Sabesp Keeps Getting Dragged Down by Brazilian Currency Woes

Image source: Sabesp.

On March 25, Companhia de Saneamento Basico do Estado de Sao Paulo (Sabesp) (SBS 3.36%) released its quarterly earnings. Like in preceding quarters, Sabesp has been slowly improving its operations through better cost controls and some strong rate increases as water has been a rather precious commodity in the drought stricken Sao Paulo region of Brazil for some time. At the same time, the same things that have been dragging the company down -- drought and a devalued local currency -- have continued to weigh on results. Here's a quick snapshot of the company's results as well as some of the major highlights for the quarter that will help put 2016 into perspective.

Sabesp's results: The raw numbers

*All financial results converted to USD at exchange rate $1 BRL = $0.29 USD
Data source: Sabesp quarterly earnings release.

Not only are this quarter's results markedly better than the same time lats year, but they were also a significant improvement from the last sequential quarter as well. Looking back over the past several quarters of Sabesp's results, though, one thing that sticks out is the company's results are pretty lumpy from quarter to quarter. So here's a quick look at the numbers for fiscal year 2015 to give a little more clarity.

*All financial results converted to USD at exchange rate $1 BRL = $0.29 USD
Data source: Sabesp quarterly earnings release.

The thing that really stands out in the company's results is that despite posting better operating numbers, the company's bottom line for 2015 was affected drastically by financing costs and the changes in foreign currency. In 2015, Sabesp's financing costs increased by 1,647 billion reals ($477 million) as the Brazilian currency lost 47% and 46% to the U.S. dollar and the Japanese Yen, respectively. The reason for this is because large portions of the company's debts are denominated in these currencies while all of the company's revenue comes from local Brazilian currency.

What happened with Sabesp this quarter
This has been a pretty reoccurring theme for the past several quarters for Sabesp. Despite lowering operational costs and slightly increasing revenue, all of those gains have been wiped out by currency effects. When holding a company long term, hopefully these currency effects will come out in the wash, but it can be discouraging for investors to see the company making modest gains in increasing profitability and have nothing to show for it.

• Combined water and sewer volumes were actually down 2% for the quarter and 6.8% on the year. That decline in volume was offset by increases in tariffs that led to near flat revenues from its water and sewer business. The largest gains in revenue came from Sabesp's construction business, which increased revenues by 14% for the year.
• Costs, SG&A, and construction expenses declined 5.2% in 2015 and represented 75.3% of net revenue for 2015 versus 82.9% of net revenue in 2014. These cost savings were a large reason why the company was able to post that 36% increase in adjusted EBITDA for the year.
• Total water and sewer connections increased 2.6% and 3%, respectively. At the same time, improvements to Sabesp's water system decreased water loss by 4.4%.
• Higher rainfall in the end of 2015 and into the first few months of 2016 have helped alleviate some of the drought issues for the Sao Paulo region. According to Sabesp, rainfall levels at its two major water collection regions were at or above 95% of their historical average from November through March.

Looking ahead
Eventually, the effects of foreign currency will turn around, and when it does Sabesp's earnings will improve considerably because the underlying operations of the company have been improving for some time. The company was able to get strong tariff increases in 2015 and is slated for another 8.45% tariff increase in 2016. The only issue for Sabesp is when those currency impacts will finally start to turn around. With so much political turmoil in Brazil and the market for two of its major commodities -- iron ore and crude oil -- in the dumps, it's hard to see when that turn will indeed come. Until this turnaround happens, investors can expect dividend payouts to be rather modest.

In the next couple years, the company is expected to ramp up capital spending to improve its sewer connections and sewer treatment systems to serve 95% of the population in the Sao Paulo region, up from 78% today. Hopefully the company will be able to learn from the lessons here that there are immense risks of taking out foreign currency denominated debt when all revenues are in a local currency.