Companhia de Saneamento de Minas Gerais (CSMG3.SA) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome, everyone, to COPASA MG's audio conference to discuss results relative to Q2 2025. This teleconference is being recorded, and a replay facility will be made available at the company's website at ri.copasa.com.br. The respective slide deck can also be downloaded from the platform. [Operator Instructions] The presentation is also being recorded and simultaneously translated into English. Translation is available by clicking on the interpretation button. For those listening to the conference in English, there's an option to mute original audio by clicking on the button. Before moving on, I'd like to state that forward-looking statements are based on beliefs and assumptions on the part of the company's management and also on information currently available for the company. These forward-looking statements might involve risks and uncertainties as they involve future events and therefore, depend on circumstances that may or may not materialize. Investors, analysts and journalists should take into account that events relative to the macroeconomic environment to the industry and to other operating factors might lead such forward-looking numbers to differ materially from those expressed in these forward-looking statements. I'd like now to turn the conference over to Mr. Adriano Rudek de Moura, CFO and IRO. You have the floor, sir.

Good morning, everyone, and welcome to our teleconference. Thank you all for joining us this morning. I am joined by the main members of our Executive Board. Thank you, Cleyson Jacomini, our Client Communication and Sustainability Officer; Guilherme Frasson, Operations Officer; Pablo Ferraco, Engineering and Environment Director; and Michelle Resende, Strategic Management and Regulation Director. It's a pleasure to be here this morning to present results relative to second quarter of 2025, a quite challenging quarter, especially taking into account the impact on the drop in volume because of lower temperatures across the main regions in the State of Minas Gerais. But it's also important to highlight some advances across different strategic fronts, which we'll be detailing further down the presentation. Starting with the main highlights for Q2 on the next slide, Slide #2. We continue to execute our bold investment plan in the year-to-date numbers close to BRL 1.2 billion, which accounts for 32% above the same period of 2024 and over 75% when compared to 2023. We are making important investments across the State of Minas Gerais. We will reach something close to BRL 2.5 billion. That's one of the main pillars of our sustainable growth plan. Every investment made not only improved the quality of the services provided, in other words, better service for the clients and population. It also improves our efficiency level and of course, increases our asset base. As for dividends, in addition to the BRL 153 million paid out in June 2024, we have already paid over BRL 700 million in April, anticipating Q1. And we are now defining the payment of another BRL 164 million on the coming 11th relative to Q3 '25. Another highlight is the completion of the hedge contracted IPCA+ swap at EUR 90.5 million, half of our foreign exchange exposure, and the cost of the transaction came out way below our raising capital -- or raising cost rather. We also are considering trying to extend that for the remainder of the amount, about BRL 100 million, and we are now analyzing potential alternatives in the coming months. Also as a highlight, a robust operating cash generation to the tune of BRL 554 million in the quarter, quite in line with what the Q2 in 2024 presented. Another highlight is the loss level, which it has been going down. We have already reached 37.6% in June, which is about 110 bps when compared to last year, quite a significant drop. Delinquency, we have reached the lowest number in record, 2.83% in default rate. Congrats to the commercial front. The results speak for themselves. Congratulations to the whole team, the commercial team. Another highlight for the quarter was the company rating, which remained AAA by Moody's. We have just renewed that in April. We also have AAA by Fitch, which was also published this year. Those ratings reflect the solid fundamentals in terms of demand, leverage levels, cash generation and also environmental impacts, which were highlighted by the very rating agencies. And last but not least, a small increase in leverage from 1.8x to 2x now at the end of the second quarter. Still room for investment and to dividend payout. Moving on to the next slide. Before we go into detail about the numbers, I'd like to share with you some of the advances of the main initiatives in terms of value creation, which is being carried out with all our associates. Our main objective now is to prepare the company to reach a new investment level in efficiency, considering all the demands and challenges irrespective of the fact that we are still a mixed capital company. Those initiatives have been presented during our Q1 conference, and they are split across 3 strategic pillars, as you can see on the slide. Number one, a process-driven organizational restructuring. The focus here is to improve decision-making process and productivity for each activity, especially in the areas pertaining to operations. We have already redesigned several operational processes. We are now transferring to a shared services center, which is at the final phase of completion. We're transferring several activities. So we plan to consolidate and standardize all the activities. The SSC, shared services center, will consolidate over 140 processes, which involve over 600 people. We have already identified several efficiency levers, which will be used in the first wave of implementation towards the end of the year and in the coming years. CapEx management. In terms of process, this second pillar is the one where we have moved further. The focus is to empower the company to improve, to face a new demand for higher investments with very strict discipline in contracting and in capital allocation. We have developed a new model to manage investments. The focus is to increase the execution capacity and make CapEx planning more well defined, especially as we go through a very special moment in terms of defining new investments. Operating efficiency, number three, very relevant pillar. We have already started our zero-based budgeting to reduce costs further. As I mentioned in our first quarter conference, starting 2026 to start working on a budget with a multiyear horizon in mind, using the best practices available in the market with the idea of improving efficiency at the end of the day. This methodology leads to a broader discussion about opportunities to reduce costs. Another front under the same pillar is the use of advanced analytics models to identify complex frauds and to direct our actions out of the field with more precision. This approach will raise our efficiency in terms of supervision and will result in positive financial impacts. We're also redesigning our strategy to source services, prioritizing critical categories and applying techniques for strategic sourcing. As I said, that implies a review of specs and also we expect to gain and scale. In other words, several initiatives, which are now part of our business plan starting in 2026. Moving on to the next slide, Slide #4. We have our EBITDA bridge starting Q2 '24 all the way over to Q2 '25. The main variations are there, both in revenue and costs. As I mentioned before, we had a drop in the volume and consumption, which is atypical for the quarter, affected by lower temperatures in May and June. This drop also affected the tariff mix. The tariff for water is growing. It's an uptrending curve. The more you consume, the more expensive it becomes. When you reduce, that makes the mix worse, worsens the mix. We also had an accounting impact that adjusts consumption on a monthly basis because the billing generated by the readings, the daily readings out in the field, do not take into account all the complete -- the working days for that month. So this is a provision to maintain the accounting regime, and that's returned in the following month for accounting purposes. We included in our release to better explain that system. We have explained how that reconciliation happens. You can find more details about this accounting process in our release, which was published yesterday, and we're going to be doing that for the next quarters as well. As a result of that combination of mix and price, the growth in net revenue was only 2.1% quarter-on-quarter, despite the average increase in tariffs as of January of 6.4%. But in terms of costs, the second quarter, excluding depreciation, personnel, which is our highest cost, it's quite in line with what we had last year. We had a drop of 200 employees in the past 12 months that sort of offset salary increases coming from collective bargaining agreements, and we continue to have a strict policy in terms of extra hours. So this is quite under control as is third parties or outsourced services. We had to replace some activities as those 200 headcount left, but at very lower costs. In terms of outsourced services, we had one-off demand for maintenance of some systems, about BRL 10 million more than last year. We had also nonrecurring expenses with consultancy firms, which are still helping us across several projects, which are part of our value creation agenda, something to the tune of BRL 9 million; nonmanageable costs in line with what we had last year, not major variations. Once again, here, we have our highest or largest account, which is electric energy, about BRL 150 million in the quarter despite recent adjustments in energy, and we already see the positive results in terms of consumption reduction and migration to the free market in addition to the use of solar energy. All of that combined has reduced energy costs. But today, 80% of our consumption is already under solar or free market. The difference appears in the captive market, and we are trying to find alternatives to further improve that reduction. As for others, we had basically an increase in tariff transfers for cities above BRL 10 million here coming from the inclusion of new cities. This transfer is made by the regulator in addition to a growth in revenue. Most of that amount is compensated at the tariff level. We also saw an increase in provisions for court cases, about BRL 14 million nonrecurring once again, out of which BRL 11 million are labor suits relative to retired employees, and they are challenging our layoff policies from back in 2008, then we used age as a criteria for laying off those people though. That sort of encompasses most of the compliance and suits we have under that. We also have an increase in PCLD of 16% or BRL 10 million, just about, basically coming from an increase in revenue and the review of the risk matrix. That matrix considers a historical risk trajectory throughout time, '22, '23, '24, but it's important to highlight the delinquency level that I just mentioned, the default level shows a shorter-term perspective. So this index is decreasing regularly. So this will eventually reflect in the PCLD in the future. Next slide, #5, we have the evolution of our net income. Starting in the second quarter of 2024 to Q2 '25, a drop of 11%, as you can see on the slide. In addition to the negative impact coming from the EBITDA, as I mentioned, we had an increase in depreciation because of increasing investments. The final financial results are in line with what we had in the previous quarter, an offset between expenses and revenues, an increase in financial expenses over debt, especially debentures, which grew over BRL 40 million because of an increase in debt and also because of interest rates, that was offset by an increase or an improvement in the foreign exchange exposure line, which decreased by BRL 150 million. The effective rate of taxes improved from 21% to 15% because we are making better use of some tax incentives. Moving on, Slide #6, cash flow. Here, our cash movements are final and ending solid cash generation for the quarter, in line with our robust CapEx level. Those BRL 391 million refer to financial activities that reflect a net result from debt raising. We have reduced amortizations, and we also take into account in this line, dividends paid out in the period. Next please, #7. As for our investment program, as I mentioned, that's a very important strategic pillar. We are keeping our prediction for the next years, contemplating the third tariff cycle as shown, an average of about BRL 3.5 billion starting next year. This year, we should reach BRL 2.5 billion, which was approved by our Board, a significant improvement when compared to amounts which were taken into account in the second tariff cycle, whose cutoff date was last March. Most of that growth anticipates investments to meet universalization programs and objectives, but it also focuses on other goals as quality improvement for services, water security, loss reduction. There's a lot of room for improvements, especially in the metropolitan area of Belo Horizonte. Also retrofit investments for sanitation and water and sewage, most of those improvements also affect our OpEx. There's a reduction in our OpEx because of that. So in summary, we are now fully meeting our schedule, which was planned. As I mentioned, BRL 1.2 billion year-to-date, quite relevant numbers, 32% above what we had Q2 last year. And as for the universalization goals in terms of water coverage, the company is already above 99% and our main challenge is certainly to universalize sewage services, which today covers about 78%, give or take. On the next slide, Slide #8, we have a couple of data points about indebtedness. Our leverage level, 2x, as I mentioned early on, still with a lot of room to raise capital and good dividend payouts. That also means that our investment schedule with that leverage level will increase in the coming years, both to meet our investment plans, but also to keep a dividend payout, which is competitive. This balance will be gauged, will be calibrated year-on-year as investments are incorporated in our asset base, and this will happen on an yearly basis, and also a plan to reduce costs as it starts to provide consequences and repercussions. We have a better capital structure. Without giving out any guidance, we understand this should be getting close to 3x, just as a reference, not as a guidance. In terms of amortization for our debt, we have a very compatible level with our cash generation. Our average term -- weighted average term is about 8 years today. We have been trying to raise in the longer term also, and we are working right now to use incentivized credit lines. So as of next year, 2026, we plan to start raising capital with more incentivized credit lines. In terms of exposure, most -- half of our debt is pegged to IPCA and CDI, over 80%. In June, we had some euros exposure accounting for 18% of our total debt. As I mentioned before, we hedged that by half of that exposure, the amount of about BRL 90 million, and they are now considering the extension of that to protect the remainder of that number, another BRL 90 million or BRL 100 million. Moving on to our last but one slide. Some of our main operating indicators all are on a better trend coming from several initiatives we have been implementing. Some have already been mentioned. I think improvement in the loss level and water distribution, continued improvement, as you can see, 37.6%. Some initiatives are still ongoing, projecting other improvements such as yearly replacement of water meters, 20% is our target for the year. We already have a renewed base much better with much better age than we had last year, 3.2 years on average compared to 5.3 years that we had up until December 2019. We're now also using new technology to identify leakages. We are speeding up the replacement of about 350 kilometers of water networks in the city of Belo Horizonte, where we have the highest loss ratio. Default, as I mentioned, the lowest default level in history. New initiatives include mobile stations, agencies in popular areas to negotiate debt. We also expand our formal collecting processes using court, our legal department as well. Also negotiation with major strategic clients, an increase in collection using PIX. 30% today already use PIX. That's quite a significant advancement. And of course, that helps reduce default. And the associates per connection rate is still at 1.2, considering a base of 9,500 employees or associates without considering COPANNOR. And to wrap up our last slide, a couple of comments about the third tariff review, which will start on January 1, 2026. Overall, we understand that the process is well advanced. Discussions are moving along well with contributions from both sides. Until now, we've had important improvements such as increase in WACC. In the next cycle, it will move from 7.9% to 9.15%. As the regulator has already mentioned, there will be an annual recognition of investments starting now in the third cycle. That recognition on an yearly basis was an important advancement during the discussions, and it will be key to improve our investment capacity to meet that robust investment plan we have in our hands. As for sharing of gains, we have already established a number defined, 75%. That impact in 2026 is still small, but that might be important in the coming cycle. That methodology has been adopted for partial sharing of efficiency gains. So as we start the new tariff cycle, in line with what was done in Sao Paulo, for example. So returning now to the review now ongoing. The process is expected to be concluded in the coming months and the final deadline is November where we'll have an official definition, which will be enforced as of January 1, 2026. With that, I think we can wrap our part, our end of the presentation with operational and financial numbers. I turn the word back over to the operator so that we can start the Q&A session. Over to you, please.

[Operator Instructions] Our first question comes from Mrs. Luiza Candiota from Itau BBA.

I have 2 questions. My first one is about OpEx, especially in terms of the outsourced services line. We saw a relevant increase when we compare numbers quarterly and yearly, as you mentioned during the presentation, even if we adjust for the nonrecurring events in the quarter. So I'd like to understand, given the initiatives in place on the operating efficiency front, how do you see this trend in this line, outsourced services, and also of PMSO as a whole, looking at the coming quarters? That's my first question. And then my second question is about the tariff review process. We are still at the phase of public consultations, as you have just mentioned. If you could give us some more color in terms of the methodology to calculate the asset base to understand if there has been any indication that the methodology will change from the older one to a new one, where you, in the past, bring the base down at the start of the cycle. Is it a different methodology now? Has there been any change and advancement in terms of methodology?

Well, thank you, Luiza, for your questions. To your point about the OpEx, that outsourced services line, as I mentioned, is a line that has a very seasonal effect. It have some nonrecurring expenses, which we understand that as of next year, they won't be necessary, if you will, anymore. We are investing in consultancy services to help us improve in our efficiency levels. In this quarter, specifically, we have something about BRL 10 million under that line. We also have one-off demands for maintenance and preservation services. That's yet another item where we are keeping a close eye on, reviewing that for us to keep that under our original budget, which, of course, contemplates an increase, but very much in line with inflation indexes. Overall, we are optimistic in terms of PMSO. All those fronts we're working on will eventually reflect a drop in PMSO. There are plenty of opportunities for 2025. The increase for this year will be very close to the inflation index and all the efforts are being made for that to happen. There are things we cannot control. But overall, I think all the initiatives are already bringing positive results. We also have other nonrecurring items, which we'll be working on in the coming quarters to avoid them in the future. But again, PMSO is under control. As for the tariff part of your question, I'll ask Michelle to address that question. But the PMT issue, I cannot say we have already eliminated that. We'll start from a much better basis. But Michelle, over to you, please, if you could help us.

Thank you for your question. Just as Rudek just said, this has already been included in the technical note and also in the public consultation documents that already includes that. So to your point, that has been addressed. We will start from the real asset base this time. That's the difference in methodology now for the coming tariff cycle. But in terms of details or potential applications, in terms of different time lines, we still need to wait for the publication of the final documents after this last public consultation. But to your point, to your question, the answer is yes. That adjustment has already been made. That's a good example of a good evolution as we improve our investments. This recognition of a different or higher asset base is important. It will increase our investment capacity.

[Operator Instructions] Our next question comes from Leonardo Nao from UNEP, State University of Sao Paulo.

I have a question about the goals for the new legal framework. Even without privatizing it, do you think it's possible to reach all those goals? And what about the more vulnerable areas? Where do those goals, objectives stand for those areas?

Thank you, Leonardo, for your question. Our investment plan is focused on meeting the universalization goals and targets contemplated in the legal framework. So the answer is yes. We will meet the targets within the legal terms. That's our focus, irrespective of privatization processes. Privatization is something we cannot control. So our plan follows independently from that. We'll apply and make those investments to reach those universalization goals and targets.

[Operator Instructions] Next question comes from Mario Wobeto from Banco Safra.

I'd like to better understand how you see the evolution of consumption levels vis-a-vis investments that were made? And how do you expect that ratio between volume and mix to move forward in the coming quarter?