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OGE Energy Is A Unique Opportunity For Energy Bulls

Summary Oklahoma utility holding company OGE Energy’s shares have underperformed its peers by a wide margin YTD, as investor sentiment has turned negative due to its exposure to oilfields. The company’s unique status, as both a regulated utility and a stakeholder in an MLP, has allowed it to finance rapid dividend growth via distributions. The company will struggle to meet its future dividend targets, if sustained low energy prices cause the MLP distribution growth to cease and Oklahoma’s economy to stagnate. The company’s share valuations have fallen sharply, however, and do not reflect the benefits provided by its unique position. While a sufficient margin of safety is not available for conservative investors, aggressive investors, who expect energy prices to remain above their earlier lows, should consider it as an investment. Investors in Oklahoma utility holding company OGE Energy (NYSE: OGE ) have seen their holdings underperform the broader Dow Jones Utility Average by a significant margin in 2015 YTD, as the company’s shares have declined by 25%. Worse, unlike many of its peers, it has been beset by slow growth over the last five years, having achieved an EBITDA increase of a mere 1% over the entire period. More recently, the market has expressed skepticism over the company’s ability to achieve its ambitious dividend goals, given its direct and indirect exposure to the financial health of domestic oilfields. This article evaluates OGE Energy as a potential long-term investment in light of these conditions. OGE Energy at a glance Headquartered in Oklahoma City, OGE Energy is comprised of two segments. The primary segment is Oklahoma Gas & Electric (OG&E), which is a regulated electric utility generating, transmitting, and distributing electricity to 819,000 customers, primarily residential and commercial, in central Oklahoma and a small part of western Arkansas (Arkansas only contributes to 7% of the company’s rate base, with Oklahoma contributing the rest). OG&E owns and operates 6,800 MW of electric generating capacity and enough transmission and distribution lines to supply a service area, including Oklahoma City and the surrounding area, covering 30,000 square miles. OG&E’s generating capacity consists of 54% coal, 35% natural gas, and 11% wind power. While it recently began operating a pilot 2.5 MW solar PV installation, by 2020 it expects its fuel mix to be 50% coal, 37% natural gas, and 13% wind. OG&E operates within a moderately favorable regulatory scheme that includes a 11.1% allowed return on equity and a 56% equity ratio. This combination has supported rapid and accelerating dividend growth by its parent OGE Energy since FY 2011, most recently in the form of a 11% YoY increase, and the company is targeting a 10% annual growth rate through FY 2019. The high allowed return on equity has also led to above-average debt ratings for OG&E of ‘A1’ from Moody’s and ‘A-‘ from Fitch. In addition to OG&E, OGE Energy also owns a 26.3% limited partner stake and 50% general partner stake in MLP, Enable Midstream Partners LP (NYSE: ENBL ). With $11 billion in assets, Enable gathers and processes natural gas from a number of South Central gas fields, including within Oklahoma, that it then pipes to destinations both within the region and outside of it. Distributions from Enable in recent quarters have equaled only 16% of OGE Energy’s total cash flows, or 20% of OG&E’s cash flows, although the parent company’s management expects them to increase by 6% to 8% annually. Q2 earnings report OGE Energy reported Q2 revenue of $549.9 million (see table), down 10.1% YoY and missing the analyst consensus estimate by $68 million. The decline and miss were the result of the utility’s electric sales volume falling by 5.3% YoY, partially offset by a 1.1% increase to customer numbers over the same period. The reduced demand was in turn due to the prevalence of cool temperatures in May and June that allowed the company’s customers to avoid using their air conditioners, with the average number of cooling degree-days over the quarter coming in 10.7% below the previous year’s average and 2.4% below the long-term average. OGE Energy financials (non-adjusted) Q2 2015 Q1 2015 Q4 2014 Q3 2014 Q2 2014 Revenue ($MM) 549.9 480.1 526.2 754.7 611.8 Gross income ($MM) 339.0 268.5 289.2 449.4 340.9 Net income ($MM) 87.5 43.2 58.4 187.3 100.8 Diluted EPS ($) 0.44 0.22 0.29 0.94 0.50 EBITDA ($MM) 237.5 170.2 202.4 367.6 251.7 Source: Morningstar (2015). OGE Energy’s gross margin declined slightly YoY from $340.9 million to $339 million, as its cost of revenue declined by 22% over the same period due to falling energy prices, almost offsetting the negative impact of reduced electricity demand on earnings. OG&E’s utility operating income fell to $127.2 million from $141.8 million over the same period, however, while income from distributions fell to $28.2 million from $39.3 million. The former was the result of the utility segment’s O&M and depreciation costs increasing compared to the same quarter of the previous year, driving a 6.4% increase to OGE Energy’s operating expenses. While management didn’t attribute this increase to regulatory lag in its Q2 earnings call , it did state that it was the result of the previous year’s capex, suggesting that rates have not kept pace. The company’s net income declined to $87.5 million from $100.8 million YoY, resulting in a diluted EPS result of $0.44 versus $0.50 in the previous year. The EPS result was in line with the consensus analyst estimate, despite the substantial revenue miss. The utility segment contributed $0.34 to the EPS result, down from $0.38 YoY, while the company also reported distributions from its stakes in Enable of $0.12, down from $0.10. EBITDA also fell from $251.7 million from $237.5 million over the same period. The company’s board opted to increase its dividend by 11% despite the overall decline to net income, exceeding its target and providing investors with a pleasant surprise in the process. Outlook Management reiterated in its Q2 earnings call that its previous forecast for OG&E to generate diluted EPS of $1.41-$1.49 and Enable to provide distributions to OGE Energy equal to an additional $0.35-$0.40 in FY 2015. An important assumption behind this forecast is that the company’s service area experiences normal weather in Q3 and Q4. Q3 temperatures were close to the average, with warmer numbers in early August and September being offset by cooler numbers in the latter parts of both months. Q4 is currently on track to be close to normal in terms of temperatures. Oklahoma is one of the few U.S. states that is not expected to experience large temperature variations resulting from the strong El Nino that has been developing over the last several months. Historical data indicates that OGE Energy’s service area experienced only slightly warmer-than-normal temperatures between October and February and slightly cooler-than-normal temperatures between April and June during previous El Nino events . This could result in higher electricity demand in Q4 (electricity demand tends to increase along with the number of heating degree-days, although not by nearly as much as natural gas demand does) and lower demand in Q2 2016, although any impacts are likely to be too small to have much of an impact on earnings. Of much greater concern is OGE Energy’s exposure to Oklahoma’s economy. The state has benefited strongly from the expansion of domestic crude and natural gas production that has developed in the region over the last five years, so much so that Forbes recently placed Oklahoma at #7 on its Best Places For Business list while CNNMoney named it #9 on its Fastest Growing Cities list. Between 2010 and 2015 Oklahoma’s unemployment rate was substantially lower than that of the U.S. while its GDP growth rate was higher. While the state’s economy has remained strong to date, its unemployment rate has begun to climb as sustained low energy prices have caused the finances of many oilfield firms to deteriorate . OGE Energy is exposed to sustained low energy prices in two ways. First, Enable’s share price has fallen by 34% YTD, as the value of many of its assets have declined, pushing its forward yield to nearly 10%. A further share price decline could cause the MLP to reduce its yield, in which case its distributions to OGE Energy will decline in absolute terms. While OGE Energy’s management has stated that it does not expect this to occur, a sentiment supported by its recent dividend increase, the company does intend to use its Enable distributions to finance both its planned dividend growth rate of 10% over the next five years as well as much of its capex, with the former resulting in an attractive dividend payout ratio of 55% by 2019. Capex in turn is expected to peak in FY 2016 at $720 million, mostly due to modernization and environmental investments, before declining to $445 million in FY 2019. Reduced distributions from Enable would not prevent this capex from occurring but it would increase the likelihood that OGE Energy would raise the capital in the form of additional debt, exposing itself to the Federal Reserve’s upcoming interest rate increase. OGE Energy is also exposed to sustained low energy prices via OG&E. 12% of the utility’s sales volume came from oilfield customers, a number that remained steady in the first half of 2015 despite declining demand overall. Crude and natural gas prices fell again in Q3, however, causing domestic production to also decline, and this weakness could show up on OGE Energy’s earnings statements later this year in the form of reduced electricity consumption by oilfield customers. Potential investors will want to keep a close eye on the company’s Q3 earnings report release next month for any such signs. Furthermore, slowing domestic fuel production will eventually cause Oklahoma’s population growth to decline if oilfield jobs growth slows or even stops. Such population growth in the first half of 2015 helped to mitigate the negative impact of mild weather in the service area on OGE Energy’s earnings, but such a buffer is by no means assured of existing in the future if energy prices remain low. While the precarious state of U.S. oilfield suggests that potential investors in OGE Energy should exhibit some caution, it is worth noting that the company is also competitively placed compared to many of its peers in other areas. In the short-term is its above-average credit rating strength. Even in the event that the company is forced to turn to debt to finance its planned capex just as interest rates are increasing, the fact that OG&E’s credit ratings are superior to those of its peers will enable it to take advantage of the widening spread that has already opened up in the corporate bond market. The impact of higher rates on its interest costs will be mitigated so long as it maintains its strong credit ratings. In the long-term OGE Energy is also better-positioned than many of its peers to weather upcoming federal rules on power plant carbon intensity (lbs of CO2 per MWh generated). The U.S. Environmental Protection Agency’s Clean Power Plan requires each state to develop its own mechanisms for reducing their average carbon intensity by a predetermined amount. Oklahoma, for example, is required to achieve a 21% reduction by 2024 and a 32% reduction by 2030. OGE Energy has already begun to reduce OG&E’s carbon intensity in order to meet other environmental regulations and changing market conditions, however, and expects to achieve a 30% reduction by 2020 regardless of the Clean Power Plan’s implementation. Cheap natural gas will only provide the company’s existing plans to convert coal-fired units to gas with additional impetus. Valuation The consensus analyst estimates for OGE Energy’s diluted EPS results in FY 2015 and FY 2016 have declined slightly over the last 90 days, as weak energy prices have increased the likelihood that Enable’s distribution growth slows in the future. The FY 2015 estimate has declined from $1.87 to $1.86, while the FY 2016 has fallen from $2.02 to $2.00. Based on a share price at the time of writing of $28.52, the company’s shares are trading at a trailing P/E ratio of 15.2x and forward ratios of 15.3x and 14.3x for FY 2015 and FY 2016, respectively. All three ratios are much lower than they were at the beginning of the year and are roughly in the middle of their respective historical ranges. Conclusion OGE Energy shares have performed poorly in FY 2015 YTD as the market has responded negatively to its exposure, both direct and indirect, to inland domestic oilfield production. Sustained low energy prices threaten to reduce both electricity demand from its oilfield customers and the distributions that the company earns via its positions in Enable. An especially lengthy period of low energy prices could hamper both economic and population growth in Oklahoma, depriving OGE Energy’s utility operations of expected demand growth in its service area as well. While the current investor sentiment around the company is bearish, it also presents a unique opportunity for those potential investors with a higher risk threshold. OGE Energy’s management has committed the company to a high dividend growth rate that it expects to be supported by distributions from Enable. Furthermore, management also anticipates using the distributions to help finance its planned capex over the next several years, mitigating the potential negative impacts of higher interest rates on its earnings. A rebound in energy prices from their current levels would provide investors in OGE Energy with both market-beating dividend growth and appreciating share values, the latter in particular being a rarity in the current utilities sector following several years of outsized returns. While the company’s shares currently appear to be fairly valued on the basis of their historical valuations, the prospect of future earnings growth and limited downside from higher interest rates makes OGE Energy a compelling investment for those investors who don’t expect energy prices to return to their previous lows for a sustained period.

Review Of NRG’s Business Update Conference Call

Summary NRG held an analyst call last Friday to provide a strategic update. NRG will create a GreenCo, including its Home Solar business. The remaining exposure to GreenCo is $125M. NRG committed to an additional $1.3B in share repurchases and debt reduction through 2016. The company also announced its performance in the latest PJM capacity auction. Last Friday, NRG Energy (NYSE: NRG ) held a conference call to present an update to its strategic direction and to present a business update. The big item in this call was the plan for simplifying NRG by creating a new “GreenCo.” The GreenCo will contain three of NRG’s current business units: NRG Home Solar, NRG EVgo, and NRG Renew. The creation of the GreenCo is expected to be complete on January 1, 2016. Part of the reason for this move is that investors have been concerned that these businesses were money pits that would just suck away the cash generated by its main wholesale power business. NRG said that these businesses are showing progress and that the time had come to increase the financial rigor and make them more self-supportive. NRG has put a limit of $125M in additional support to GreenCo from the parent. It is also pursuing potential strategic partners. NRG feels that the GreenCo business will be self-sufficient by the middle of 2016. NRG provided an update on how the Home Solar business has been doing this year, and presented the following chart: Exhibit 1 Source: NRG 9/18/15 presentation NRG felt that the solar business got off to a slow start in 2015, but that it has achieved some momentum as the year has progressed. 2015 sales are up 103% year-to-date, even after the slow start, and the 2,500 bookings in August are a monthly record for NRG. That level puts it with Sunrun (NASDAQ: RUN ) in the competition for third place in domestic market share, behind SolarCity (NASDAQ: SCTY ) and Vivint (NYSE: VSLR ). Installations and deployments are still lagging, but NRG feels this lag will be addressed by year-end. Getting the installations and deployments figured out is obviously a big thing for its solar business. It is one thing to be able to take orders, but it is another to actually deliver a product, and this is what NRG needs to prove to investors. (Reminds me of this old Seinfeld episode .) Of course, one of the advantages of solar deployment being behind schedule is that it has burned less cash in the business. At January’s investor day, NRG estimated $250M in cash being spent at Home Solar in 2015, but now its estimate is only $168M. Other reasons for the decrease are a partnership with NRG Yield (NYSE: NYLD ) and better terms from tax equity providers. It really makes sense for NRG to make the move to break out the GreenCo businesses. You can see how small these GreenCo businesses really are compared to the older NRG businesses by looking at the YTD EBITDA table: Exhibit 2 (click to enlarge) Source: NRG Q2 2015 Earnings Presentation Management is spending significant time involved with these businesses, even though there is a small effect on the bottom line. Yes, there is the potential for high growth if these work, but there are lots of risks as well, and with management spending all of their time on the small businesses, they risk missing opportunities at the big businesses that could really impact the bottom line. Management does not want to quickly sell the GreenCo business at this time. They think that as the business continues to grow and as the IPO market improves, they could extract a lot of value. One example they gave is that the Texas market has been very slow to embrace solar. They feel that if Texas takes off, the GreenCo would really be a big beneficiary, and they would like to keep exposure to this upside. NRG said it thinks it could eventually realize a significant multiple above the $125M commitment it is making today. RUN, the company with a similar-sized solar business, has an enterprise value of about $1.7B, so there may be hope that NRG can extract value from this endeavor. The call reviewed a number of other topics besides the GreenCo announcement. Over the last six months, NRG has been examining ways to optimize its generating portfolio through deactivations, fuel conversions, or other means. On Friday, NRG announced that non-strategic asset sales would also be part of its portfolio optimization. The company feels that there are a number of valuable assets that could be sold, simultaneously reducing its need for CAPEX and providing capital to be used elsewhere in the company. NRG mentioned that there is a good chance a number of these sales would be in the PJM region. If transactions do take place in PJM, it could give investors some nice data on values for similar assets that would help in estimating the value of other companies with big nearby portfolios (Dynegy (NYSE: DYN ) and Talen (NYSE: TLN ) for example). NRG also plans to reduce development, marketing, and G&A spending by $150M in 2016. It estimates that it will cost $60M to put these expense reductions in place. NRG expects that over the next six to nine months, cost reductions, CAPEX reductions, non-recourse financings, and asset dispositions will free up $1B in capital. By the Q3 conference call, NRG will announce the details of where the first 50% of this $1B will come from. The final 50% will most likely take place through asset dispositions, which it expects to happen in 2016. This $1B will be used for stock repurchases and debt reduction. NRG also committed to an additional $300M of stock repurchases and debt repayments from cash flow it expects to receive this year. All of these balance sheet reductions are on top of the remaining $251M of stock buybacks that NRG has already committed to for 2015. Also, don’t forget that in 2016, NRG’s operations will produce additional cash flow that could be used for further reductions to the balance sheet and dividends to shareholders beyond this current plan. NRG also mentioned that maintenance and environmental CAPEX is expected to go from about $725M in 2016 to $400M in 2017, which will continue to help its cash flow over the long run. The call also provided updates regarding NRG Yield. The big item was that an agreement has been reached to move the Edison Mission Wind portfolio to NRG Yield. This is going to bring $210M of cash to NRG, and the entire deal was completed at an implied enterprise value of $452M. The implied EV/EBITDA of the deal was approximately 11x. It was also announced the NRG Yield would not be looking to raise any equity until the markets for Yieldcos improved. This could impact its ability to obtain more assets, but stated that NYLD can still grow its dividend at a 15% CAGR without any further asset dropdowns from NRG. Exhibit 3 (click to enlarge) Source: NRG September 18 presentation The big update about NRG’s traditional generation business was the review of last month’s PJM capacity auction. (My Seeking Alpha article discussing the auction can be found here .) Exhibit 4 (click to enlarge) Source: NRG 9/18/15 presentation The company’s 2018/19 results give about $225M of extra revenue compared to the results of the original 2017/18 auction. If you assume a 40% tax rate, and then take NRG’s 331M shares, you get an almost 41¢/share impact to earnings. NRG did not break out the specific units that cleared the auction, but it did show some data by zone. I have totaled the cleared capacity data NRG gave in Exhibit 4 above, and compared it to the available capacity in the different regions. Exhibit 5 (click to enlarge) Source: NRG and Garnet Research estimates It should be noted that NRG’s numbers include imports, which explains why the total of NRG generation that cleared in the RTO is above the amount located in that zone. If all of NRG’s assets in PJM (not including imports) had cleared at the CP price, it would have received about $1.1B in revenue, instead of the $950M level it achieved. According to page 16 of PJM’s report on the auction results, the COMED zone (the area around Chicago) had 23,320 MW of capacity clear the auction. This means that NRG had about 18% of the cleared capacity. PJM’s report also shows that 26,275 MW were offered in the auction for that zone. Exelon (NYSE: EXC ) has already stated that its 1,800 MW Quad Cities nuclear plant did not clear in COMED, and it now appears, assuming NRG offered all of its capacity, that the remaining capacity that didn’t clear was entirely owned by NRG. This should be a sign that if things continue to tighten around Chicago, NRG has a good chance of benefiting. With the new auction results, expect an update of this slide from the Q2 results presentation when NRG presents Q3 results. Exhibit 6 (click to enlarge) Source: NRG Q2 2015 Earnings Presentation NRG now has about $950M from the latest auction that will be split between 2018 and 2019 in the above chart. The recent PJM transitional capacity auctions for the 2016/17 and 2017/18 planning years will add $125M to be split between 2017 and 2018, and an additional $105M to be split between 2016 and 2017. Friday’s announcements should be pretty positive for NRG, but the initial reaction has not been that enthusiastic. Exhibit 7 (click to enlarge) Source: SNL NRG did take a big hit on Friday after the conference call. But most of this was giving back that gains from earlier in the week that came when it announced it would hold the call. The market also had a down day on Friday, so NRG was likely carried along with everyone else, further worsening performance. So far this week, the stock has continued down, even with Friday’s positive news. Most of the other independent power producers were down significantly as well, so NRG’s fall has not been isolated. Conclusion This was a positive call for NRG. It is simplifying its business and will be returning significant capital to investors. The stock market has driven NRG’s shares down further since the announcement, on top of an already tough year. If NRG can execute this plan, it should at least stop the relentless decline it has been experiencing. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Companhia de Saneamento Basico do Estado de Sao Paulo-SABESP’s (SBS) Q2 2015 Results – Earnings Call Transcript

Companhia de Saneamento Basico do Estado de Sao Paulo-SABESP (NYSE: SBS ) Q2 2015 Earnings Conference Call August 18, 2015 01:00 PM ET Executives Rui Affonso – CFO and IR Officer Mario Arruda Sampaio – Head of Capital Markets and IR Analysts Carlos Remeika – Covalis Capital Michael Gaugler – Janney Montgomery Scott Operator Good afternoon, ladies and gentlemen. At this time, we would like to welcome everyone to SABESP’s conference call to discuss its results for the second quarter of 2015. The audio for this conference is being broadcast simultaneously through the Internet in the website, www.sabesp.com.br. In that same address, you can also find the slide show presentation available for download. [Operator Instructions] Before proceeding, let me mention that forward-looking statements are being made under the Safe Harbor of the Securities Litigation Reform Act of 1996. Forward-looking statements are based on the beliefs and assumptions of SABESP’s management and on information currently available to the company. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions because they relate to future events and, therefore, depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of SABESP and could cause results to differ materially from those expressed in such forward-looking statements. Today with us, we have Mr. Rui Affonso, Chief Financial Officer and Investor Relations Officer; Mr. Mario Arruda Sampaio, Head of Capital Markets and Investor Relations; and Mr. Marcelo Miyagui, Head of Accounting. Now, I’ll turn the conference over to Mr. Arruda Sampaio. Sir, you may begin your conference. Mario Arruda Sampaio Okay. Thank you and again good afternoon, everybody for one more earnings conference call. We have a nine slide presentation today to discuss the second quarter of 2015 and as already mentioned, after that, we will open for the Q&A session. Let’s start on the slide three. Here, we show the company’s billed water and sewage volume, which fell 7.5% between second quarter last year and second quarter this year. This is due to the decline in water availability and consequently the measures adopted since February 2014 to continue supplying the population in the Metro region of Sao Paulo on an ongoing basis. As a result of the water crisis, there was also a substantial decline in water production. Volume was 14.6% down in the quarter and 18.1% down in the first six months of this year. On the next slide, on four, we will discuss our financial results. Net operating revenue increased 2.5% compared to last year second quarter. Excluding construction revenue, net operating revenue decreased 7.6%. This is due to the granting of bonuses and the 7.5% reduction in total billed volume as we mentioned in the previous slide. The decrease was mitigated by the application of the contingency tariff and the application of the repositioning tariff index of 6.5% since December 2014, which you all are already aware and familiar with and plus the 15.2% tariff increase effective since June and impacting only 1.5% in this quarter. I would like also to remind you that this last tariff increase includes a 6.9% increase due to the extraordinary tariff revision and the balance to the 15.2% is the ordinary annual tariff adjustment to inflation, which happened in April. Cost and selling, administrative and construction expenses increased 1.5% in the period. If we exclude construction costs, there was a decline actually of 11.2%. Adjusted EBITDA increased 14.3% to BRL756.6 million from BRL661.7 million in the same period of 2014. It’s worth noting that in the last 12 months adjusted EBITDA reached BRL3.4 billion. Yet, adjusted EBITDA margin came to 26.8% versus 24% in the second quarter of 2014. In fact, in the last 12 months, the EBITDA margins stood at 30.6%. If we exclude construction revenue and cost, the adjusted EBITDA margin came to 38.4% in the second quarter of 2014 against 31.2% in the second quarter of 2014 and 42.4% in the last 12 months. Net income totaled BRL337.3 million; that is 11.5% higher than in the same period of last year. On slide five we will move on to it and discuss the main variations in costs and expenses in relation to second quarter last year. I mentioned before in comparison with the second quarter cost expenses increased 1.5 and excluding construction cost, there was a decline of 11.2. This quarter all the cost items recorded were below second quarter 2014 except for tax expenses which increased by 0.7%. Depreciation and amortization went up by 27.6% and electric power cost which rose by 44.2%, something we had already anticipated to everybody that would happen last quarter. In the reduction side, it’s worth highlighting the decline of 74.4% in the general expenses, 23.2% in services and 4.1% in the payroll and related charges. The last, these three corresponding to a large share or the bulk share of our total costs. For more detailed information on our cost variation we ask you to refer to our detailed earnings release. Let’s move on to slide six, here we present the main variations in the items that affected our net income which totaled again BRL337 million. Net operating revenue increased by BRL68.8 million or 2.5%. Cost and expenses of gain including construction costs increased BRL35.3 million or 1.5%. Other operating revenues and expenses recorded a positive variation of BRL6.4 million. Net financial expenses, monetary restatement and foreign exchange variations fell BRL177 million in the period. Finally, income tax and social contribution increased BRL182 million when compared to second quarter 2014. Let’s move to the next slide, in fact the next two slides, seven and eight. We will update you on rainfall and water inflow into Cantareira Systems reservoirs. The year of 2015 has been recording irregular rainfall and extremely dry winter. In July, of the three main systems we use to supply water to the São Paulo Metro region, that is the Cantareira, Alto Tietê, and the Guarapiranga systems. Of these, Cantareira System was the only one that recorded below average rainfall. We are still operating in fact in the Cantareira with the first portion of the systems technical reserve and the other interesting thing is that today the Guarapiranga System has a relevant role in supplying water to the entire metro region of São Paulo. In fact, today again surpassing the Cantareira System. On slide eight, we can see that the water inflow into the Cantareira System reservoirs to 11.3 cubic meters per second in July which despite being low or below historical leverage, it’s almost the double of the volume recorded in July 2014 when water inflow came to only 6.4 cubic meters per second. In the first two weeks of August, water inflow has been lowering than in August last year. However, the month has not ended yet, we still have 13 days in front of us. It’s also important to note that August is usually a dry month, and reservoir levels are expected to decline in this period. In fact, for this month, SABESP received from the National Water Agency, ANA and the state electric, power and water department, it’s called DAEE an authorization to increase water withdrawal from the Cantareira System from 13.5 cubic meters per second in July to 14.5 cubic meters per second in August. This water withdraw increase by 1 additional cubic meter from the Cantareira System reflects the need to sphere the Alto Tietê System whose water inflow has been lower this year than last year. Well lets’ go through slide 9 and give you an update on the main measures SABESP has been adopting since February last year to continue uninterrupted water supply to the São Paulo metro region population despite relevant reduction in water traction for the reservoirs in the Cantareira System. The start we highlight that water production in the Cantareira System in July, 2015 over February 2014, when we introduced the measures to reduce consumption fell from 31.77 cubic meters per second to 13.51 cubic meters per second, in contraction of 58%. This means 18.3 cubic meters per second less withdraw since we adopted the consumption reduction measures. Specifically, on the measures, there are four main initiatives we adopted to offset this lower water traction and at the same time, maintain water availability to the metro regional São Paulo. They are, first, the reduction in consumption incurred by the Bonus Program responsible for approximately 18.6% of the savings. Second, the water transfers between the São Paulo metro region production systems currently responsible for 40.3% of this reduction. Third, operational maneuvers and investment in reducing water losses accounting for 36.6% of this reduction. And finally, the lower transfer to the cities of Guarulhos and São Caetano do Sul responsible for 4.5%. Specifically regarding the Bonus Program, we point out that the population is maintaining the adherence to the program, and in June and July, the percentage of population that has achieved reduction was 83%. In terms of water production for the entire, and that is, again, the entire metro region not only the Cantareira, in fact, the entire São Paulo metro region, this reduction came to 27% over February last year. In numbers, water production was at 71.4 cubic meters per second at the beginning of 2014 and closed in July this year at 51.9 cubic meters per second. Let’s go to slide 10 and present to you in detail the investments and execution and under development for the period between 2015 and 2017, which are vital to cope with the water crisis and bring more water security to the São Paulo metro region in the short, medium and long terms. The main objective of the investment being executed this year and next year is to increase the reservation capacity of the Guarapiranga and Alto Tietê System enabling the expansion of the production in these systems and the transfer of more water for the areas originally covered by the Cantareira System. In other words, reduce the dependence on the Cantareira System. For 2015, there will be an expansion of 6.5 cubic meters per second led by the interconnection between the Rio Grande and the Alto Tietê System. This investment when completed will transfer 4 cubic meters of water per second from the former to the later. As a result, more areas currently supplied by the Cantareira System will be able to receive water from the Alto Tietê System. The interconnection is the most relevant project we are carrying out in 2015 and approximately 80% of the work is already concluded and it should be delivered by the end of September. All in all, in the periods between 2015 and ’17, water availability and security will increase by up to 21 cubic meters per sec. Let’s move to slide ten, our last slide, where we’ll — we will discuss the Bonus program and the contingency tariffs. As already mentioned, the Bonus has been maintained an average adherence of around 83%, generating savings of 6.5 cubic meters per second in the entire metro region of Sao Paulo. So, this figure is for the entire metro region. Regarding the contingency tariff effective as of February 2015 and which objective is not to increase revenues but to reduce water demand by encouraging the rational use of water, of the total clients, 17% consumed above average in July this year. Considering that 77% [ph] of those — whose consumption was above average are in the minimum consumption range for social category both not subject to the contingency tariff, only 10% of all consumers actually paid higher tariff than this month, the month of July. As we mentioned in our earnings release, the impact of the Bonus on the Company’s revenue came to BRL231 million in the second quarter of 2015, while that of the contingency tariff totaled BRL123 million. It’s important to comment that the funds collected from the contingency tariffs are being used in the emergency work we mentioned before and expenses directly related to the cracks. Well, those were the remarks and now we are open for questions. Question-and-Answer Session Operator [Operator Instructions] Our first question comes from Carlos Remeika of Covalis Capital. Please go ahead. Carlos Remeika Hello, thank you for taking my questions. I have a few rather simple ones. I’d like to ask what you expect for tax rate for full-year 2015, given you’re making quite a bit of adjustments on a quarterly basis. And second question, I saw in the second quarter, BRL117 million decrease in provisions for lawsuits. It’s already been better in the Q1 and I was just wondering what would you expect for second half if it’s possible at least directionally to save, if it still continues to be lower year-over-year? Thank you. Mario Arruda Sampaio Okay. Carlos, just a second here. Carlos, Mario. Regarding the tax rate for this year, the only thing we can say without giving more guidance than we usually give is that we will continue working with 34%, okay. And no more detail we will give you because and again, it’s not part of what we do. On the next, on the provisions, what we can say is that there was a big provision of BRL70 million reversal of provision, which impacted specifically non-recurring this quarter. And again, we can’t comment and we are not – I mean, we don’t expect – we are not going to comment for the next quarter. I mean, we can’t say that there was BRL70 million reversal of this only provision of non-recurrence. Carlos Remeika Okay, thank you. Operator Our next question comes from Hujan Yang [ph] of Hummingbird Partners. Please go ahead. Unidentified Analyst Hi, thank you for taking my question. So I have a question about tariff adjustments. I understand there is a back and forth between SABESP and ARSESP on determining adjustments. Could you give us more color on how much leverage that we have had in determining the adjustment? So what usually causes the difference in weighing inputs between the two parties, for example considering the Q1 differences caused by the [indiscernible]. Rui Affonso Just a second, Hujan. Could you repeat the part on the different inputs, just that we can make sure we understand. Unidentified Analyst Sure. I was asking what cause the difference in weighing the input between the two parties, for example and currently I just pulled up the Q1 slides, there is the compensation period. Rui Affonso Okay, let me get that information to see if we can answer. Just a second. Mario Arruda Sampaio Okay, let me jump in. It’s Mario. First off, for the leverage negotiation, let’s put it this way, it’s authority — we have a discuss that is technical. They are very open for the discussions. We open and develop all the discussions on an agenda basis. So the leverage is just as usual, as you can see in the electricity sector. Although, the major company being regulated by the state regulatory agency is SABESP. If I understood the question, I mean, this would be the answer. As for the second point, the difference in input. We understand there are two issues. First, is the deferred implementation of the tariff revision, which should have happened in April last year and we SABESP postponed it to December. So that was deferred, but although deferred, we were granted an adjustment, a capitalized adjustment of that tariff implementation, so ultimately we implemented a 6.5 increase and not a 5.4, which was the original number. That is one. The other was the extraordinary tariff increase, the 15.21. The difference there is that we ask for compensation for the years of ’13, ’14, which were actual years plus expected ’15 and ’16 — forecasted ’15 and ’16 and ultimately what the regulator, he recognized to a great extent, the ‘13 and ‘14 and agreed upon the projections on the ’15 and ’16, but he decided to implement only the ’15 and ’16 and the ’13 and ’14, he will add that as a regulatory asset for the next tariff revision as of April 2017 for the next cycle. Okay? Unidentified Analyst I see. So just a quick question on that point, so does that mean that the 2013 and 2014 compensation period then amounts to the 7.02%? Mario Arruda Sampaio No, no, that’s the point. What happened this April was the ordinary, the normal tariff adjustment to inflation and the number there was something around 7%. I don’t have the — I don’t remember the specific number, we’re going to get it. So that was just inflation. The extraordinary tariff increase that we were granted was 6.9%. What we asked for was ‘13 and we’re getting the — I don’t have in the top of my mind was 13.2, 13.4 [ph] something like that. So the difference between what we ask for the extraordinary and what we got from the extraordinary is the deferred ‘13 and ‘14 revisions. So the ’15 rounding numbers, okay, about 7%, 6.9% is the actual revision, what was granted to us, and the difference to that is the inflation for the period. Okay. So what we did not get, we will get it in the next tariff cycle. So it was deferred to the next tariff cycle. Unidentified Analyst Okay. I got it. Thank you very much. Operator Our next question will come from Michael Gaugler of Janney Montgomery Scott. Please go ahead. Michael Gaugler Hello, everyone. Mario Arruda Sampaio Hi, Michael. Michael Gaugler Just one question, a couple of mine have already been answered. I noticed in the quarter cash fell pretty substantially and I’m wondering what was behind that and if you would anticipate that cash levels will remain about where they were at the end of the second quarter going forward? Mario Arruda Sampaio Okay. Michael, the reason that the cash fell this quarter substantially is basically because we anticipated that we paid down in anticipation a BRL500 million debt that was due in November this year. So we took the decision to anticipate, we prepaid, there was no fee for prepayment, it was already agreed to. So to that extent, we reduced our total debt for the quarter, albeit we did reduce the cash. Probably no, we won’t give you a guidance of where we see the cash flow at the end of the year, but we will come to market and we should, to some extent, replenish our cash availability. So can’t give you the number we’re working with, but I can anticipate that we should put our cash availability up from where it is today. Michael Gaugler Okay. Thanks, everyone. Mario Arruda Sampaio Thank you. Operator [Operator Instructions] Our next question comes from Kellyn Cailey of ZENA Investment Management. [ph] Please go ahead. Unidentified Analyst Hello, my question is on debt. Given that we’ve seen some depreciation of the Brazilian real since the quarter end and there are some forecasts out there that we could get to something like BRL4 per dollar by the end of the year. What are the levers that you have to deal with the impact that this will have on your debt balances and therefore your debt covenants to keep you in compliance? Mario Arruda Sampaio Okay, just a second there. Kellyn, first our debt exposure went up to 46.2%. Last quarter it was 45.8 and quarter before that 40, so it’s actually going up because of the exchange rate against the real as we all know. What are we going to do about it is, we’re not going to hedge our debt profile, it makes it inadequate to hedge. In addition to that the hedge would have no effect on our debt covenants. The way they are estimated, they did not take into account any hedging. S, again, in summary, it is very expensive. It doesn’t make sense for the debt profile and the cash flow and it doesn’t affect our debt covenant estimate, but we are obviously doing a lot. We have been in the process of going after receivables. We are going after — we have been able to increase tariff last December. We are just now in the discussion around an extraordinary tariff increase which has – which will be fully implemented, the 15% on the third quarter. So we have also done a lot of improvement in our cost structure. As you can see on the quarter to quarter basis, we’ve been able to reduce costs by 11.2%. So, yes, the covenants will continue fairly stressed, but I think we have many elements in front of us and actions we have taken that we are very well in a position to go over next quarters even if the exchange rate continues stressed as it is right now. Okay? Unidentified Analyst Okay, can I just ask a follow-up on the cost structure, so the cost reductions in the quarter, is that – do you view the run rate be 11% underlying decline as something that is sustainable as we move through the rest of the year? Mario Arruda Sampaio Again, that would be — giving you the specific would be giving you a guidance, but what we can tell you is that there are further actions we have taken that we expect coming in at some time. So again, it is hard to say exactly when, but we cannot tell you how much we expect. Okay? Unidentified Analyst Thank you. Operator Our next question comes from Doug Newton of The Wendakker Partnerships. [ph] Please go ahead. Unidentified Analyst Hi, good afternoon, Mario. The exploration of changes into the tariff structure, what impact might that have on the company’s total revenue. Mario Arruda Sampaio Doug, the effect is neutral. So it’s just how we cut the pie and not the size of the pie. Unidentified Analyst Got it, thank you. Operator [Operator Instructions] At this time, I’m showing no further questions. So, now I’d like to turn the conference back over to SABESP for their final remarks. Rui Affonso Okay everybody, thank you once more for participating of this call and we will obviously be back next quarter and hope to see you then. Thank you, bye, bye. Operator The conference has now concluded. Thank you for attending today’s presentation, you may now disconnect and have a great day. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. 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