro environment-supporting high investment and dividend payout expectations (impacting both free cash flow and shareholder returns).
  
• Ongoing ESG and sustainability efforts, as well as demonstrated advances in loss reduction and default rates, could be fueling a perception that Companhia de Saneamento de Minas Gerais will benefit disproportionately from growing institutional ESG investment flows, thus supporting higher valuation multiples on the belief of structurally lower cost of capital and long-term earnings stability.

Companhia de Saneamento de Minas Gerais Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Companhia de Saneamento de Minas Gerais's revenue will grow by 4.8% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 17.5% today to 11.4% in 3 years time.
• Analysts expect earnings to reach R$1.0 billion (and earnings per share of R$2.81) by about August 2028, down from R$1.4 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting R$1.6 billion in earnings, and the most bearish expecting R$651.5 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 15.6x on those 2028 earnings, up from 7.1x today. This future PE is greater than the current PE for the BR Water Utilities industry at 7.1x.
• Analysts expect the number of shares outstanding to grow by 0.44% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 17.8%, as per the Simply Wall St company report.

Companhia de Saneamento de Minas Gerais Future Earnings Per Share Growth

Risks

• The company is executing a robust, multi-year investment plan-projected to reach R$3.5 billion annually-focused on efficiency, universalization, and infrastructure upgrades, supported by regulatory annual recognition of investments and a higher WACC; this enhances the asset base and potential revenue growth.
  
• Operational efficiency initiatives, such as process restructuring, deployment of a shared services center, advanced analytics for fraud detection, zero-based budgeting, and scaling strategic sourcing, are already reducing personnel and operating costs and are likely to further improve net margins and earnings over time.
  
• The company demonstrated strong and stable operating cash generation (R$554 million in Q2) and maintains solid AAA credit ratings from Moody's and Fitch, reflecting reliable demand fundamentals, manageable leverage (2x, with guidance up to 3x), and favorable access to long-term financing, all of which support long-term earnings stability.
  
• Regulatory modernization-including the move to a real asset base for tariff calculation, annual investment recognition, and partial efficiency gain sharing-ensures improved cost recovery and incentivizes further investment, underpinning revenue certainty and margin stability through upcoming tariff cycles.
  
• Progress toward and commitment to meeting Brazil's universalization targets for sanitation-already at 99% water coverage and accelerating sewage coverage-alongside ongoing network upgrades and technological modernization (e.g., leak detection, smart meter renewal, migration to the free energy market), strongly position the company for sustainable topline and margin growth in the face of long-term industry demand trends.

Valuation

• The analysts have a consensus price target of R$25.25 for Companhia de Saneamento de Minas Gerais based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of R$31.1, and the most bearish reporting a price target of just R$21.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be R$8.9 billion, earnings will come to R$1.0 billion, and it would be trading on a PE ratio of 15.6x, assuming you use a discount rate of 17.8%.
  
• Given the current share price of R$25.3, the analyst price target of R$25.25 is 0.2% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.