Fitch Affirms Sabesp's Ratings
KEY RATING DRIVERS
The rating action reflects the manageable operating scenario for Sabesp in 2016 given the company's current moderate water reservoir levels, improved operating flexibility and end of tariff bonus program effective since May 2016, which should benefit the company's credit metrics going forward. Fitch expects Sabesp's cash flow generation to gradually recover during the next two years as hydrology stressed conditions eases.
Sabesp's ratings incorporate the strength of its cash flow from operations (CFFO) during regular hydrologic conditions, with higher predictability than other industries. The ratings also benefit from the company's near monopolistic position in its business area, as well as on the economies of scale obtained as the largest basic sanitation company in the Americas by number of customers.
Fitch considers Sabesp's challenges linked to its BRL1.5 billion debt maturing in 2016 which includes the USD140 million bonds due in Nov.2016, to be manageable. The company's satisfactory cash balance and proven access to domestic and international debt market mitigate refinancing risks.
Fitch's analysis considers the risks associated with Sabesp's high percentage of foreign-currency debt on its balance sheet, which has increased during 2015, and the still-new regulatory environment for the company. Fitch has also factored in political risk inherent with Sabesp's public control by the State of Sao Paulo, with the potential for changes in management and strategy after each election.
Gradual Leverage Reduction
Fitch expects Sabesp's net leverage to decrease to 2.5x by 2019 from 3.5x year-end 2015. The agency estimates the net leverage ratio will be around 3.0x by the end of 2016, and is supported by higher average tariffs, given the end of the tariff bonus program and 8.4% tariff adjustment, both effective from May 2016, in addition to estimated lower capex for the year. Fitch forecasts moderate EBITDA margin increase to 41% by the end of the year (or BRL3.9 billion) from 39% in 2015 (or BRL3.3 billion) as operating scenario pressures ease.
Cash Flow Recovery
Sabesp should resume its strong CFFO generation capacity in the next two years as hydrological conditions continue to return to more regular patterns. Fitch estimates Sabesp's 2016 CFFO of around BRL2.3 billion with increasing trend to BRL2.8 billion by 2018 will be supported by growth of operations and tariff adjustments. The agency expects Sabesp's lower capex during 2016 of around BRL2.0 billion and dividend payments to result in a slightly positive FCF.
During 2015 the company's strong BRL2.6 billion CFFO benefited from a reduced tax payment. In the same period, the company's FCF was slightly negative at BRL8 million due to aggressive investments, which amounted to BRL2.5 billion, and by a BRL202 million dividend distribution during the same period.
Moderate Reservoirs Levels
Sabesp's satisfactory water reservoir level at one of its most important systems, Cantareira, mitigates concerns during the dry season in 2016 (between May-October). The reservoir water level in the Cantareira system was 35.8% by May 9th, 2016, which favorably compares with the negative 9.7% (implying use of technical reserve) registered in the same period in 2015. Fitch expects that the company's improved operating flexibility with systems interconnection and ongoing enhancements to available water capacity should reduce potential operating restrictions in the future. Adequate rainfall levels are still needed to avoid operating pressures.
High FX Debt Exposure
Sabesp should remain carrying risks associated with its high percentage of foreign-currency debt, which peaked at 50% of its total BRL13.2 billion debt by year-end December 2015 as part of its strategy to access both domestic and unhedged international funding. By the end of December 2015 Sabesp's total debt consisted mainly of IDB and JICA loans (BRL4.6 billion), debenture issuances (BRL4.3 billion) and bonds (BRL1.9 billion). The company could breach its 3.65x gross leverage covenant if FX rates rebound to above BRL4.0/USD by the end of 2016.
Fitch expects Sabesp's FFO debt service coverage ratio to remain adequate and above 3.7x during the next five years despite expected weakening due to the rising costs of the local debt market. Approximately 33% of Sabesp's debt is tied to the Brazil's benchmark interest rates (SELIC), currently at 14.25%, TJLP and IPCA rates. Historically, Sabesp's debt service coverage has been comfortable, based on its sound cash generation. During 2015, FFO/interest coverage was 6.7x, benefiting from higher FFO generation, which was an improvement of the 6.3x ratio in 2014.
KEY ASSUMPTIONS
--Stable total volume billed in 2016 and 2017 and annual growth of 2.4% onwards;
--Annual tariff increases of 8.4% in 2016 and Fitch's inflation rate estimates between 2017 - 2020;
--EBITDA margin of 41% in 2016 with slight growth to 42% by 2020;
--Annual capex of BRL2.0 billion in 2016 and between BRL2.6 -2.8 billion from 2017 to 2020
RATING SENSITIVITIES
A negative rating action may occur due to one or a combination of the following:
--EBITDA margins below 33%.
--Net Leverage above 4.0x.
--(Cash+CFFO)/short-term debt below 1.3x.
A positive rating action may occur due to one or a combination of the following:
--Lower operational cash generation committed to investments sustainably or cash generation growth above Fitch's expectations.
--Net leverage below 2.5x.
--EBITDA margin above 40%.
--(Cash+CFFO)/short-term debt above 2.0x.
--Lower FX debt exposure.
LIQUIDITY
The maintenance of substantially more robust liquidity positions since 2010 mitigates Sabesp's debt refinancing concerns. The company faces challenges related to its BRL1.5 billion short-term debt as per December 2015, which includes BRL547 million linked with its USD140 million bonds due in November 2016. Sabesp's financial strategy is to refinance its bonds with international funding during the 4Q2016 is tight. This is to avoid a potential covenants breach in the case of anticipated issuance given the gross debt covenants limitations. Fitch believes that Sabesp's proven track record of accessing financing from the international debt market partially mitigates its refinancing risks. As of December 2015, Sabesp's cash and marketable securities position was adequate at BRL1.6 billion, covering short-term debt by 1.1x.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
--Long-Term Local-Currency Issuer Default Rating (IDR) at 'BB';
--Long-Term Foreign-Currency IDR at 'BB';
--USD140 million notes due 2016 at 'BB';
--USD350 million notes due 2020 at 'BB';
--National Long-Term Rating at 'AA-(bra)'.
The Rating Outlook is Stable.
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