Rising Costs And Contract Uncertainties Will Strain Future Earnings In Brazil's Water Utilities

Key Takeaways

• Upward pressure on costs and rising doubtful accounts could strain margins and cash flow, hindering earnings growth.
  
• Dependence on regulatory tariff approvals and uncertain municipal contracts risk revenue stability and profitability.
  
• COPASA's strong revenue growth, improved debt rating, and heavy infrastructure investment highlight its potential for enhanced future earnings and profitability.

Catalysts

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

• The company's cost structure may continue to face upward pressure due to significant increases in outsourced services and non-manageable costs, negatively impacting net margins.
  
• Rising provisions for doubtful accounts reflect potential challenges in revenue collection, which could strain cash flow and imped the company's ability to grow earnings if not effectively managed.
  
• The reliance on tariff adjustments approved by the regulatory body to sustain and grow revenue may pose risks if future approvals are delayed or smaller than expected, potentially impacting revenue stability.
  
• The significant increase in investment requirements as part of the company's strategic plan may lead to higher debt levels or strain available capital, affecting earnings due to increased financial expenses.
  
• Uncertainty surrounding the renewal and negotiation of municipal contracts may influence future revenue streams and profitability if agreements are not successfully secured or if they involve more unfavorable terms.

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 7.2% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 17.8% today to 14.7% in 3 years time.
• Analysts expect earnings to remain at the same level they are now, that being R$1.4 billion (with an earnings per share of R$2.58). However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting R$1.7 billion in earnings, and the most bearish expecting R$605.2 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 10.4x on those 2028 earnings, up from 6.3x today. This future PE is greater than the current PE for the BR Water Utilities industry at 6.3x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 16.75%, as per the Simply Wall St company report.

Companhia de Saneamento de Minas Gerais Future Earnings Per Share Growth

Risks

• COPASA reported a 9.6% increase in net revenue for the third quarter of 2024 compared to the same period in 2023, indicating strong revenue growth that could support stability or increase in share price.
  
• The company achieved a 13.6% growth in EBITDA compared to Q3 2023 and an adjusted EBITDA margin of 40.5%, reflecting strong operational performance and potentially positive impact on earnings.
  
• Fitch has revised COPASA's corporate debt rating to positive, and Moody's maintains a AAA.br stable outlook, which could reduce borrowing costs and positively impact net margins.
  
• The company is investing heavily in infrastructure, with a planned investment of R$9.8 billion from 2024-2028, which could expand its revenue base and improve future earnings.
  
• COPASA is actively negotiating with municipalities and regulatory bodies to secure favorable contract terms and tariff adjustments, potentially stabilizing or boosting future revenues and profitability.

Valuation

• The analysts have a consensus price target of R$24.549 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$28.0, and the most bearish reporting a price target of just R$20.7.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be R$9.7 billion, earnings will come to R$1.4 billion, and it would be trading on a PE ratio of 10.4x, assuming you use a discount rate of 16.7%.
  
• Given the current share price of R$23.26, the analyst price target of R$24.55 is 5.3% higher. 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.