Fitch Upgrades Sabesp to 'BB+'

Fitch Ratings has upgraded the ratings of Companhia de Saneamento Basico do Estado de Sao Paulo (Sabesp) as follows:

--Local Currency long-term Issuer Default Rating (IDR) to 'BB+' from 'BB';

--Foreign Currency long-term IDR to 'BB+' from 'BB';

--USD140 million notes to 'BB+' from 'BB';

--USD350 million notes to 'BB+' from 'BB';

--National long-term rating to 'AA-(bra)' from 'A+(bra)'.

The Rating Outlook is Stable.

The rating actions reflect improvement in Sabesp's financial profile due to implementation of a more conservative financial strategy, supported by improvements on its coverage measures of short and medium-term debt. The rating action is also supported by Sabesp's ability to preserve strong operational cash generation and a high EBITDA margin, even in an environment of greater cost pressure.

Fitch's ratings on Sabesp also incorporate that the company's tariff revision process, to be concluded in November 2012, should not substantially alter its operational cash generation capacity. Changes in this assumption could lead to a reassessment.

The ratings reflect Sabesp's satisfactory financial profile with adequate margins, manageable leveraging and robust cash flow from operations (CFFO). The ratings also are supported by the company's near monopolistic position in its business area, as well as the economies of scale as the largest basic sanitation company in the Americas by number of customers.

Sabesp's ratings are limited by its aggressive capex going forward, with long-term returns, a recurring need to debt rollover, despite important progress having been made, and the growing foreign exchange exposure of its indebtedness. Sabesp's businesses are also subject to hydrological conditions and the political risk inherent to its state control. Sabesp is also exposed to Brazil's basic sanitation regulatory model, which is recent and has yet to be tested.

Solid Operational Cash Generation; Investments Pressure Free Cash Flow

Fitch considers that Sabesp's operational cash generation will remain robust after implementation of the tariff revision. In recent years, net revenue has been growing and the company has been efficient in maintaining its EBITDA margin at high levels. Excluding construction revenue, the net revenue of BRL7.9 billion LTM ended 1Q'12 rose 11% compared with FYE10, benefited by tariff adjustments of 6.83% in September 2011 and 4.04% in September 2010, as well as a 3.1% increase in the volume of water and sewage billed.

Sabesp reported an EBITDA of BRL3.4 billion, LTM ended 1Q'12, with a margin of 43% (excluding construction revenue), which remains strong for the industry, despite being pressured by additional recurring expenses of around BRL320 million relative to the contract signed in June 2010 with the municipality of Sao Paulo. Under this agreement, Sabesp must transfer to a municipal fund 7.5% of the gross revenue generated in the city, excluding construction revenue, net of taxes (PIS and Cofins) and the municipality's delinquency. The Municipality of Sao Paulo represents around 55% of the company's total revenue.

During the LTM ended 1Q'12, Sabesp also registered a consistent CFFO of BRL2.6 billion, compared with BRL2.1 billion in 2010. Free cash flow (FCF) was a negative BRL67 million, pressured by the company's ambitious investments of BRL2.3 billion and dividend distributions of BRL423 million. Fitch believes that Sabesp will continue to report negative FCFs in the next few years, due to its high annual capex of around BRL2 billion. Historically, these have not contributed significantly to the growth of Sabesp's CFFO, since the company does not pass on to its tariff the investments in expanding its sewage treatment capacity.

Maintenance of Adequate Credit Measures

Sabesp has been efficient in sustaining moderate leveraging through the most diverse economic scenarios. By the end of March 31, 2012 the company's total adjusted debt/EBITDA ratio was 3.1x and the net adjusted debt/EBITDA ratio, 2.5x, compared with 3.2x and 2.5x, respectively, at FYE10.

Fitch's expectations are that the company will manage its net leveraging under 3.0x going forward, despite continued strong investments. This is important for maintaining its ratings. As of March 31, 2012, Sabesp's total adjusted debt was BRL10.4 billion, with a significant portion (BRL2.9 billion) exposed to exchange rate fluctuations and unhedged, which could generate negative pressures in the event of a significant devaluation of the Real.

Greater Liquidity Reduces Debt Refinancing Risk

The maintenance of substantially more robust liquidity positions reduces Sabesp's debt refinancing risk. The large volume of financial obligations maturing in the coming years, combined with expectations for negative free cash flows, indicates the need to continually rollover payment of a relevant portion of its debt.

Nevertheless, the company's strategy to issue its funding needs in advance has been positive, reducing the company's exposure to tighter short-term liquidity scenarios. Sabesp's satisfactory track record in accessing the debt market, due to the strength of its business, also mitigates partially this risk.

As of March 31, 2012, Sabesp's cash and marketable securities position was BRL2.0 billion, equivalent to a short-term debt covered of 1.9x (1.1x including total payments maturing until 2013). Sabesp may access the debt market in the coming quarters to for new issuances to complement its refinancing needs for financial obligations maturing in 2013. The amortization schedule for the company's debt is manageable and without large concentrations of payments in the next five years.

Low Business Risk

Sabesp's low business risk is based on its almost monopolistic position as the provider of water and sewage services and was confirmed by its resilient performance during the global economic crisis. Competition is limited in its business and the company benefits from the large gains of scale compared with other companies in the sector.

Sabesp has been efficient in reducing losses and has made progress in signing concession contracts with the municipalities it serves. As to the political risk, Fitch has not noted any relevant change in company's risk after the change of government in the state of Sao Paulo, in early 2011.

Key Rating Drivers:

The ratings could be upgraded as a result of lower commitment of operational cash generation to investments, cash generation growth above Fitch's expectations, or longer debt maturity profile to reduce its dependence on frequent refinancing needs.

Pressure on the ratings could occur in the event of frustrations and greater volatility of cash generation due to the new tariff model, larger than expected investments and a weakening of the current liquidity policy.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:

--'National Ratings - Methodology Update' (Jan. 19, 2011);

--'Corporate Rating Methodology' (Aug. 12, 2011).

Applicable Criteria and Related Research:

National Ratings Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=595885

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229

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Contacts:

Fitch Ratings
Brian Bertsch, [phone]
Media Relations, New York
[e-mail]
Elizabeth Fogerty, [phone]
Media Relations, New York
[e-mail]
or
Primary Analyst:
Gustavo Mueller, [phone]
Associate Director
Fitch Ratings Brasil Ltda.,
Praca XV de Novembro, 20 - Sala 401 B - Centro
Rio de Janeiro - RJ - CEP: 20010-010
or
Secondary Analyst:
Mauro Storino, [phone]
Senior Director
or
Committee Chairperson:
Ricardo Carvalho, [phone]
Senior Director