Is Sabesp Still Sexy?

Here's a bit of a head-scratcher. At the end of 2006, an equity research analyst at Brean Murray publicly identified Companhia de Saneamento Basico do Estado de Sao Paulo (NYSE: SBS) as his top water utility pick for 2007. Earlier this week, the company reported its first-quarter results, and Brean Murray downgraded its rating on the stock less than halfway into the year. What gives here?

Sabesp, as the company is known, provides water and sewage services to the Brazilian state of Sao Paulo, which happens to be the most populous in the Western hemisphere. Sao Paulo is almost twice as densely populated as California, and it's Brazil's economic powerhouse, contributing roughly one-third of Brazil's GDP. Sabesp is the dominant company in the space, and it has grown rapidly along with Brazil's economy. Its market cap dwarfs those of publicly traded American water utilities like Aqua America (NYSE: WTR) and California Water Service Group (NYSE: CWT).

So did the Sabesp story change with this quarter's results? Not at all -- unless one was expecting the double-digit revenue growth seen in past years. The company turned in roughly 9% higher sales while incurring relatively higher costs compared to last year. This cut into its margins a bit, but not dramatically. It wasn't a great quarter or a bad one.

How do we view the Wall Street downgrade, then? Well, research analysts have the thankless job of placing price targets on the stocks they cover. In our Foolish view, that's an invitation to be exactly wrong. In this case, the analyst got his $38 price on the stock, and then some. Brean Murray views the shares as fairly valued, so they now rate the stock a hold. Fine.

It's up to you to decide whether the company is now fairly valued or not. There is certainly a lot of froth when it comes to water investing. Some investment newsletters refer to the stuff as blue gold. Still, Sabesp trades at a deep discount to its American peers -- about 50%, by my estimates. Whether that discount is warranted because of the risks involved, which I'll address in another piece, I haven't yet decided.

For related Foolishness:

• Aqua America Trickles Down: Fool by Numbers
• Emerging Market Musings: Brazil
• Teardown: Top Stocks in Emerging Markets

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Fool contributor Toby Shute owns shares of Aqua America. The Motley Fool has a clean, refreshing disclosure policy.