Privatization And Cost Cuts Will Shape Water Utilities Amid Risks

Key Takeaways

• SABESP's privatization efforts and expanded consumer base aim for significant revenue growth and universal service coverage.
  
• Strategic operational consolidations and modern infrastructure initiatives focus on increasing efficiency, cash flow, and earnings by optimizing costs and improving billing processes.
  
• Policy changes and litigation may create revenue uncertainty, while expanding services and privatization risks could strain resources and affect earnings stability.

Catalysts

Provides basic and environmental sanitation services in the São Paulo State, Brazil.

• SABESP's new privatization and concession agreement efforts to include informal and rural consumers are expected to drive significant customer base growth and universalization progress, potentially boosting future revenue.
  
• Efficiency improvements through strategic operational consolidation, which include a streamlined CapEx process and incentivized cost management, are projected to enhance net margins by reducing expenses and increasing productivity.
  
• Contract termination of large client discounts aims to close a R$480 million revenue gap, promising a direct positive impact on earnings as these contracts phase out and new rates are implemented.
  
• Initiatives to modernize metering infrastructure and improve collection policies are expected to enhance cash flow, ultimately supporting the company's earnings growth by reducing non-revenue water losses and increasing billing efficiency.
  
• SABESP's strategic focus on reducing regulatory gaps and implementing zero-based budgeting (ZBB) promises cost savings and more effective financial management, translating to improved margins and stronger future earnings.

Companhia de Saneamento Básico do Estado de São Paulo - SABESP Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Companhia de Saneamento Básico do Estado de São Paulo - SABESP's revenue will decrease by 3.3% annually over the next 3 years.
• Analysts assume that profit margins will increase from 26.5% today to 27.5% in 3 years time.
• Analysts expect earnings to reach R$9.0 billion (and earnings per share of R$13.39) by about April 2028, down from R$9.6 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting R$12.0 billion in earnings, and the most bearish expecting R$5.2 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 15.4x on those 2028 earnings, up from 7.7x today. This future PE is greater than the current PE for the US Water Utilities industry at 5.8x.
• 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 16.92%, as per the Simply Wall St company report.

Companhia de Saneamento Básico do Estado de São Paulo - SABESP Future Earnings Per Share Growth

Risks

• The introduction of new policies and changes to discount contracts, coupled with ongoing litigation from affected clients, may create revenue uncertainty, impacting overall net margins.
  
• Increased investment in expanding water and sewage services to meet universalization targets, particularly for low-tariff customer segments, could strain financial resources and reduce net profit margins.
  
• Execution risks related to the new privatization model and concession agreements, such as delays or cost overruns in capital expenditure projects, could negatively affect earnings and operational efficiency.
  
• Challenges in regulatory approval could delay potential revenue recovery from contract terminations, impacting expected profits and financial projections.
  
• Personnel reduction through voluntary termination plans, while aimed at improving cost efficiency, may lead to short-term operational disruptions or additional expenses, affecting earnings stability.

Valuation

• The analysts have a consensus price target of R$126.855 for Companhia de Saneamento Básico do Estado de São Paulo - SABESP 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$142.6, and the most bearish reporting a price target of just R$101.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be R$32.7 billion, earnings will come to R$9.0 billion, and it would be trading on a PE ratio of 15.4x, assuming you use a discount rate of 16.9%.
• Given the current share price of R$107.3, the analyst price target of R$126.86 is 15.4% 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.