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

Good morning, ladies and gentlemen. Welcome to COPASA MG's conference call to discuss the results for the third quarter of 2025. This conference is being recorded, and the replay can be accessed on the company's IR website, ri.copasa.com.br. The presentation is also available for download on the platform. [Operator Instructions] We would like to inform you that the presentation is being recorded and translated simultaneously. [Operator Instructions] Before proceeding, we would like to clarify that any forward-looking statements are based on the beliefs and assumptions of COPASA's management and current information available to the company. These statements may involve risks and uncertainties as they relate to future events and therefore, depend on circumstances that may or may not occur. Investors, analysts and journalists must understand that events related to the macroeconomic environment, industry and other factors could cause results to differ materially from those expressed in their respective forward-looking statements. I would now like to turn the floor over to Mr. Fernando Passalio de Avelar, COPASA's CEO.

Good morning, ladies and gentlemen, investors, analysts and members of our team. I'm here with the CFO and IRO and main executives of our management team. I would like to thank for Cleyson Jacomini, Chief Client Communication & Sustainability Officer; Pablo Ferraço, Chief Engineering and Environmental Officer; Michelle Resende, Chief Strategy and Regulatory Officer as well as Guilherme Frasson. It's an honor to be here together not only to discuss the solid results for the third quarter, but also to discuss the transforming moment we are going through. The market has recognized our potential. And today, I would like to share our vision on how we are navigating in this scenario and building the future of our company. Recently, we watched the analysis of the main institutions that follow the sector, especially the reports of renowned institutions that watch what we do closely. We were very happy to see that there is a consensus in an optimistic view. And there's a clear recognition of our intrinsic value and our growth potential. This positive perception is a reflection of the pillars that we have made solid with a lot of work and strategic planning across the years. The first and most visible pillar is the advance of the controller in the process of destatization. The approval of PEC 24/2023 in the first round and the legislative assembly of Minas Gerais on October 24 was an important mark with 4 more votes than what was required for the approval. And we see that there is a doubtful alignment in politics and approval of society to retrofit the company and decrease, eliminate any bottleneck for the future and accelerate the universalization of the sanitation in our state. This is not COPASA's project alone. It's a project for the future of the state of Minas Gerais, which will favor millions of people. We know that the schedule for 2026 is a challenge, but we remain optimistic. On our side, we are prepared to cooperate with the controller shareholder as we are assigned to the project. Till then, we are planning the next steps to ensure that the process happens in a fast manner and especially in a very transparent manner. The second pillar, as mentioned by the journalists are the improvement in our regulatory environment. And to that purpose, the constructive, technical and constructive dialogue has been fundamental with the institutes. The new regulatory framework and the recognition of the CapEx in our asset base and the indication that there is sharing of gains and efficiency is in line with the main practice of the market, and that is translated into more legal safety and as a consequence, more attractiveness to investors in relation to the investments we need to make. We understand that there was a clear sign that the tariff review was a result of a lot of debate, and we came to an understanding that we have to have robustness in our balance sheet so that we can make advances in the universalization of the services provided to our millions of clients. We understand that we still can improve some points. And to that purpose, we have made contributions in the last public consultation. However, this is a maturation process and mutual construction. Our dialogue with the regulatory agency is technical and open. And we are sure that we are going to get to a balanced model that will remunerate in a fair way the investor and would encourage the continuous search for further efficiency with direct benefits to consumers. Lastly, we understand that the agenda on which we are working is allowing for opportunities, for expansion and value creation in the cementation area in Brazil. We have a lot to invest to retrofit, modernize and grow, generating solid returns and contribute in a decisive way to universalize the service of the water and sewage in the state of Minas Gerais. What we have been building since 2019 is a new COPASA, more agile, more efficient with more capacity of investment and ready to meet its mission with excellence. Our commitment is to generate value to our shareholders with the continuous improvement in our services to the people in Minas Gerais and sustainable growth to our employees and to the state at large. I would like to thank you for the confidence you have placed on us and the analysts who have worked hard and are following what we do. We are confident on what we have done, and we are confident in the future that we have for COPASA. And this is my initial comment, and I turn the floor to Mr. Adriano de Moura to comment on the results of the third quarter, and we will be together with the other executives to answer any questions you might have. Thank you.

Thank you, Fernando. Good morning, everyone. I would like to thank you to attend our conference for the third quarter of 2025. It's a great honor to be here sharing the good results for the quarter. It was a very challenging quarter, but with important advancements in strategic fronts about which we are going to discuss later. We're going to start with the first slide about the highlights for the quarter. We continue implementing our daily investment plan, getting to near BRL 2 billion, advance of 26% in relation to the same period of last year and more than 65% when compared to the same period of 2023. We are making important investments in all the state of Minas, and we are very close to our target of 2025, about BRL 2.5 billion. I would like to remind you that this is one of the main pillars of our sustainable growth plan, considering that each investment made in addition to improving the services provided and also meeting the demands of the population, it also improves the efficiency in different aspects, and it also increases the remuneration basis of assets. In relation to dividends, in addition to the BRL 345 million that were paid in the first half of 2025, we have planned the payment of BRL 170 million that will be paid on November 11 as an advance of the interest on equity. We are following our dividend policy for 2025 with a payout of 50% in addition to an interim dividend that would depend on the circumstances of the moment. Another highlight I'd like to share with you for the quarter is the contraction of hedge -- FX hedge by means of a swap of IPCA+. We ended the quarter with EUR 90 million and EUR 32 million in addition, adding to BRL 150 million. That's equivalent to EUR 120 million. We have a remaining balance of about EUR 135 million that when new fundings come in will be considered. But the idea is to make headway in the evaluation of what's the best relation of cost benefits so that we can reduce this FX exposure, taking advantage of the development of the FX variation. I would also like to draw your attention to the operating cash flow, reaching BRL 701 million, 26% higher than the third quarter of '24. Another highlight is the losses reduction. We reached 37.3% in September, 110 bps less when compared to the previous year. Passalio has already mentioned about the third review that's making good headway and positive advances and the preliminary increase of 5.5% as of next year. Another highlight we'd like to share with you is the EBITDA that in spite of the revenue due to the low temperatures for the period, it was still in line with what we had in 2024. In the 9 months, we accumulated BRL 2.2 billion, 40.2% margin for the period. And lastly, our leverage level, which is still very comfortable, standing at 2.1x. And this was the close -- what we had in the closing date of September 30. And we still have good room for good investments and good dividend payments. Before I provide more details about the details of the quarter, I would like to provide an update on our advances of our main initiatives of value generation that we are running with participation of all members. We would like to mention that this agenda does not depend on any destrategization agenda, but what we're doing is preparing the company for a new investment level considering the new challenges of the sanitation framework. Those initiatives have been presented along the year and divided into 3 strategic pillars basically. In the pillar of process-driven organizational restructuring, we implemented the CSC, which is a Shared Service Center, consolidating more than 140 processes. This area involves more than 600 people. We are very optimistic with the potential of opportunities that we have down the road with this way of standardizing and centralizing the services. We know that the impact will be gradual, but we are already identifying the improvements in the budget for next year. As for our CapEx planning, this is one of the pillars where we see a lot of progress. And the focus is to trade COPASA for the new demands of new and high investments with the discipline of capital allocation and efficiency in the contracts. We want to ensure that all investments are addressed to strategic projects that can be in the remuneration basis and ensure somehow the reduction of OpEx. As for operational efficiency, in the third quarter, we have started the project of zero-based budget with additional reduction of costs. So as of 2026, we'll have a pure annual view considering efficiency improvement projects using this methodology. We are very optimistic with the results that we have reached so far. Only 5 weeks, we've been in this process, and we already see the potential that we can reach -- still talking about operational efficiency, another example that I would like to give, we are redesigning our service sourcing, and we are prioritizing some critical categories and using techniques of strategic sourcing, and that would include a review of specifications of the study of demands and optimizing service levels with the purpose of providing more transparency in the contracting activities based on performance and in such a way that, again, scale will provide better precification and better services provided. And we are in the final phase of the strategic planning review, that's for 2026 to 2030. And we'd like to highlight all the challenges we have with the prioritization of the efforts with the purpose of universalizing and improving the services considering the regulations. So this is an agenda that is going to advance a lot in the third quarter -- in the next quarter. Moving on to the next slide. We have the main EBITDA variation comparing the quarter -- third quarter of 2025, and we talk about revenue and costs. As for revenue, the increase in the tariff was offset by the negative impact of mix and volumes as a result of low temperatures, especially in June, July, where there was an 8% drop in relation to the last year in the same period. There was a recovery in August. It was about the same level when comparing year-on-year. And in September, we saw a better recovery with volume increasing by more than 3%. But on average, the reduction was 1.7% in terms of volume of water and 0.9% in sewage. As for costs and expenses without depreciation, personnel costs, which is the highest cost we have, had an increase below inflation levels. We had a reduction of nearly 200 employees in the last 12 months, and that practically offset the increase in salary from the collective bargaining that was signed in November last year. We continue with a rigid policy of extra hours, showing a relevant drop in extra hours when we compare quarter-on-quarter. As for outsourced services, we continue reviewing contracts and optimizing services. We have some one-off contracting to meet the needs for system services and nonrecurring expenses for consulting services. At Electric Energy, we had a growth of 9.5%, impacted especially by the red flag tariff level. And we are continuing our strategy to migrate to the free market and using solar energy more. In September, we ended the quarter at 25% in the captive market, 17% in the solar energy and 58% in free market. In the line of others, we had some optimization in the tariff pass-through in the amount of BRL 7 million by including new cities. However, this increase will have a positive impact in the tariff review. In addition, we had an increase of BRL 6 million in the lawsuits and compensations that were offset by nonrecurring revenues from auctions in the amount of BRL 8 million. In the next slide, the main variations of net income among the quarters, a little drop in relation to the third quarter of 2024. We had an increase in depreciation as expected as a result of the increases of CapEx. The financial result net, we had a relevant improvement of BRL 70 million, nearly 34% in relation to the same period of 2024, especially as a result of the positive result in FX variation, BRL 57 million on average that was reduced by the impact on the higher fees on financing that grew BRL 43 million. And the effective rate improved from 22% to 19.6%, basically by the use of the fiscal benefit of the equity. Cash flow, we see the cash flow movement starting from the initial base up to the end of the quarter, I would like to highlight the solid operating cash generation in line with the robust level of CapEx in the period. We have a net impact of BRL 270 million related to financing activities that reflects the funding of debts produced by the amortization of the period in addition to the dividends and the payment on the equity, as we mentioned in the presentation. Moving on, our projections for investment as of the third tariff cycle. As we can see in this graph, it's a strategic pillar for the company. We estimate that on average, there will be a BRL 3.5 billion per year as of the third cycle, practically the double of the second tariff cycle that ended in March of this year. And a good part of this growth is for the -- to meet the needs of the universalization of services, but also improvements in the services provide to consumer water security, loss reduction, there's a lot of room for improvement yet, especially in the metropolitan region of Belo Horizonte and retrofitting investments is also planned in the sewage treatment plants that would also reduce our OpEx. As we previously mentioned in the highlights, we are meeting the physical schedule and the financial schedule as well that was planned for the year. In relation to the goals for the universalization, we have 99% of water coverage, much above our target for the universalization according to the new legal framework. And we are also going to look at the universalization of sewage that has a lower coverage level. Net debt, we show our comfortable leverage rate of 2.1x, and that includes the allocation of capital and the payment of dividends. And the trend is that this leverage level should grow across the years to meet the investment plan and also to maintain a competitive dividend policy. As we mentioned in the last call, this balance will be adjusted every year as new investments will be -- will be included in the regulatory base. And after when we see the results of the reduction of expenses so that we are going to have a leverage of near to 3x in the next year, not as a guidance, just to provide you a reference. In terms of amortization, we have a very good level compatible with our cash generation level. We are going to continue focusing our long-term resources, looking at the lines of incentivized funding. And in terms of exposure, nearly 70% of our debt today is linked to IPCA and DI. In FX, 18% is linked to euros. And as I mentioned before, we have a hedge for the exposure so that we are going to be less and less exposed across the year. Moving on to the slide before the last, which showed the evolution of the main indicators for our operations. Some of them have already been previously mentioned, such as the improvement in the loss rate. Some initiatives are underway that will lead to continuous improvement in this dimension of loss, which is the replacement of the water meters. Today, we have a renewed target of 3.2 years when compared to 5.3 years that we had in December 2019. So we are also using new technologies to eradicate leaks, and we accelerated 350 kilometers of network in the metropolitan region of Horizonte with the -- we have the highest level of losses. In terms of delinquency, there was a bit increase to 3.01, it's still a very low rate when compared to the main players, especially in residential and social categories. Even considering the effort of our collection teams, we are going to reinforce those efforts so that we can reduce this rate even further for the next months. In September, the ratio of employees per connection remains at a stable level, considering a basis of 9,500 employees, not considering COPANOR. On Slide 10, to end our presentation, we have some comments on the process of the third tariff review. And the cycle will start in January 2026. In general, this process continues making progress. We said 5.5% as a preliminary indication in the last public consultation, good contributions have been made both by COPASA and also by the market. And the original schedule is to complete the process in the beginning of December. And the application is going to start in January 2026. With this, we end our presentations of our operational and financial results for the third quarter, and I turn the floor to the operator so that we can start the Q&A session.

[Operator Instructions] [indiscernible]

She has 2 questions. One in relation to the cost journey. The company mentioned that there is a possibility of implementing new efficiency measures to get the company prepared for the new level. As I said, this is a priority of our agenda. This is our top priority for efficiency. And it's one of the pillars that we are making good headway. In this quarter, we started our zero-based budgeting that brings excellent references to the market so that we can have a pure annual view with the best benchmarks and with the best initiatives in terms of cost reduction. This project is still in the beginning, 5 weeks so far. And we have already seen excellent results that are going to be incorporated in our budget for 2026. As I mentioned, this is our top priority. And the second question is related to the negotiation of new BH contract. So I'll turn the floor to [indiscernible]

I would like to start by saying that in relation to the city hall of Belo Horizonte, we are having high-level talks with them and the negotiations are very good in terms -- in technical terms. And this is what I can say. We can say that we have been working hard, and we keep an eye not only in the Belo Horizonte contract, but we also have some other concessions on our radar that may offer opportunities for us to evaluate both by the COPASA and by the government. Considering the sanitation legal framework, we have the possibility according to Article 14. We have new possibilities, and we have our eye also on this. So we are moving ahead in terms of opportunities that we have or we are going to have in the future with the [indiscernible] in the assembly. We have several questions in relation to efficiency and reduction of PMSO. We are working on those agenda, as I've already mentioned. I would just like to reaffirm that this is one of our priorities, especially considering the budget as of 2026. In relation to Belo Horizonte, I think COPASA has already made some comments on that.

[Operator Instructions] So we are still collecting questions. So if you have any questions, please we are available. [Operator Instructions] Our next question comes from João Pimentel with Citi.

I would like to ask a question about asset base. If we look at the history of COPASA, historically, it has underinvested versus the peers. If we look at the investment level and the regulatory depreciation, it's underinvested in the last 7 or 8 years. I would like to know -- first, I would like an explanation for that. And looking to the future, naturally, the company will have an increase of CapEx, very relevant considering the universalization process underway. But after the cycle of investment, what would you consider to be a normalized CapEx after this cycle of higher investment because it seems that COPASA has a catch-up to be made in terms of regulatory assets when you compare to SABESP -- for example, you see that the asset base is much below considering the size and the company when compared to SABESP. So what do you imagine that will happen after this universalization cycle? What would be CapEx for maintenance or CapEx for expansion after [indiscernible] depending on the moment where the universalization will be reached. What do you think is the base to be recovered after the period of higher investment?

Thank you, João, for the question. It's a very relevant topic for us. But when we look into the future, this is what we have to say. In the past, we had some investment restrictions. But when we think about investment in the third cycle onwards, we have a very aggressive goal. We have already provided guidance of investment in the amount of BRL 70 billion up to 2029. This is practically the double of what we have been investing in relation to the past cycle. The last cycle stood below the regulatory depreciation. So if we consider this level of BRL 3 billion, plus for the third cycle that would be an increase of BRL 2 billion per year, considering a depreciation of about BRL 1 billion regulatory depreciation. So this is a very aggressive growth for the next cycle, I would say. This is more than BRL 10 billion if we consider the average of BRL 2 billion per year. So what we have done recently is that we underwent one adjustment for the company. We qualified our company. We trained our company. We updated the processes, improved all the systems so that we could be face this level of investment. This is a very large growth of CapEx. We have shown that we stand at BRL 2 billion more in our budget so far. Our target is to reach BRL 2.5 billion, and that's already 20% higher than what we had last year and nearly 70% more than if we compare to 2 years ago. So it's another level of investment, and we are going to continue implementing it. Pablo, I don't know if you have anything to add. Pablo is our Chief Engineering and Environmental Officer. I'm going to pass the floor to him.