Sabesp Q2: Extended Valuation Overshadows Big Result (NYSE:SBS)

investment thesis

I recommend keeping Sabesp (NYSE:SBS) after 2Q24 results. Sabesp reported strong results in 224Q, even beating market estimates for both revenue and earnings per share. In addition, the company will have much more freedom make assertive decisions because of privatization.

However, the valuation is extremely stretched when looking at the company’s EV/EBITDA relative to its own history. As an analyst who adheres to the philosophy of value investing, I still recommend holding the stock, requiring a greater margin of safety to recommend a buy.

Review of Sabesp 2Q24 results

Sabesp released its Q2 results on August 9, and the company beat market estimates for revenue by 21.7% and profit estimates by 25%, as we can see below.

Next, I will do a full report on each segment of the results. It’s important to note that the company discloses results in BRL, and I’ll convert them to dollars using the ratio 1 USD = 5.59 BRL, which was the Brazilian dollar exchange rate on the last day of Q2. Enjoy reading!

Revenue – above expectations

Sabesp posted a good annual revenue growth of 11.9% to BRL 5.4 billion ($979 million). The increase was due to the 6.4% rate adjustment from May 2024 and also due to the 3.2% y/y increase in billed volume.

In my opinion, privatization should give more freedom to management to improve the company. Therefore, I consider the revenue outlook to be of continued growth due to the stability of tariff prices and the expansion of strategic concessions until 2060.

Costs, Expenses and Margins – Good cost control

The company achieved a nice 15.5% y/y reduction in costs and expenses. However, this was possible due to the larger base in T223 when the company implemented its voluntary layoff plan.

With this, the company achieved an EBITDA margin of 54% compared to 44.8% in Q223. The excellent track record of the newest shareholder, Equatorial (which has an excellent track record in capital allocation), is believed to help Sabesp continue to grow revenues, reduce expenses and increase margins.

Debt – Healthy leverage

Sabesp ended Q224 with a net debt of nearly BRL 16 billion ($2.9 billion) and a cash position of BRL 5.2 billion ($930 million). As a result, the company achieved leverage of 1.6x, well below the agreements.

On the outlook, I believe the new tariff rates, in addition to the focus on efficiency, can further improve the company’s debt profile going forward.

Capex – Strong investments in the future

The company reported investments of BRL 1.3 billion (USD 232 million) in Q2 224. The company is expected to significantly increase investments due to the New Sanitation Framework, and projections indicate total investments of BRL 70 billion (USD 12.5 billion dollars) for the complete universalization of services.

Therefore, I believe the following results should show high capex, as well as reducing the dividend payout, which is why I think the company should have a dividend yield close to 2% for the next 12 months.

Net income – Overview of results

With revenue growth and cost containment partially offset by higher financial expenses, the company achieved a 62% annual increase in profits to BRL 1.2 billion ($216 million).

It is worth noting that this expansion in profits was also affected by a weaker base in Q223. However, I believe the company will continue to expand its operating margins due to privatization. But if the outlook is so good, why is there no buy recommendation?

Rating – Very broad

One of the most assertive ways I can find to analyze a company is to compare its EV/EBITDA multiple to its own history, and that’s what we’ll do next:

Over the past 3 years, the company has traded at a maximum of 7.6x EBITDA and is currently trading at 7.3x EBITDA. However, if it reverts to trading at its 3-year historical average of 6.1x EBITDA, this represents a 16% downside, which corroborates my recommendation to hold the stock and wait for a more opportune time to invest in Sabesp.

And before I talk about thesis risks, it’s important to point out that Seeking Alpha’s powerful tools corroborate my thesis for owning the company’s stock.

Potential risks to the thesis

When an analyst recommends owning a stock, it means that if the stock goes up, they will not participate in the increase. Therefore, one of the risks of not buying Sabesp shares is that the company is now private, so it is possible that it will experience a widening of multiples by the market.

In addition, the main shareholder of the company will be Equatorial Energia (OTCPK:EQUEY), a company with an excellent history of allocating capital in Brazil and one of the largest combiners on the Brazilian stock market.

Sabesp’s investment case is complex and investors should conduct pragmatic and diligent analysis before choosing to invest in the company.

conclusion

My thesis not to invest in Sabesp never considered the operational aspects of the company. In my opinion, Sabesp was one of the best state-owned companies, and now, as a privatized company, it has even more freedom to make better decisions.

Despite seeing a company with excellent margins, a good debt situation and good future prospects, I don’t feel confident when I see that the EV/EBITDA multiple is at its highest levels in the last 3 years.

Based on this analysis, I recommend holding Sabesp shares. In my view, investors should wait for an opportunity to buy the company’s stock at a more attractive price, such as the potential downside of 16%. In my opinion, the risk/reward ratio is not attractive.