BRL 17 Billion Upgrades Will Modernize Water Systems Amid Risks

Key Takeaways

• Significant investment in sewage coverage and infrastructure upgrades is expected to boost future revenue and system efficiency.
  
• Emphasis on ESG initiatives and improved operational efficiency could enhance brand value, attract investors, and support long-term growth.
  
• Large CapEx and currency debt risks could strain cash flow and net margins, with regulatory uncertainty and inefficiencies potentially impacting financial performance.

Catalysts

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

• COPASA is embarking on a robust investment cycle, planning to invest around R$17 billion from 2025 to 2029 to increase sewage coverage and improve system efficiency, potentially boosting future revenue through expanded services and infrastructure upgrades.
  
• The company aims to enhance operational efficiency by adopting new organizational designs and technologies such as automation and data analytics for fraud detection, which could drive improvements in net margins by reducing costs and enhancing productivity.
  
• COPASA is preparing for a tariff review starting in January 2026, with anticipated regulatory changes that include an increase in WACC from 7.2% to 9.15% and revisions to annual adjustment methodologies. These could lead to higher revenue growth and improved financial stability.
  
• The company boasts strong ESG credentials, being recognized by Time Magazine as a leader in sanitation sustainability. ESG initiatives, such as the social tariff programs and riverbed protection, could enhance brand value, attract eco-conscious investors, and support long-term revenue growth.
  
• COPASA’s commitment to maintaining low default rates and reducing water loss through increased investments in technology and infrastructure could improve cash flow management and enhance net income by minimizing financial losses from non-paying customers.

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 5.0% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 16.7% today to 15.6% in 3 years time.
• Analysts expect earnings to reach R$1.4 billion (and earnings per share of R$2.81) by about May 2028, up from R$1.3 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting R$1.8 billion in earnings, and the most bearish expecting R$1.2 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 10.5x on those 2028 earnings, up from 6.1x today. This future PE is greater than the current PE for the BR Water Utilities industry at 6.1x.
• 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 17.08%, as per the Simply Wall St company report.

Companhia de Saneamento de Minas Gerais Future Earnings Per Share Growth

Risks

• The large planned capital expenditures (CapEx) for the coming years, amounting to R$17 billion, could strain the company's cash flow and impact net margins if not managed efficiently or if projected returns are not realized.
  
• The significant increase in outsourced service costs and temporary consultancy fees could indicate underlying inefficiencies or additional upcoming expenses, potentially affecting net margins if these costs persist or increase unexpectedly.
  
• The ongoing challenges related to the water loss index, which still remains above industry average despite improvements, could affect operational efficiency and profitability, impacting both revenue and net margins negatively.
  
• The company's exposure to foreign currency debt, particularly with 20% of total debt in foreign currencies, poses a risk of increased financial expenses due to exchange rate fluctuations, which could negatively impact net income if not adequately hedged.
  
• The uncertainty surrounding the regulatory environment, particularly regarding the new tariff review and regulatory OpEx methodology, may affect revenue predictability and stability, which could impact financial performance if regulatory outcomes are less favorable than anticipated.

Valuation

• The analysts have a consensus price target of R$24.569 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$27.8, and the most bearish reporting a price target of just R$22.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be R$9.1 billion, earnings will come to R$1.4 billion, and it would be trading on a PE ratio of 10.5x, assuming you use a discount rate of 17.1%.
• Given the current share price of R$21.08, the analyst price target of R$24.57 is 14.2% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
• 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.