RIO DE JANEIRO--(BUSINESS WIRE)--Fitch Ratings has downgraded Companhia de Saneamento Basico do Estado de Sao Paulo's (Sabesp) Foreign and Local currency Issuer Default Rating (IDRs) to 'BB' from 'BB+' and its National Long-term rating to 'AA-(bra)' from 'AA(bra)'. The Rating Outlook is Stable . A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The downgrade reflects the weakening of Sabesp's financial profile in 2014 combined with the expectation of further deterioration during 2015. The company faces a low hydrology environment that has sharply reduced the company's reservoir levels and water supply capacity. The company's decision to apply the incentive water reduction program has also contributed to deteriorate Sabesp's revenue and cash flow generation during 2014. Sabesp has relevant challenges in next quarters due to the expected continued reduction on the volume of water and sewage billed and pressured average tariff as the incentive program to reduce water consumption remains.
For 2015, Fitch forecasts Sabesp's net leverage measured by total proforma net debt/EBITDA to be high and above 4.0x from 3.1x in 2014, and 1.9x in 2013. The pro forma analysis excludes the EBITDA benefits of BRL696 million from the agreement with the state government of Sao Paulo regarding past liabilities since it is non-operating, non-recurrent and estimated short-term cash impact limited at BRL90 million. The rating action assumes rainfall resuming at historical levels in 2016 and lifting of the incentive water reduction program during 1Q2016. Changes to these assumptions may pressure the current ratings.
Sabesp's ratings incorporates the strength of the company's cash flow from operations (CFFO) during regular hydrologic conditions, combined with its satisfactory liquidity position and lengthened debt maturity profile which should contribute to partially mitigate the more challenging scenario. The ratings also reflects 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.
The analysis considers the risks associated with Sabesp's high percentage of foreign currency debt on its balance sheet, which has increased during 2014, and the still-new regulatory environment for the company. Fitch also factored in the political risk inherent with Sabesp's control by the State of Sao Paulo, with the potential for changes in management and strategy after each election. Cash flow generation can be jeopardized due to political decisions, as occurred with the postponement of the tariff adjustment in 2014.
Severe Drought to Further Pressure Financial Profile
Fitch expects Sabesp's lower net revenues of around 5.0% by the end of 2015 compared with 2014 given the restricted water availability and the water reduction incentive program. The expected revenue reduction should be partially mitigated by the tariff increases of 6.5% in December 2014 and 15% to be effective from June 2015. The company's decision to maintain its water reduction incentive program should continue to deteriorate its revenue and CFFO generation capacity and negatively impact its credit metrics during 2015.
Fitch forecasts Sabesp's proforma EBITDA in 2015 to be BRL2.5 billion, which should maintain the company's net leverage pressured at 4.1x in the same period. During LTM ended March 2015, the company's EBITDA decreased to BRL2.5 billion from BRL2.9 billion by the end of 2014 and BRL4.0 billion reported in 2013. Fitch estimates the company's net leverage and financial profile to gradually recover from 2016 onwards assuming hydrologic conditions return to normal standards. The agency forecasts that consumer lower volume consumption behavior should lag to resume at historical levels in approximately 3 - 4 years.
Low Reservoirs to Continue Impacting in 2015
Sabesp's low water reservoir level at the Cantareira System remains a concern as dry season initiated on May. The reduced reservoir level of 19.7% by May 20th, 2015 incorporates 29.2 percentage points (p.p.) from additional capacity introduced to the system and is 17.2 p.p. lower compared with the same period in 2014. Another important water supply system, the Alto Tiete, has also registered low level at 23.2% in the same date.
The Cantareira System used to be responsible for nearly one-third of the total volume of water produced by the company and for the supply of its main service region. Sabesp has taken successive measures avoid water rationing which includes reducing water withdrawal from this System, lowering network pressure and transferring water from other systems to the regions previously supplied by the Cantareira. Sabesp has also increased investments on other systems to reduce the dependency of the Cantareira System. Significant rainfall levels are needed to recover the water level on this crucial water supply system.
Sabesp's increased costs due to low hydrology should continue to pressure the company's EBITDA margin which is estimated to register around 33% by the end of 2015, according to Fitch forecasts, partially mitigated by the tariff increases in 2015. During the LTM of March 2015, the company's lower margin of 32% negatively compares with 45% reported in 2013, influenced by decrease on revenue, higher payroll, energy and treatment costs, in addition to water reduction consumption campaign expenses. EBITDA margin calculation does not consider construction revenue on net revenues.
Weakening Cash Flow
A challenge to Sabesp is managing its high annual capex estimated at 2.4 billion for 2015 and between BRL2.7 - 2.9 billion during 2016 - 2019 in order to mitigate the estimated negative FCF during the next years. The company's CFFO generation during the LTM ended March 2015 of BRL2.0 billion has shown an important reduction when compared with BRL2.5 billion and BRL2.9 billion respectively in 2014 and 2013. In the same period, the company's FCF was negative at BRL1.2 billion, pressured by the aggressive investments, which amounted to BRL2.8 billion, and by the dividend distribution of BRL467 million in the same period.
The maintenance of substantially more robust liquidity positions since 2010 reduces Sabesp's debt refinancing risk and should benefit the company throughout the deteriorated operating environment . The company's proven access to debt market and manageable indebtedness maturity profile should also alleviate pressures on its financial flexibility.
As of March 31, 2015, Sabesp's cash and marketable securities position was strong at BRL1.7 billion. The BRL1.4 million short-term debt resulted in adequate coverage ratio by liquidity of 1.3x. At the same date, Sabesp's total adjusted debt of BRL11.8 billion presented lengthened debt amortization profile, although with a significant portion (BRL5.4 billion, or 46%) exposed to exchange rate fluctuations, which could generate negative pressures on the company's credit metrics and financial covenants in the event of a significant devaluation of the Brazilian Real. By the end of March 2015, the company registered BRL971 million of debt maturing until 2016 exposed to the foreign currency volatility, which poses further risks.
--Reduction of total volume billed of 11% in 2015 and 3% annual increase from 2016 - 2019.
--Annual tariff increases of 15,2% in 2015 and around 6% from 2016 - 2019.
--EBITDA margins of 33% in 2015 with gradual growth to 42% by 2019.
--Recovery of historical average rainfall level in 2016 and lift of water reduction incentive program on the 1Q2016.
--Capex of BRL2.4 billion in 2015 and between BRL2.7-2.9 billion during 2016 - 2019.
Negative Rating Actions: Further downgrades may occur due to one or a combination of the reasons below on a sustainable basis:
--EBITDA margins below 33%.
--Net Leverage above 4.5x.
--(Cash+CFFO)/short term debt below 1.5x.
Positive Rating Actions: Ratings upgrade is unlikely in the short term. In the medium to long turn upgrades may result from:
--Lower operational cash generation committed to investments or cash generation growth above Fitch's expectations.
--Net leverage below 2.5x.
--EBITDA margin above 40%.
--(Cash+CFFO)/short-term debt above 2.5x.
--Lower FX debt exposure.
Fitch has downgraded the following ratings:
--Local currency long-term Issuer Default Rating (IDR) to 'BB' from 'BB+';
--Foreign currency long-term IDR to 'BB' from 'BB+';
--USD140 million notes to 'BB' from 'BB+';
--USD350 million notes to 'BB' from 'BB+';
--National long-term rating to 'AA-(bra) from 'AA(bra)'.
The outlook for the corporate ratings is 'Stable' .
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage