We came across a bullish thesis on Companhia De Saneamento Basico (NYSE:SBS) on ValueInvestorsClub by Nails4. In this article, we will summarize the bulls’ thesis on SBS. The company’s shares were trading at $14.90 when this thesis was published, vs. the closing price of $16.62 on Mar 07.

A treatment plant with a large industrial wastewater treatment pipe in the foreground.

SBS provides basic and environmental sanitation services in the São Paulo State, Brazil. The company supplies treated water and sewage services to residential, commercial, and industrial private customers, as well as the public.

A high fiscal deficit and free fall of the Brazilian currency have made the equity markets one of the most performing ones. However, this also offers an opportunity to buy some good companies at a cheap valuation. The utility sector in Brazil offers a unique proposition where well-managed companies have provided compounding gains. Companies like SBS are allowed to levy rates based on WACC, opex, size of regulatory assets and expected volumes. The estimated costs are often different from the realized expenses, creating an opportunity for utility companies like SBS to earn supernormal profits. However, companies like Luz that operate in Rio, haven’t been able to manage costs well leading to a bankruptcy-like situation.

SBS also benefits from the inflation adjustment of the regulatory asset base. This will allow the company to grow at least at the existing inflation rate. Another noteworthy development is the privatization of the company. The government has allowed SBS to estimate costs based on the 2022 cost structure when it was not really efficient. The new management has an interesting profile with expertise in cost reduction across companies.

Based on the inflation rate of growth and accounting for depreciation and capex, the regulatory asset base is expected to triple in five years. Earnings are expected to quadruple due to higher revenue and better cost management. SBS offers a compelling growth story with an inflation hedge, rising ROIC, a deleveraged balance sheet and competent management. SBS could also become an acquisition target for Equatorial, one of the best-run utility firms in the country. This transaction should provide a better multiple for SBS if it performs well under the new management.

While we acknowledge the potential of SBS as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns, and doing so within a shorter time frame. If you are looking for an AI stock that is more promising than SBS but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.

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Disclosure: None. This article was originally published at Insider Monkey.

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