4 Reasons to Like SBS

1. Demand: According to the history of an all-encompassing market known as "life," demand for water is more inelastic than that for any other commodity. Companhia de Saneamento do Estado de Sao Paolo (SBS) provides clean water and treates waste water for South America's largest city's drinking, farming, industrial and cleaning needs. Brazilian stocks like PBR and VALE are dependent on international demand for oil and steel, respectively, and fluctuate with the prices of those commodities. Fundamentally, SBS is subject only to the volatility of Sao Paolo residents' "desire to live."

2. Dividends: The Company returns profits to shareholders. 18% institutional ownership is massive for a South American company valued in the billions. Corruption has always been an issue in Brazil, but the share distribution (less than 1% of the remaining float is short) and an accelerating yield over 10% in the last 20 months are very reassuring.

3. Value: At $30/share, SBS trades under 7x 2008 earnings and a price to book ratio of 0.64. The investing world apparently believes this is an unsustainable business to value it below its assets. With a growing customer base of 20 million and years of revenue growth continuing through Q1 2009, this investor disagrees.

4. Relative Value: Water utilities in the United States have been as resilient as any sector I follow. Apparently nobody denies that our water needs are inelastic, as domestic providers trade at P/Es of 15-20 and P/Bs of 1.5-4. Growth, if only in population, is much more evident in Brazil than it is here. With so much capital emerging markets depend on coming from developed ones, lack of interest is a powerful thing. See below:

• Companhia De Saneamento B Sico Do Estado De Sao Paulo Sabesp Ads'S -- 29.90 0.11
• American Water Works Company Inc. (AWK) - 18.66 0.18
• California Water Service (CWT) - 35.46 -0.17
• Artesian Resources Corp. (ARTNA) - 14.86 0.36
• Pennichuck Corp. (PNNW) - 21.02 -0.32

Disclosure: Long SBS

Comments

[Danny Furman]

I attempted to copy and paste charts for all the utilities mentioned. The point is that none, except SBS, are significantly cheaper than they were a year ago. Additionally, many of the other companies have struggled lately, while SBS continues to grow.

2009 Jun 17 09:09 AM

[jimrogersfan]

good company, but why purchase SBS as opposed to EWZ?
look how closely they track - All beta and no alpha

2009 Jun 17 10:12 AM

[jimrogersfan]

From the big picture fundamentals, it appears to be a good company. However, why invest in SBS as opposed to EWZ? Look how close they tract. - All beta and no alpha

2009 Jun 17 10:16 AM

[SeekingValue]

I agree that this is a compelling value play. There were two other issues I noticed when researching these guys that worried me a bit. 1) The state of Sao Paolo owns roughly 51%, which means that it may not be run in a way that maximizes broader shareholder value. For instance, the state has a huge overdue water & sewage bill with SBS, and SBS says in their annual report that they may not be able to collect. 2) The report also says that SBS gets a large amount of their water from a couple of state-owned reservoirs. Currently they get this water for free, but they say that if the state should start charging them it could be a problem.

Now, this report I read is almost a year old now, so things may have changed. And I don't know how things really work in Brazil... maybe these issues aren't such a big deal. I'd love to hear if anyone has new information or a Brazilian insiders perspective.

All that said, if it gets down to $25 or so, there would be enough margin for error that I'll be a buyer.

2009 Jun 17 10:40 AM

[Danny Furman]

EWZ=better growth
SBS=better value and income
That's how I see it.

2009 Jun 17 02:08 PM

[sabre_jenn]

SBS does not appear to pay regular dividends -- and based on the most recent 12 months, it has paid a yield of about only 2.5%?

Before that, it paid no dividends for two years. If dividends resume at their old rate (not guaranteed), SBS would be paying about 3.6% yield

Yahoo, Google and Seeking Alpha all say SBS pays no dividend at all

So where do you get 10% yield from?

2009 Jun 17 02:49 PM

[sabre_jenn]

I just checked the investor presentation directly from SBS's own website... they say the yield *was* in the high single digits two years ago, but the current yield according to SBS itself is 2.1%

2009 Jun 17 02:54 PM

[Victor84]

As long as they keep paying a dividend, I don't see how this isn't the safest play around with a $35 fair value upside. This is one stock that I've held for a while now and they got needlessly battered by the crisis. Last time I checked SBS provides the most essential service for a rapidly growing city in an emerging powerhouse of a country; has anything changed except a 50% share price reduction?

2009 Jun 17 02:54 PM

[sabre_jenn]

Victor84 -- if you have held SBS for a while, could you tell us what dividends it actually pays?

The author's 10% yield claim is not supported by any financial website I could find -- they all claim the payout is "zero" (no regular payment). One site says it paid 2.5% this year so far, but nothing for 2007 and 2008

SBS's own investor presentation says 2.1% yield now, and less last year (they say they paid a dividend in 2008, though small)

What is the correct dividend?

2009 Jun 17 03:08 PM

[Jeff Nielson]

Danny, it was only about a year ago where I heard Jim Rogers talking about water-treatment companies as a HUGE buy (one of the few mainstream "names" who I always listen to).

He was specifically referring to China, but obviously this is going to be a great business in many jurisdictions.

What exchange does this trade on?

2009 Jun 17 03:19 PM

[sabre_jenn]

Jeff - SBS trades on NYSE

The state of Sao Paulo owns 50.3%, 26% is traded on NYSE, and the remaining trades locally in Sao Paulo

That said, I am unable to get any reliable info on SBS dividends. The author claims 10%, various websites say 0%, and SBS's investor presentation says 2.1% ???

2009 Jun 17 03:24 PM

[Victor84]

"Dividends in the form of interest on own capital, declared for the year 2008, will be paid at the ratio of BRL 0.88 ($0.45) per share held on the reference date as of Aug. 12, 2008 and BRL0.42 per share held on the reference date as of Jan. 21, 2009, respectively," Sabesp said.

So you're correct about the yield %.

In previous years their dividends were
2004: .79
2005: 1.38
2006: 1.12
2007: 1.29

They assumed a heavy debt load with their expansion plan, which is hurting them. However, it's obviously going to recover and grow incrementally.

2009 Jun 17 03:25 PM

[Victor84]

Clarification: Previous dividends denominated in USD

2009 Jun 17 03:47 PM

[Danny Furman]

I got 10% by adding the dividends paid over the last 20 months. As with another Brazilian holding of mine, electric utility CPL, it is my understanding that SBS is required to pay a very high percentage of profits as dividends, although I haven't been able to find a 10K or evidence of that clause. That information was brought to my attention by a SA contributor, citing the need for these companies to distance themselves from a history of corruption in Brazil.

It appears that SBS has adopted a semi-annual dividend, however it paid shareholders more regularly prior to 2007. It has always operated profitably and revenue doubled from 2004 to 2007, so added infrastructure obviously accompanies such rapid growth. What I deduce is that cash is not always on hand, as capital needs come first. Therefore dividends are irregular, yet larger when more sporadic.

As you alluded to, Jeff, water treatment is an entirely appealing industry. As we torch the atmosphere and populations grow, an already apparent worldwide water shortage will make water more and more commonly referred to as "blue gold." US companies in this industry are too highly (fairly) valued for my consideration, but water rates will surely increase enough to guarantee sustainability of its providers here and abroad.
Desalination is the technology and growth play for water. I own shares of CWCO, a Bermuda based "ocean filterer" that has reported a great start to 09 and pays regular dividends. ERII is a publicly traded US based desalination company and has operations in China and Spain, but it is valued too highly for my liking and insiders have been selling like mad lately. One to keep an eye out for is Chinese utility Duoyuan Global Water (DGW), set to IPO next week.
By the way, Jim Rogers' take on China played a significant role in my decision to concentrate my portfolio there.

2009 Jun 17 05:06 PM

[Mad Hedge Fund Trader]

Nuclear is going to be the next big thing. The nuclear industry, which has been in hibernation since the accident at Three Mile Island in 1979. There is absolutely no way we can deal with our energy crunch without a huge expansion of our nuclear capacity, which sits at a lowly 20% of our power generation. France has already achieved this, getting 85% of its electric power from nuclear, followed by Sweden at 60%, and Belgium at 54%. Unless you’re a nuclear engineer, you are probably unaware that the technology has moved ahead four generations. The first one produced the aging behemoths we now see on coasts and rivers, which used high grade fuel that would melt down if someone forgot to flip a switch. Generations two, three, and four never got off the drawing board. Generation five is not your father’s nuclear power plant, relying on a new form of fuel embedded in graphite tennis balls that is just strong enough to generate electricity, but too weak to risk a disaster. This eliminates the need for four foot thick reinforced concrete containment structures, which accounted for 50% of the old design’s cost. Low grade waste can be stored on site, not shipped to Nevada or France. The permitting process is being shortened from 15 years to four by confining new construction to existing facilities instead of green fields, urged on by a less fearful public and even some CO2 conscious environmentalists. At least 30 new reactors are expected to start construction in the US over the next five years, and over 90 in China. There has got to be an equity play here. The Market Vectors Nuclear Energy ETF (NLR), which has jumped an impressive 78% to $25 since March, is the easiest way in. You can also buy its largest components, like Cameco (CCJ), the world’s largest uranium producer, or Électricté de France (EDF SA) which has the monopoly in France and is developing a major export business.

2009 Jun 17 05:18 PM

[Sovestor]

How about competitors, profit margins, return of equity, return on assets, insider ownership, etc...........????

2009 Jun 18 04:03 AM

[Danny Furman]

No competition, 51% stste owned and 19.52% insider owned with 0.44% remaining short. ROE, ROA, Margins are all industry leading.


On Jun 18 04:03 AM Sovestor wrote:

> How about competitors, profit margins, return of equity, return on
> assets, insider ownership, etc...........????

2009 Jun 18 09:48 AM