BUILDING BRAZIL 12 BRAZIL CONFIDENTIAL JA N UA RY 6-18 2012SIGNS OF A CLEAN-UP IN THESANITATION SECTOR BLOOMBERGSUMMARY The waterand sanitationsector is badlymanaged andundercapitalised,but a processof transition isoccurring. Sabesp andCopasa, listedcompanies whichhold concessionsin the south-east, are the bestsuited for organicgrowth. They areturning to thebond marketsand PPPs to easecapital pressures. The privatesector’sparticipationin the industry A Sanepar water treatment plant in Irai, Rio Grande do Sul. Brazil’s best sanitation companies are in the south and south-eastcould increasefrom 10% to upto 40% within A new frameworka decade. Firms The better public providers are looking Ensuring universal access to piped water and sewerageowned by the to expand, and private-sector collection in Brazil would cost an estimated R$270bnmajor engineering companies are winning contracts. ($148bn, £95bn, €115bn). In 2010, the industry investedcontractors are less than R$20bn, including both public and private Yexpanding, in ou don’t have to travel far in Brazil before you sources. The federal government has pledged to investparticular through bump into the shortcomings of the sanitation a further R$35m by 2014, under the second phase of thecombined water sector. The sewerage network reaches less than Programme for Growth Acceleration (PAC 2). But thatand 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. ProvisionCopyright 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 thispublication 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 Timeslimited 2010. “Brazil Conﬁdential”, “FT” and “Financial Times” are trade marks of the Financial Times Limited.
BUILDING BRAZIL SIGNS OF A CLEAN-UPIN 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 averagecustomers, making it one monopolies operate, but in recent years the of 7%. However, both companies face uncertainties inof 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: SNISCopyright 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 thispublication 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 Timeslimited 2010. “Brazil Conﬁdential”, “FT” and “Financial Times” are trade marks of the Financial Times Limited.
BUILDING BRAZIL SIGNS OF A CLEAN-UPIN 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, waterrespective companies, Sabesp and Copasa. companies and residential One sticking point is adjustments to the tariff consumers – which managesystem, 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 feesoperational cost. Sabesp invested R$2.5bn in 2010 out for water by about 10% perof net income of R$9.2bn, while Copasa has invested year. Industry can reduce itsan average of R$870m per year since listing in 2006 exposure to this increasingand 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 bywhat 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 toservice contracts with municipalities. One uncertainty aggregate pollutants. But thefor Sabesp relates to a contract it was recently awarded to quality of the end product is not as good as that achievedsupply 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-ﬁltrationand the company may seek to pass it on to consumers OPPORTUNITIES membranes and as a resultvia higher tariffs. However, it is not certain that the state cannot be used in sectors likeregulator 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 keytheir customer bases signiﬁcantly. Copasa currently America will rise by over 50% parts in Europe, the US andprovides water to around three-quarters and sewerage by 2020, to around $72bn, Asia, which it then sells on toto a quarter of the 800 municipalities in Minas Gerais according to forecasts from the large suppliers of utilitiesand has identiﬁed another 104 municipalities it wishes consultancy Frost & Sulli- and industry in Brazil andto 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 the20m, but still only covers half of São Paulo’s 645 and commercial sectors, region are forecast to doublemunicipalities. 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 supplypublicly 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 offederal government agencies or enter into PPPs to Kemira (KRA1V:HEX), Frost & Sullivan thinks thatfuel this expansion. Another option is multilateral Veolia (VIE:PAR), Dow this will change as demandagencies, 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) andThe states that invested most in sanitation technologies allow them to Vale (VALE5:SAO), which2009 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 ofSource: SNIS some parts of the coun- water.”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 thispublication 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 Timeslimited 2010. “Brazil Conﬁdential”, “FT” and “Financial Times” are trade marks of the Financial Times Limited.
BUILDING BRAZIL SIGNS OF A CLEAN-UPIN 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 toDeso – 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 ofits IPO and is looking for additional sources. It can’t 34% for Guariroba at the time of the acquisition and aissue new shares because the state government is at its negative margin for Prolagos and is up to 20pp highershareholding 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. Theits 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$75maround 35% of Sabesp’s debt is denominated in foreign of seven-year bonds via HSBC (HBS:NYSE), rated Acurrency, mainly US dollars. Net debt was 2.1x ebidta by Fitch. Mr Crivellari says that the business is alsoin 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 businessincreasingly entering into PPPs, which allow them to wishes to triple the number of users from the currentfund investment, while retaining direct contact with level of 1.25m in the next ﬁve years, and may considertheir 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 concessionthe sector owned by Galvão Engenharia and FIGTS) extended for another 18 years and is in the process ofin Taiaçupeba, São Paulo in 2009. The 15-year contract approaching municipalities with a view to winningcovers 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 recentlyfor water treatment for the west of São Paulo city and competed for the AP-5 PPP, a project to collect and ACTIONone 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 POINTSmajor PPP for collection and treatment of sewerage in Brasil, which are owned by Developer, Queiroz Gal- 01 Equipav, athe 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 ebitdatencourt, Copasa’s head of investor relations, told Bra- Águas do Brasil has ten other concessions, covering margin of aroundzil Conﬁdential that her ﬁrm is currently studying the 2m customers in eight municipalities in Rio de Janeiro 60%, 20pp higherpossibility of a PPP to expand the distribution network and four in São Paulo. In 2011, net revenues were than that enjoyedfor 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 publicEquipav’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 resultdered and also direct concessions, private companies, will look for further funding from the development of reduction ofwhich currently hold about 10% of urban provision in bank, to ﬁnance the AP-5 programme. Claudio Ab- energy, labour andBrazil, will increase their share to up to 40% by 2020, duche, Águas do Brasil’s director-general, says that the equipment costsaccording to Paulo Oliveira, chief executive of the ﬁrm “has no interest” in a stock listing. and investments inconcessionaires 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 theinto the sanitation ﬁeld in 2005 through the acqui- same scaleability as municipal contracts (which cover 02 In the supplysition of two companies – Águas Guariroba from residential, commercial and public sanitation), it is a chain, multinationalAigües de Barcelona, which has the contract for fast growing area as a result of the high demand from companies import advancedwater 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 improvedpalities 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, increasedCrivellari, has been on making signiﬁcant capital invest- from Belo Horizonte in Minas Gerais. demand for waterments to increase the number of clients and improve Foz received a senior loan of R$361m from BNDES from Brazilianefﬁciency. Cuts have been made to the company’s three and R$74m in mezzanine ﬁnancing from InfraBrasil, corporationslargest operational costs – labour, energy and chemi- a $942m fund run by Santander (SANB4:SAO). In 2010, such as Vale andcals. Automation reduced labour costs, while electric- Foz also received a R$92m ten-year loan from the IFC to Petrobras, whichity costs have fallen 14% in the past four years, as the ﬁnance greenﬁeld projects, improve existing assets and operate localcompany now carries out distribution and collection reinforce the existing capital base of the business with content rules, couldduring off-peak hours. Finally, chlorine costs have fallen a view to making potential acquisitions. The IFC has the stimulate the localby 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 thispublication 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 Timeslimited 2010. “Brazil Conﬁdential”, “FT” and “Financial Times” are trade marks of the Financial Times Limited.