We are raising Sabesp (BVMF: SBSP3) to “Sector Outperform” rating and raising our price target to R$22 (increased by 5%); while risk assessment remains “Medium”. First quarter reservoir inflows were good, in spite of readings in the Cantareira system that were yet lower than long-term averages. Overall, the main São Paulo (SP) reservoirs now demonstrate a level of 32% with April pending.
Yesterday, ARSESP granted Sabesp a initial 14% tariff hike starting in May, the result of a 7.1% boost for inflation and a 6.4% extraordinary surge. The surge was larger and came sooner than expected. It was good that the SP state government stuck to the regulatory framework procedures and allowed Sabesp to take measures to protect its cash flow. Moreover, Sabesp plans to lobby for a slightly higher tariff surge given anticipated energy costs. Overall, this is positive but political risks remain associated to the 2016 SP major elections.
We expect that current positive news on reservoirs, the CTEEP share settlement, higher tariffs, ônus/bonus tweaks and the increased by 20m3/s capacity plans for the SP region counterbalanced opex uncertainty. Sabesp is trading at 0.92PBV versus a 1.20 times 5yr average that includes periods of no RAB framework and higher concession risk. Going forward, its shares should be fuelled by opex levels, the 2016 tariff review talks and hydrology.
With Andean Utilities trading richly, we are now fully overweight on Brazil Water. Copasa and Sabesp are our top picks. Regulatory risk and hydrology are major risks to be considered while trading.