Financial Times Interview - jan 2012

1. BUILDING BRAZIL 12 BRAZIL CONFIDENTIAL
JA N UA RY 6-18 2012
SIGNS OF A CLEAN-UP IN THE
SANITATION SECTOR
BLOOMBERG
SUMMARY
The water
and sanitation
sector is badly
managed and
undercapitalised,
but a process
of transition is
occurring.
Sabesp and
Copasa, listed
companies which
hold concessions
in the south-
east, are the best
suited for organic
growth. They are
turning to the
bond markets
and PPPs to ease
capital pressures.
The private
sector’s
participation
in the industry A Sanepar water treatment plant in Irai, Rio Grande do Sul. Brazil’s best sanitation companies are in the south and south-east
could increase
from 10% to up
to 40% within A new framework
a decade. Firms
The better public providers are looking Ensuring universal access to piped water and sewerage
owned by the to expand, and private-sector collection in Brazil would cost an estimated R$270bn
major engineering companies are winning contracts. ($148bn, £95bn, €115bn). In 2010, the industry invested
contractors are less than R$20bn, including both public and private
Y
expanding, in ou don’t have to travel far in Brazil before you sources. The federal government has pledged to invest
particular through bump into the shortcomings of the sanitation a further R$35m by 2014, under the second phase of the
combined water sector. The sewerage network reaches less than Programme for Growth Acceleration (PAC 2). But that
and sewerage half the population, and most of the waste it leaves a considerable shortfall. The hope is that sanita-
contracts. does collect isn’t treated. One in five Brazilians lack tion could follow the example of the highways sector,
access to piped water. which has benefited from greater private-sector involve-
The sector is dominated by badly-managed publicly- ment (through PPPs and concessions).
owned utilities, which operate effective geographical The federal government is trying to overhaul the
monopolies without formal contracts or independent institutional framework. In 2010 it passed a law obliging
regulation. all municipalities to develop a sanitation plan by 2014
However, the government has committed itself to re- and create independent regulators. Other rules allow for
form. It can take heart from good management seen in differentiated tariffs for customers who consume and
the south-east, where two state-controlled providers – earn less, but indemnify utilities that cut off supplies to
Sabesp (SPSB3:SAO) and Copasa (CSMG3:SAO) – are in those who don’t pay at all.
the process of formalising contracts and relationships Policy is set at the federal level by the Ministry of
with regulators. A small group of efficient privately- Cities, which together with the Ministry of Health
held firms are also gaining ground. The question is and public banks such as BNDES and Caixa Econômi-
whether the sector as a whole will remain a laggard. ca Federal provides funding to utilities. Provision
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2. BUILDING BRAZIL SIGNS OF A CLEAN-UP
IN THE SANITATION SECTOR 13 BRAZIL CONFIDENTIAL
JA N UA RY 6-18 2012
and regulation, however, is delegated to the regional Good management means that sector indicators are
level. Brazil has 27 publicly owned sanitation compa- above average for public sector companies. They both
nies – one per state – alongside a multitude of publicly had system losses of less than 30% in 2009, compared
owned municipal sanitation companies. with a national average of 37%, and unpaid bills at Co-
Sabesp serves 23.5m In most parts of the country geographical pasa were 1.32% in 2010, less than the national average
customers, making it one monopolies operate, but in recent years the of 7%. However, both companies face uncertainties in
of the biggest sanitation south-east – and to a lesser extent the centre- relation to regulation and future capital-raising.
companies by customer west – has been opened up to competition. The regulatory framework for both states is ex-
base in the world As a result, a small number of private utili- pected to be announced later this year by the respec-
ties, most of them subsidiaries of large engi- tive state governments, although the process has
neering contractors, have been gaining ground and now
cover 10% of urban provision. Concessions are awarded
by municipal governments and typically last for 30 years. Financials of leading utilities
However, the implementation of formal contracts via a Net revenues (R$m)
public tender process is still at a very early stage. 2005 2006 2007 2008 2009 2010 2011*
Providers generally charge tariffs to customers for Copasa 4,953 5,527 5,971 6,352 6,731 9,230 7,226
supply of water and, where offered, collection of sewer-
Sabesp 1,477 1,682 1,863 2,060 2,202 2,323 1,872
age. In some cases they also charge for the use of water
although water metering is still not widespread. Tariffs Ebitda margins (%)
have traditionally been set by the utilities themselves Copasa 39.7 39.0 40.2 28.9 39.6 45.6 42.5
based upon a calculation of operational cost and infla- Sabesp 46.1 44.3 45.2 44.7 40.7 34.9 31.1
Notes: R$1=$0.5, £0.3, €0.4. *Jan-Sep
tion. However, where they exist, independent regulators Source: companies
are in the process of defining new charging models. In
São Paulo and Minas Gerais these will take into account
capital expenditure when making tariff adjustments
and this model may be repeated elsewhere. Much still to be done – especially in the north
Access to water and sewerage services, 2009
Headway in the south-east % of households
The biggest beneficiaries of reform could be those ar- Piped Water Sewerage collection
eas where the service is currently worst. For example, Sewerage treatment
in the north-east, where just 80% of the population 100
doesn’t have sewerage collection, companies have too
80
many staff and too little monitoring capacity. Mean-
while, because of fraud, leaking pipes and clandestine 60
connections, the northern state of Amapá consumes %
as much water per person as São Paulo. Amápa’s state 40
company, Caesa, cut half its jobs last year but still
20
lacked the funds to pay for its phone lines.
In contrast, Brazil’s best sanitation companies are 0
North North- South Centre- South- Brazil
in the south and south-east, the regions which also east west east
have the best coverage. Santa Catarina’s Casan and Source: SNIS
the companies for Minas Gerais, São Paulo and Paraná
(Copasa, Sabesp and Sanepar [SAPR3:SAO]) are all
listed on the Bovespa, with the shares of Copasa and
Sabesp trading on the Novo Mercado, the segment Efficiency is highest in the south
with standards for corporate governance. Water losses as a share of water companies’ turnover, 2009
However, the stocks lack liquidity. Only 0.002%
of Casan’s stocks are traded, for example. This may 60
change though, Santa Catarina state assembly recently 50
passed legislation allowing for the state government
40
to sell 49% of its stake in the company to a strategic
investor, which may happen as early as 1Q12. % 30
53.7
Sabesp, in which the São Paulo state government 44.0
20 36.2 37.1
holds a 50.3% stake, serves 23.5m customers, making it 33.8
10 25.3
one of the biggest sanitation companies by customer
base in the world. The smaller Copasa, in which Minas 0
North North South- Centre- South Brazil
Gerais state government has a 53% stake, serves 13.2m east east west
people. Both companies have significant potential for
expansion of their customer bases. Source: SNIS
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publication or parts of it, including forwarding by email, to any individual or other third party. Any violation of these restrictions may result in personal and/or corporate liability. (c) The Financial Times
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3. BUILDING BRAZIL SIGNS OF A CLEAN-UP
IN THE SANITATION SECTOR 14 BRAZIL CONFIDENTIAL
JA N UA RY 6-18 2012
already been subject to delays. try have had committees
The new regulators are part of the state govern- – composed of representa-
ments, which are the majority shareholder in the tives from industry, water
respective companies, Sabesp and Copasa. companies and residential
One sticking point is adjustments to the tariff consumers – which manage
system, which will from this year take into account water resources. The com-
capital expenditure as well as the rate of inflation and mittees have increased fees
operational cost. Sabesp invested R$2.5bn in 2010 out for water by about 10% per
of net income of R$9.2bn, while Copasa has invested year. Industry can reduce its
an average of R$870m per year since listing in 2006 exposure to this increasing
and so both should stand to gain from linking tariff cost by re-using water. Tra-
adjustments to investment. However, it is not known ditionally it has done this by
what basis the regulators will use to calculate the value treating water with coagu-
of these companies’ respective asset bases. lants such as iron chlorate
Both companies are in the process of formalising their and aluminium sulphate to
service contracts with municipalities. One uncertainty aggregate pollutants. But the
for Sabesp relates to a contract it was recently awarded to quality of the end product is
not as good as that achieved
supply the municipality of São Paulo. The contract con-
tains a service fee priced at 7.5% of gross revenues gener-
INSIGHT with advanced technol-
ated from São Paulo. This is unusual in the public sector,
SUPPLY CHAIN ogy such as ultra-filtration
and the company may seek to pass it on to consumers OPPORTUNITIES membranes and as a result
via higher tariffs. However, it is not certain that the state cannot be used in sectors like
regulator would accept such a move. Annual sales of water and the pharmaceutical industry,
Another issue for Sabesp and Copasa is financ- wastewater treatment where purity is paramount.
ing growth. Both have the opportunity to expand technology services in Latin Dow manufactures key
their customer bases significantly. Copasa currently America will rise by over 50% parts in Europe, the US and
provides water to around three-quarters and sewerage by 2020, to around $72bn, Asia, which it then sells on to
to a quarter of the 800 municipalities in Minas Gerais according to forecasts from the large suppliers of utilities
and has identified another 104 municipalities it wishes consultancy Frost & Sulli- and industry in Brazil and
to target for sewerage contracts, while Sabesp provides van. The vast majority of the elsewhere in Latin America.
water to 23.8m customers and collects sewerage from market is in the residential The company’s sales for the
20m, but still only covers half of São Paulo’s 645 and commercial sectors, region are forecast to double
municipalities. This expansion is likely to take place although industry is seeing in the three years to 2012,
via organic growth rather than M&A activity, as other faster growth. although it did not supply
publicly owned companies are largely opposed to be- Within Brazil, around 85% specific figures.
ing acquired and many don’t hold formal concessions of the market is dominated While much of the equip-
for the services that they provide. by multinational companies ment used in the sector in
In the context of lacklustre equity markets, Sabesp such as Nalco (NLC:NYSE), GE Brazil currently is imported,
and Copasa are likely to issue bonds, take loans from (GE:NYSE), Kurita (6370:TYO), Alessandra Lancellotti of
federal government agencies or enter into PPPs to Kemira (KRA1V:HEX), Frost & Sullivan thinks that
fuel this expansion. Another option is multilateral Veolia (VIE:PAR), Dow this will change as demand
agencies, such as the IFC, which recently provided (DOW:NYSE), Buckman and increases from large state-
Ashland (ASH:NYSE). Their owned companies such as
distribution networks and Petrobras (PETR4:SAO) and
The states that invested most in sanitation technologies allow them to Vale (VALE5:SAO), which
2009 out-compete Brazilian rivals. have significant local content
Rio Grande do Sul
Advanced technologies rules for their respective sup-
R$359.7m can reduce the cost to the end ply chains.
Pernambuco user by 20-30%, according to While legislation is
R$440.5m
Renato Ramos, head of re- increasingly rigorous, the
search and development Dow sector would receive an even
Bahia Water & Process Solutions greater boost were laws to
R$458.7m
São Paulo Latin America, because they be better enforced, says Ms
R$2,712.9m consume less energy and Lancellotti. “Many small and
chemicals. medium industries are not
Minas Gerais
There are legislative driv- monitored,” she says. “Very
R$937.3m ers, too, to the growth of often they don’t even have a
such technology. Since 1997 system for the treatment of
Source: SNIS some parts of the coun- water.”
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publication or parts of it, including forwarding by email, to any individual or other third party. Any violation of these restrictions may result in personal and/or corporate liability. (c) The Financial Times
limited 2010. “Brazil Confidential”, “FT” and “Financial Times” are trade marks of the Financial Times Limited.

4. BUILDING BRAZIL SIGNS OF A CLEAN-UP
IN THE SANITATION SECTOR 15 BRAZIL CONFIDENTIAL
JA N UA RY 6-18 2012
R$59m to Casan and the state utility for Sergipe – factory in Campo Grande, which allows the company to
Deso – to fund training, installing water meters and supply its local network and sell the surplus. As a result,
registering users. ebitda margins for the two companies are expected to
Copasa has exhausted the capital available from exceed 50% for 2011. That compares with a margin of
its IPO and is looking for additional sources. It can’t 34% for Guariroba at the time of the acquisition and a
issue new shares because the state government is at its negative margin for Prolagos and is up to 20pp higher
shareholding limit, so it plans to issue R$400m in 2012. than that of Copasa and Sabesp.
It has also obtained a €100m loan from the German Long-term financing is provided by Caixa Econômi-
development bank KfW but does not wish to increase ca Federal to Guariroba and BNDES to Prolagos. The
its foreign currency exposure significantly beyond the business is looking for alternatives in capital markets.
current level of around 2% of gross debt. In contrast, In 2007, Prolagos made a private placement of R$75m
around 35% of Sabesp’s debt is denominated in foreign of seven-year bonds via HSBC (HBS:NYSE), rated A
currency, mainly US dollars. Net debt was 2.1x ebidta by Fitch. Mr Crivellari says that the business is also
in 2009, 1.9x in 2010 and 2.0x ebidta in 3Q11. looking to external markets and has held conversa-
State companies in the south-east of Brazil are tions with the IFC and IDB. He says that the business
increasingly entering into PPPs, which allow them to wishes to triple the number of users from the current
fund investment, while retaining direct contact with level of 1.25m in the next five years, and may consider
their customer bases. Sabesp established the R$300m a partner.
CAB Spat PPP with CAB Ambiental (a small player in The business recently had the Prolagos concession
the sector owned by Galvão Engenharia and FIGTS) extended for another 18 years and is in the process of
in Taiaçupeba, São Paulo in 2009. The 15-year contract approaching municipalities with a view to winning
covers the expansion of the capacity of water treat- combined water and sewerage contracts, which cre-
ment by 50%. ate better synergies and allow for lower tariffs than
Sabesp plans to launch two more PPPs in 2012, one separate water or sewerage concessions. It recently
for water treatment for the west of São Paulo city and competed for the AP-5 PPP, a project to collect and ACTION
one for sewerage on the northern coast of the state. Ce-
dae, the Rio de Janeiro utility, also recently launched a
treat sewerage in western Rio de Janeiro city, but lost
out to a consortium of Águas do Brasil and Foz do
POINTS
major PPP for collection and treatment of sewerage in Brasil, which are owned by Developer, Queiroz Gal- 01 Equipav, a
the deprived western zone of Rio de Janeiro city, which vão, Trana and Cowan, and Odebrecht respectively. private operator,
will require R$2bn investment over 30 years. Paula Bit- The consortium paid R$84.2m for the PPP contract. has an ebitda
tencourt, Copasa’s head of investor relations, told Bra- Águas do Brasil has ten other concessions, covering margin of around
zil Confidential that her firm is currently studying the 2m customers in eight municipalities in Rio de Janeiro 60%, 20pp higher
possibility of a PPP to expand the distribution network and four in São Paulo. In 2011, net revenues were than that enjoyed
for Belo Horizonte, although this is at an early stage. R$488m, while the ebitda margin grew 1pp to 135%. by the most
Leverage is low, just 20% of net revenue in 2011, and is efficient public
Equipav’s efficiency entirely comprised of long-term financing provided by sector companies.
Through a growth in the number of PPPs being ten- BNDES at a rate of around 8.5% per year. The company This is as a result
dered and also direct concessions, private companies, will look for further funding from the development of reduction of
which currently hold about 10% of urban provision in bank, to finance the AP-5 programme. Claudio Ab- energy, labour and
Brazil, will increase their share to up to 40% by 2020, duche, Águas do Brasil’s director-general, says that the equipment costs
according to Paulo Oliveira, chief executive of the firm “has no interest” in a stock listing. and investments in
concessionaires organisation Abcon. Foz do Brasil, meanwhile, has a strong footprint metering.
Infrastructure and services group Equipav moved in the industrial sector. While this doesn’t offer the
into the sanitation field in 2005 through the acqui- same scaleability as municipal contracts (which cover 02 In the supply
sition of two companies – Águas Guariroba from residential, commercial and public sanitation), it is a
chain, multinational
Aigües de Barcelona, which has the contract for fast growing area as a result of the high demand from
companies
import advanced
water and sewerage in Campo Grande, and Prolagos the oil and gas, mining, steel and paper and cellulose
technologies,
from Águas de Portugal, which covers five munici- industries. One such contract is the agreement to treat
offering improved
palities in Rio de Janeiro. water for the Franco-Japanese steel tubing joint ven- water purity.
The focus, according to finance director Flávio ture Vallourec Sumitomo Brasil (VSB), based 100km However, increased
Crivellari, has been on making significant capital invest- from Belo Horizonte in Minas Gerais. demand for water
ments to increase the number of clients and improve Foz received a senior loan of R$361m from BNDES from Brazilian
efficiency. Cuts have been made to the company’s three and R$74m in mezzanine financing from InfraBrasil, corporations
largest operational costs – labour, energy and chemi- a $942m fund run by Santander (SANB4:SAO). In 2010, such as Vale and
cals. Automation reduced labour costs, while electric- Foz also received a R$92m ten-year loan from the IFC to Petrobras, which
ity costs have fallen 14% in the past four years, as the finance greenfield projects, improve existing assets and operate local
company now carries out distribution and collection reinforce the existing capital base of the business with content rules, could
during off-peak hours. Finally, chlorine costs have fallen a view to making potential acquisitions. The IFC has the stimulate the local
by around one-third, following the construction of a option of switching its loan into a 4% stake in Foz. supply chain.
Copyright Notice: The material in this publication is protected by international copyright laws. Our subscriber Agreement and copyright laws prohibit any unauthorised copying or redistribution of this
publication or parts of it, including forwarding by email, to any individual or other third party. Any violation of these restrictions may result in personal and/or corporate liability. (c) The Financial Times
limited 2010. “Brazil Confidential”, “FT” and “Financial Times” are trade marks of the Financial Times Limited.