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David Einhorn And Reasons Why Widely Followed Stocks Get Mispriced

Over the weekend, I was reading David Einhorn’s book Fooling Some of the People All of the Time. I’ve had it on my bookshelf for some time, and it has always taken a back seat to other books until I decided to pick it up recently. It’s an entertaining read, basically recounting his short thesis on Allied Capital in great detail. It is a good book because it provides a glimpse into the significant amount of research and due diligence that a great investor like Einhorn performs in his investment approach. Source: Columbia Business School Don’t Count Einhorn Out Einhorn – like many well-known value investors – has had a very tough year . But we have not seen the end of Einhorn’s run as a top-quality investor. To borrow an analogy I used in a post last year – just as so many were so quick to write off Tom Brady after an early season loss to Kansas City last year that left the struggling Patriots at 2-2 and looking like a shell of their former dominant selves, I think far too many people are writing off Einhorn (as well as others) who have had a bad year. As I said last year, if the Patriots were a publicly traded equity, the stock would have been beaten down after the Chiefs blowout and it would have been one of those rare opportunities to load up. Lo and behold (and as painful as it is for me to say as a Bills fan), the Pats rattled off a long string of consecutive wins on their way to their 4 th Super Bowl title, and continued that winning streak until a surprising upset loss last night to the Denver Broncos (coincidentally led by a young QB who is temporarily replacing another legend that many are also writing off-perhaps prematurely). Back to the book – there is one chapter where Einhorn describes a meeting he had with a well-known mutual fund manager. To put this meeting in context: Einhorn was in the midst of doing significant due diligence on a company called Allied Capital, a business development company (BDC) that used aggressive accounting practices, questionable reporting of their financial results, and very liberal valuations of the illiquid equity and debt securities that they held for investment. Einhorn had been short the stock for some time, and although it slowly was becoming apparent that Einhorn’s thesis was largely correct, the stock hadn’t fallen much and continued to trade in the same general range that it had prior to Einhorn’s famous speech where he announced his short thesis. So Einhorn was introduced to this fund manager through his broker, who thought that it would be good for both sides to hear each other’s thesis on the stock (Einhorn was short and this mutual fund manager had a large long position). Einhorn showed up to the meeting fully prepared with a briefcase full of his research, and the mutual fund manager came in with nothing but a notepad and a pen. As it turned out, this fund manager hadn’t even read Einhorn’s research – this is despite being long a stock that was very publicly criticized by Einhorn and others who had published significant and detailed research laying out their thesis for everyone to see. Einhorn couldn’t believe that this fund manager owned a large block of stock and not only did he not do his own primary research, but he didn’t even read the secondary research that was easily and freely available for him to read regarding the potential problems at Allied. What’s the point here? I’ve always thought that there are two main reasons that stocks generally get mispriced: Disgust Large-cap stocks that get mispriced are almost always due to disgust. These stocks are large companies that are widely followed by investors and analysts. There is very little information that is not widely known by all market participants. However, sometimes these large companies run into a temporary problem and investors sell the stock because the outlook for the next next quarter or the next year is poor. Investors can take advantage of this situation by: a) accurately analyzing the situation and determining that the nature of the problem is in fact temporary and fixable, and b) be willing to hold the stock for 2 or 3 years – a timeframe that most individual and institutional investors are not willing to participate in. Some investors refer to this concept as “time arbitrage”. It just means that you’re willing to look out further than most investors and willing to deal with near-term volatility and negative (but temporary) short-term business results. In addition to a company specific “disgust”, these large caps can also get beaten down when the general market environment is pessimistic. In bear markets, companies with no problems at all often see their stock prices get beaten down because of macroeconomic worries or general market pessimism. So although many value investors look at small caps because they feel this is where they can gain an informational advantage, I think taking advantage of this “disgust” factor is just as effective and is an important arrow to have in the quiver. Neglect Often times, the most mispriced stocks in the market are small-cap stocks that are underfollowed and neglected. The obvious advantage here is to locate a situation that no one else has discovered by looking under a lot of rocks and in the nooks and crannies of the market. Sometimes things slip through the cracks. I would also put special situations in this category. Sometimes companies are misunderstood as well-but this is usually because they are neglected to a certain extent. The market has collectively not been willing to put the effort into understanding these situations sufficiently, and this creates potential mispricings. Einhorn’s Experience Einhorn talks a lot about “the guy on the other side of his trade”. In other words, each stock trade has a buyer and a seller and both think that they are getting the better deal (or they wouldn’t be engaged in the transaction). I don’t really spend a lot of time thinking about this angle, but it is interesting to consider who might be selling you shares that you are buying, and the reasons why. In this case, Einhorn thought he might be selling (shorting) shares to sophisticated institutional investors who disagreed with Einhorn and believed Allied was undervalued. However, as Einhorn learned, this wasn’t the case. The institutional investor was “too lazy or too busy”, as Einhorn put it, to put the time and effort into understanding what he owned. So, I’m not sure which category this type of situation would fall into, or maybe ignorance deserves its own category. But the experience with the mutual fund manager that Einhorn describes is certainly evidence of how sometimes even widely followed stocks get mispriced. If an investor is buying millions of shares for reasons that don’t have anything to do with the intrinsic value of the company, then there is the potential for a mispricing to occur. To Sum It Up I think most investors intuitively understand that it’s occasionally possible to find a bargain in an underfollowed stock, but I think just as often, large caps (or more widely followed) companies get mispriced for these reasons (disgust, ignorance, short-term thinking, or irrational behavior). Here is the passage of the book I referenced above where Einhorn met the mutual fund manager: “…so James Lin and I walked over with a briefcase full of our research. We met with Painter and Stewart in the conference room. Stewart brought nothing but a legal pad and pen. “Okay,” he said, “go ahead.” I thought this was supposed to be a two-way dialogue. “First, what did you think of our analysis?” I asked him. “Do you see anything wrong with it?” He said he hadn’t read it. While I could believe that Allied’s shareholders might generally be too busy to have read the lengthy analysis we put on our website, it was hard to imagine a professional, who was the second largest Allied holder, would come to a meeting with us and acknowledge such lack of preparation. So I asked him why he held the stock. Stewart said that in the tough market he felt it was a good time to own a lot of high-yielding stocks and his Allied holding was really part of a “basket approach”… Einhorn concludes: “I left with a new understanding of what we were up against. It wasn’t an issue of investors understanding our views and disagreeing. In addition to the small investors, Allied’s other investors were big funds managing lots of other people’s money-too busy or too lazy to worry about the details, other than the tax distribution.”

How Low Can This Market Go?

Summary What started this chaos in the first place? The cracks in the system that will become obvious in time. How the next few days, weeks and months are likely to unfold. Summary and how to plan your investments. I realize that everyone is expecting a number. I will get to that in the summary (do not skip down yet as the rest of the article will tell you how we get there). Understanding is the best basis for making investment decisions. First, I want to explain how we got to this place, what the potential problems are and how the whole conglomeration of situations we face will unfold. So, we are going to peel the onion, so to speak, one layer at a time so we can prepare for what may be coming our way. You be the judge as to whether this story makes sense. What started this chaos in the first place? It often begins with denial, which only makes things worse in the end. By denial I am not trying to blame our government, the Federal Reserve (well, maybe a little because it should have seen this coming and probably did), the financial institutions (well, maybe a little for all the little things that add up to big things which I will explain in a moment), or the financial talking heads (how can I blame the child-like innocence of the misinformed). No, the denial was present in a few areas of the global economy where nobody was looking. First up is China, the magical land of impressive GDP growth. When imports are down and manufacturing is contracting the Chinese government tells us that domestic consumption is growing at a staggering ten percent rate, offsetting the other problems in the economy. Does that make sense? Imports are falling. Less stuff to buy from outside of the country. Manufacturing is contracting. Less stuff to buy from inside the country. Explain to me how consumption is growing when there is less available to buy…for months now. Domestic consumption is the one piece of the Chinese GDP growth picture that cannot be accurately estimated by outside sources. Imports and exports are all reported and verifiable based upon shipping traffic. Until the purchasing managers’ index becomes more manipulated it provides the outside world with a decent view into manufacturing. So, I cannot help but suspect that the central government of a centrally planned system that controls all official communications might decide to report numbers that make the leaders appear to be “in control.” This situation has been obvious to me for some time, but who else wanted to consider the possibility because that would mean the world as we know it is not really the world as we know it. No one wants that. So, we all keep denying the obvious and assume it will all work itself out because the leaders are in control. Then money flows out of China made the headlines and some people got worried. But those with cooler heads reminded us that this, too, was a normal extension of a nation growing at a robust rate. The rich merely wanted to diversify their holdings some and expand the reach of the Chinese economy by buying up assets around the globe. The first rounds of this type of activity were actually just that. But then, it was more investing in assets that had no relationship to the Chinese economy at all: real estate in English-speaking cities as housing for college-age children and for rental income and potential appreciation. Then wealthy Chinese began buying more real estate in an attempt to relocate more of their wealth. Some of the billionaires in China were selling some of their prize holdings and reinvesting those funds outside of China. It has been a slow process over several years but the pace has increased dramatically in 2014 and the first half of 2015. Now it is reported that nearly half of Chinese millionaires are planning on leaving China by a study conducted by Barclays and Ledbury Research and reported by CNBC . Why are wealthy Chinese investors not investing in the Chinese economy if it is growing so rapidly? Would not the opportunities have far more potential for outsized gains in an economy that continues to grow at seven percent per year? The wealthy know the answer to these questions. The growth is not what it is reported to be and the opportunities are not as abundant anymore. Thus, the money is searching for better returns and safety elsewhere. Foreign investors began to get a little leery of the huge stock market run up in the Shanghai Index of more than 100 percent in one year and started to take some profits. Local Chinese investors, many of whom had never invested in stocks before, were opening accounts at a record pace as equities leaped higher. The easy money had already been made in China’s real estate market and now needed somewhere else to go in search of better returns. About 70 percent of the wealth of Chinese individuals is invested in real estate. Only about 15 percent is invested in stocks; or it was 15 percent but is a lot less now. Once foreign investors started leaving the market began to decline and many of the locals decided to get out while they still had some profit left. Stocks now went into a free fall, declining by more than 30 percent in a little over two weeks. (click to enlarge) Source: Zero Hedge In steps the Chinese government with a multitude of new laws (from Bloomberg) in an attempt to stop the bleeding. The first attempt worked for one day. Then stocks began to fall again. Another round of government intervention stopped the fall for another day or two. Then the crash continued. Finally, the Chinese government pulled out all the stops and allocated nearly a half billion dollars to a fund to buy stocks and prop the market up. That lasted a little longer. Apparently, the fund may have run out of money because the Shanghai Index has continued its crash the last few days unabated. Suddenly, everyone is looking for the reason and now it seems that the consensus is that slowing global demand is the culprit. Commodity prices have been falling for several years. Copper, the metal used in more industrial and construction applications than any other continues to fall because of lacking demand. This is not new news. It has been happening for us to see since 2011. Does that sound like denial? So now that we are beginning to admit to ourselves that demand is, in fact, slowing and is the culprit, we are forced to face the reality that the global economy does not project the rosy picture we have been wanting to believe. So, how did all this start? Investors around the world have been forced to face reality and reality does not please them, especially in China. It is, after all, perception that really counts. And for now, at least, perception has turned negative. So that is how it started but there are other cracks in the global economy and, yes, even in the U.S. economy, that are beginning to show. The cracks will become obvious in time Slowing global demand is not the same thing as shrinking global demand. What we will be facing in the near future is shrinking global demand as corporations and individuals realize that it is time to retrench again. It will not take much to push the teetering European economy into recession. Likewise, Japan is near the brink. The emerging markets will stumble inevitably due to the close dependence upon the Chinese economy. This is already happening but is just beginning to be reported in the news. This is the first crack in the global economy. The second crack resides in the junk bond universe. The primary cause will be seen as the energy sector in the U.S. which issued enormous amounts of high yielding debt to finance lease and property acquisitions and still more to finance drilling and other capital investments. Hundreds of billions of dollars have been sunk into the fracking industry because the price of oil was above $100 per barrel and would never go below $80 again. At least that was the prevailing belief because everyone thought that Saudi Arabia would cut production to prop up the price of oil. Surprise! If you want to understand the rest of that story please see my recent articles on the energy sector outlook here . This crack is getting wider and threatens to engulf much of the junk bond industry. Think about it for a minute. When more and more small (and not so small) energy companies go through bankruptcy those bonds will be next to worthless. As the equities markets around the globe fall, the risk premium investors are willing to accept on high yield bonds must increase. The result is that the rest of the junk bonds denominated in U.S. dollars go down in value and investors begin selling, prompting even more downside and a larger spread. Not only will questionable companies in the U.S. come under greater financial strain with the cost of borrowing rising, there are a lot of high-yield bonds issued to companies in emerging markets that will take a hit, too. Because the currencies in those countries are less stable, cheaper rates could be obtained by issuing debt in U.S. currency denominations. This leads us to a third crack that is even less obvious. Emerging markets [EM] account for most of the global economic growth right now, outside of the U.S. (which is slipping also). I still count China in this EM group. The stronger dollar has caused many EM currencies to fall in value relative to the respective trading partners and it has increased the cost of capital that is needed for further expansion. The slowing has only just begun. And the defaults on U.S. denominated junk bonds issued by companies in the EM countries will bring more pressure to force yields even higher to account for the added risk. This could put the entire junk bond universe at risk on a global scale. Another crack in the system is the rising proportion of car loans, especially for used autos, that are being made to subprime buyers (from NY Times). Remember the subprime mortgage mess in 2008? This problem is much smaller, but it could hit both the financial sector and the auto industry very hard as the number of such borrowers getting behind on payments continues to grow. Remember, if a recession starts the subprime borrowers will take the brunt of any layoff activity. And a recession is definitely in the cards now as reality begins to dawn. How the next few days, weeks and months are likely to unfold All of this is based upon opinion after having tried my best to understand all the pieces and the use of logic to determine how, or if, the unrelated events and circumstances may fit together. That is what we all try to do in analyzing a company or a situation. We review as much of the disparate evidence that is available to us from all possible sources that we find and use logic to piece together a picture that makes sense to us. So, here is what makes sense to me going forward. There are really two primary keys to watch to discern how much more damage the global economy and, by extension, equity market are likely to sustain. The timing of the events will be hard to determine until we see them unfold, of course. But we should be able to determine the direction of the trend from day to day and week to week based upon the severity of these two factors: the Shanghai Index and the WTI crude oil price. The Chinese government has certainly not run out of money that it could use to buy stocks to support the market. Has it already run through the almost one half trillion dollars already? Hard to say. But if the government is the only buyer, which is understandable considering what we have witnessed thus far, the selling pressure would eat through that in a few days. It has been a few days already. Will it commit more or will its leaders let the market fall more before trying to defend the market? Keep an eye on the Shanghai Index. If buying returns it may just be the government meaning that the slide could continue again after a reprieve. Most Chinese retail investors have never invested in stocks before last year when brokerage accounts were opened at record rates as the market screamed rapidly higher. It looked like easy money. Now it looks a bit different. Greed has been replaced by fear and every time the market rebounds I expect those who have not bailed yet will do so. If the market does not bounce they will continue to sell in panic. In other words, the Shanghai market may tell us when the fear has cleared from the Chinese equity market. The bigger worry is that the fear washes over into real estate. If real estate value begin to tumble in Beijing we will have a much larger problem to contend with and it could prolong the pain for the rest of the world for months longer than otherwise. This does seem within the realm of possibilities since many of the tier 2 and 3 cities have been experiencing falling prices for real estate. If it spreads to the remaining major cities it could begin to feed on itself. The second factor to watch is the price of WTI crude oil (Bloomberg). If it continues to fall or even if it just remains below $40 (Bloomberg), where it is now, it could wreak havoc in the energy sector. That, in turn, could lead to a collapse in junk bonds worldwide. All those investors taking on more and more risk reaching for higher yield could find their nests filled with lumps of coal instead of golden eggs. If the junk bond market collapses, it will most likely push the U.S. economy into recession along with China, Japan, Europe and most of the rest of the global economy. Then come the layoffs. The next shoe to drop then will be auto sales. People without jobs will no longer be able to make payments on cars they couldn’t afford in the first place. All the subprime auto loans and the financial institutions that own them will become suspect. That will amount to another negative jolt to the system. Next, home sales will begin to slow down as demand diminishes and values could begin to fall back to earth here in the U.S. once again. Then again, maybe the Fed will find a way to contain the problem to equities and energy bankruptcies. Perhaps it could just start buying stocks to support the market. I do not claim to have any clue as to what lengths the Fed will take to save the financial system and all those saintly bankers. Maybe I have become paranoid and am reading way too much into the situation. Then again, maybe not. I am fully hedged so I don’t have a horse in this race either way. To be clear, I would rather be wrong and have everything come up roses. In conclusion, to determine whether things will continue to get worse or better watch the two key factors I mentioned: the Shanghai Index and WTI crude. If both continue to show negative signs it will most likely get worse and worse until those two things improve to tolerable levels. If WTI crude miraculously rises to over $50 per barrel and the Shanghai Index begins to rise again then the world as we know it will likely not end today. Watch them, not just tomorrow or the next day, but for the next two to three months. Things could and probably will seem to get better for short periods just to turn negative once again. Or maybe not. Summary Okay, I promised you a number at the beginning of the article and now I am going to explain how we get to the right one. You may want to relax for a few moments and indulge in your favorite libation(s) as you may need a steady hand. This process is tried and true and certain to provide the answer you seek. First, you need to take into consideration the information with which you are now armed from reading this article. Think about it and make some decisions as to which pieces you agree with and which ones you do not. Let those convictions guide you in determining you expectations and proceed to the next step. The best way to make a prediction of this nature is to look at the charts of the major index you like to follow and identify the levels of major support. If you are unfamiliar with the technical analysis required to perform this part of the process you can find an easy-to-understand explanation of identifying support levels here . Then write each of those numbers down, each on a separate piece of paper. You can vary the size of the pieces of paper if you want. The next thing you need to do is get out the old dart board and hang it on the wall. Then fasten the pieces of paper on the face of the dart board in a random order using whatever form of adhesive you prefer. I like scotch tape. Now comes the most scientific part of the analytical process. Holding a dart in your hand at about ear level, take careful aim at the piece of paper you want to hit and let the dart fly! If you are unhappy with the first projection try using a different dart. You may have picked out a faulty one on the first try. How else could the result have been so disastrous? Repeat as many times as needed to achieve the outcome you desire. You should be happy and confident now. The best part is that you have identified the bottom that you want and expect to occur. You are probably just as close as all the pundits and financial talking heads are going to be. I believe they use slightly different analytical techniques but the outcomes will generally be the same. Seriously, the best way to invest when the markets are going down like this is to take out your list of favorite companies that you have been unable to buy because those stocks always seemed to be overvalued. Pick a price at which you would just love to own that stock and you would expect it to provide you with significant appreciation potential and a great yield over the long term. Start buying in increments of perhaps a quarter of the total you would like to own as a full position. When the market has a really terrible day and takes your stock down with it, if the price of the stock hits your wish price, pull the trigger and get that first piece. In case the market might go even lower, determine another even lower price at which you could not resist buying more. If the stock hits that price add another portion to your position. Keep this up until you have your full position in place. Then sit back and stop worrying. If you bought stock in a great company with bright long-term prospects you will do fine in the end. In essence, I am telling to do the obvious. Buy great companies when they are on sale! Let me provide an example that easier to understand. Let us say you own a nice dining room table but could only afford two chairs when you made the initial purchase. Later on there was a sale on the matching side chairs that you need, but you could only afford two more at the time. You probably bought those and now have four chairs. But now there is a going out of business sale at the furniture store and it is selling the chairs at ridiculously low prices. It also has two of the leaves that would fit into the table when fully extended and those are on sale as well. You can make one of two decisions: You could scream and panic because suddenly you realize that the price you paid for the original table and chairs was way more than you would have been able to buy them for if you had waited. If you get really mad, you may even sell the table and chairs you have now out of desperation because those items have lost so much value. You would take a big loss, but at least you would not have to look at those pieces of furniture that you were taking a terrible beating on because of the lost value. Or… You could take advantage of the sale and complete your dining room set the way you had always wanted! Buying the chairs and the leaf will now allow you to entertain in style with a larger gathering. Having taken advantage of the sale prices allows you to live the way in which you have always dreamed. I hope you realize that buying furniture, or anything else for that matter, is little different from making good investments. If you can buy what you want when it is cheap you end up in a much better place financially. Buying the stocks you always dreamed of owning when the prices go way down provides you with the opportunity to improve your future. I will always choose option number two and I hope you do the same. Good luck! As always, I welcome comments and will try to address any concerns or questions either in the comments section or in a future article as soon as I can. The great thing about Seeking Alpha is that we can agree to disagree and, through respectful discussion, learn from each other’s experience and knowledge. 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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