Tag Archives: cash

Short IWM, SLY Or VB And Long GWX? U.S. Small Caps Likely Overpriced

Summary U.S. small caps seem overvalued relative to international small caps. The dominate way to exploit this fact would likely be short VB and long GWX with a Sharpe ratio of 1.93. Given uncertainty about the underlying valuations of the ETFs, expected returns are between 22-42%. On Saturday, I stumbled across what I believe to be irregularity in the pricing of small-cap stocks, which I thought was worth exploring for a trade during my daily commutes. Since I generally operate under the assumption that I am wrong and the market is right and I am not much of a trader, I thought it was worth publishing the idea for critique before I put any real Helvetic francs to work. As we all know the major averages have taken a beating and the small-cap stocks have been hit harder than the large caps as one might expect. The international small-caps now seem undervalued relative to the United States where foreign capital continues to pour into small-cap companies to take advantage of the rising dollar, while at the same time be insulated against large-cap foreign earnings currency translation. Are (U.S.) Small-Caps Fundamentally Overpriced? Pitching my thesis, someone asked whether U.S. small-caps fundamentally overpriced. There are a number of ways of answering that question, in terms of growth, historical terms, GDP expectations, or using a model of international financial integration. In terms of growth the U.S. stocks now have a FW PEG ratio of about 1.25x, which is fundamentally overpriced, whereas the international stocks are about fair value with a FW PEG of about 1. In historical terms, stocks are pricey in general, but the international stocks are more in line with history. But in general, since stock prices often have little tether to their underlying claim on future profits, so we often look to analogous assets for guidance. Since I am a macro-economist, this article answers that question of fundamental valuation from an international capital mobility perspective, and the answer is, “Yes, U.S. small-caps are dear.” Under complete capital mobility, efficient exchange rate discovery, then U.S. small-caps are fundamentally misvalued . The U.S. has nigh perfect capital mobility, and we shall see below the exchange rate discovery is efficient. International investors prefer a cheaper claim on future profits for similar asset classes, ceteris paribus . The expected change in the dollar that drove international investors into small caps is likely overdone, meaning U.S. stocks are likely overpriced. Figure 1: Recent trend of the SPDR S&P International Small Cap ETF ( GWX) ((blue)) vs. the iShares Russell 2000 ETF ( IWM) (red). Source: Yahoo! Finance (click to enlarge) As one piece of evidence of this thesis, there seems to be a large discrepancy in the valuation levels between the Russell 2000, and the other major U.S. small-cap ETF holdings, and State Street’s GWX. The other international small-cap indices, the iShares MSCI EAFE Small-Cap ETF ( SCZ) and the Vanguard FTSE All-World ex-U.S. Small-Cap ETF ( VSS), are also a bit cheaper than IWM / the SPDR Russell 2000 ETF ( TWOK), but GWX seems to be the cheapest, and thus is the focus of this arbitrage. The ETF’s undervaluation is a bit surprising because GWX’s index, the S&P® Developed Ex-U.S. Under USD 2 Billion, does not seem terribly underpriced vis-à-vis the Russell 2000. Further evidence is exhibited in Table 1, which shows the standard valuation metrics of the major U.S. small-cap ETFs against GWX. Table 1: Fund and Index Characteristics ETF: Vanguard Small Cap ETF (NYSEARCA: VB ) SPDR S&P 600 Small Cap ETF (NYSEARCA: SLY ) SPDR Russell 2000 ETF ( TWOK)/IWM GWX Earnings Growth 3-5 Year Growth 14.87%* 14.61% 15% 16.67% Weighted Average Market Cap 2018 1714 1908 1248 Number of Holdings 1494 600 1963 2303 Price/Cash Flow 10.6 10.74 10.46 3.12** Price/Earnings 29.5 21.6 17.94 15.62 Price/Earnings ratio FY1 19.19 19.6 18.78 16.52 Return on equity 11.8% 11% 6.84% 9.40% Price/Book Ratio 2.5 2.03 2.07 1.37 Dividend Yield 1.43% 1.31% 1.62% 1.66% Price/Sales*** 1.17 1.16 1.15 0.74 * Average of SLY & IWM. Not all fund information is available. Some of the values are taken from the underlying index. **Still listed on their website as of this writing, but SSGA responded in an email stating the fund’s current P/CF is 8.55x. ***Source: macroaxis.com. Data as of Saturday, 15th August 2015. Based the fund information, most of the key metrics indicate that GWX is cheaper than its U.S. counterparts. That discount for an analogous asset class opens up the possibility of a pair trade by going long GWX and short one of the small-cap U.S. ETFs. ETFs have been a great financial innovation allowing retail and institutional investors to cheaply invest. Yet, I do think they have a few weaknesses that became more apparent in this exercise. The first is that all the characteristics needed to rationally evaluate the ETF holdings are not entirely reported, nor are they comparably reported across providers. Moreover, the entire holdings lists are often not reported in a way that allows one to match with external data to fill that gap. A glaring example is that State Street reports a 3.12x cash flow for its benchmark index on its website for GWX, but the index provider reports 14.12. It is hard to know whether this is typo (doubtful because attributes are reported daily and hence are likely automated), or some value-factor “optimized sampling” (a term of art in the ETF industry), which the State Street uses to juice returns when selecting the 2303 stocks from the 3571 stocks from the benchmark index, or how negative cash flows are accounted for. All these small differences make a pure arbitrage play more difficult because the margin of error is slim already given the relative efficiency of the market. The other thing that became clear is that the funds often trade at a premium to NAV and their holdings seem to be slightly bid up vis-à-vis their benchmark (i.e. NAV premium drag on top of ETF drag on top of indexing drag). Both likely have some drag on returns; depending how you leg into the long and short side you might already be down 100 bps before commissions. Not a trade breaker, but an additional complication. As an additional caution for our investors outside the U.S., please be aware that this arbitrage strategy poses additional risks because foreign versions of these ETFs exist in highly fragmented regulatory environments, which are essentially legalized scalping operations with mile-wide bid-ask spreads, implied local currency premia, higher expense ratios, and stronger departures from NAV. Étude d’Arbitrage Now that we have a trading thesis in hand, the question is how to best operationalize it. While the spark of a trading idea came from the price of the Russell 2000, alternate ways to implement the strategy might be to short Vanguard’s VB or State Street’s IWM, two widely held small-cap ETFs. We thus need to ascertain the concomitant risk-return profiles for each possible implementation (a tedious feat, and why most arbitrage is done with computers). Since we are dealing with percentages, there are a few ways to calculate the returns depending on whether you think the trade will lean to one side. The assumption here is both legs will eventually regress toward their mean netting profit on both sides. Rather than rely on a single indicator like price to book, I calculate the average of them all in order to estimate the expected arbitrage for a leg. Table 2 shows the expected gains for each leg, which are calculated off the center point values of the legs. Table 2: Arbitrage ALTERNATE SHORT LEGS LONG LEG GWX AGAINST: VB SLY TWOK/IWM VB SLY TWOK/IWM Price/Cash flow* 12.5% 11.1% 12.7% -9% -9% -10% Price/Earnings -36.9% -13.8% -6.5% 19% 19% 7% Price/Earnings ratio FY1 -5.9% -7.9% -6.0% 9% 9% 7% Return on equity 18% 6% -16% -6% -6% 16% Price/Book ratio -32.0% -16.3% -16.9% 24% 24% 26% Dividend yield convergence -3.5% -11.8% -1.2% 11% 11% 1.2% Price/Sales -23.2% -22.1% -21.7% 28% 28% 28% 5-Year growth convergence -3.5% -4.7% -3.5% 4% 4% 3% Ex{Center point arbitrage on leg} 9.3% 7.4% 7.4% 10.1% 10.1% 9.7% Ex{Total gain} (3.12x CF) 19% (42%) 17.5% (39.7%) 17.1% (39%) *Assumed to be 13.12x not 3.12x. See text. Since, the expected gains may be sensitive to the cash/flow outlier, I conservatively assume the cash flow to be 13.12x rather than 3.12. Being short the U.S. small-caps and long foreign small-caps implies being short dollars and long foreign currency, which means currency is a concern. A fair assumption might that the spot rate is the correct rate, but currency translation has been a major headache for me this year (thank you SNB…), so I am especially cautious. In order to estimate FX effects, I use the standard economist’s model that domestic net interest and inflation rates equal net inflation interest and inflation rates abroad, where “abroad” I define as Japan and the Eurozone. Currency Risk USD (EUR+JPY) /2 Spread Inflation (IMF 2016 forecast) 1.49% 1.10% 0.39% Interest (forward 6-month LIBOR) 0.56% 0.24% -0.32% Net spread: 0.07% Estimated USD appreciation needed to eliminate spread: 0.29% What amount of currency appreciation would U.S. rates into line? About 0.3%, assuming an inflation/currency elasticity of -0.24 (Kim 1998, pg. 617). Bond and currency traders seem to be doing their job extremely well, so we probably should not worry about currency. Since the strategy is equally long and short, it should be market-neutral. Yet, despite the proposed trade having an expected beta of zero, it entails risk. Therefore, I estimate the portfolio standard deviation using 2 years of adjusted price return data from Yahoo! Finance as a proxy for the portfolio risk. Strategy Profiles Table 3 shows the strategy implemented either using 2 or 3 ETFs. Using more than one short leg held out the possibility of reducing risk. Table 3: Strategy Implementation Profiles Three Asset Two Asset -VB/+GWX -SLY/+GWX -IWM/+GWX -SLY/+GWX -VB/ +GWX -IWM/ +GWX -TWOK/ +GWX -SLY/ +GWX Ex{Sharpe}* (3.12x CF) [+ lending] 1.54 (3.57) [4.15] 1.40 (3.39) [3.61] 1.93 (4.31) [4.99] 1.43 (3.44) [4.01] 0.68 (2.54) [3.07] 0.82 (2.00) [2.34] Ex{Equity Arbitrage} 23.51% 22.15% 25.05% 22.32% 22.32% 21.97% Ex{Currency Delta} -0.29% -0.29% -0.29% -0.29% -0.29% -0.29% Ex{Borrow Costs} -1.24% -1.48% -1.00% -1.48% -9.11% -1.47% Ex{Lending Income} 6.29% 6.29% 6.29% 6.29% 6.29% 6.29% Ex{SD Portfolio} 10.9% 11.1% 9.4% 11.0% 11.9% 18.6% *Returns calculated without lending income and 13.12xCF. See text. I present 3 different Sharpe values. The most conservative version assumes a price to cash flow of 13.12x. The second uses the provider’s index information. And the third includes the market rate security lending income. If you are able to collect the market rate for lending GWX, the trade becomes almost a pure arbitrage play. With an expected Sharpe of 1.93, the dominant operationalization would appear to be short VB and long GWX. Conclusion It would therefore seem, even based on conservative calculations, the proposed long-short strategy dominates a long position in the S&P500, which has an expected Sharpe of about 0.47. All of the trades seem to meet the first test of rationality, and thus a decent risk-adjusted trading opportunity. For this reason, I like to know what you think. Is the data wrong? Have I made an error in calculation? Is there a problem with my deduction and/or conclusion? If not, how would you implement the trade and when? Based on your feedback I shall make a determination to open a small position. 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.

How I Diversify And Hedge My Portfolio For Market Volatility

Wide diversification and a ‘buy and hold’ strategy are not necessary for success. In fact, there are much better ways to hedge the market, capitalize on upside, and protect yourself from downside. Here is how I diversify my portfolio. Wide diversification is only required when investors do not understand what they are doing.” – Warren Buffett Every couple weeks I list my portfolio along with top-rated stocks to members of Tipping the Scale. I do this because my holdings often change depending on stock gains, valuation, and when new opportunities arise. Soon after my last update, a person noted that I did not own any materials, utilities, and was very light on industrial stocks and ETFs. He continued that for a portfolio of my size, he was surprised I did not prioritize “diversification”. My response is that I do diversify, just differently, and that my intention is not to track the market, but to rather beat the market. With well over a decade of consistency, my bottom line approach has not changed much, having worked very well in all markets. Here’s what I do. Rather than prioritizing industries and sectors of the market to achieve diversification, I diversify by purpose. Each holding in my portfolio fits into one of five categories, my sectors if you will, and thereby having a purpose. That category dictates management style, selection, and activity. Here are the five categories and the weight that each has in my portfolio Category Weight Top rated stocks 35% Dividend & Income Stocks 30% Deep Value 10% Growth & Momentum 5% Cash 20% Top-rated stocks are those that score in the upper echelon of companies covered in Tipping The Scale. Typically these are stock that score 88 or higher, meaning the company had to score relatively high in all 10 categories that TTS tracks. These include business growth, macro outlook, profitability, management vision, valuation, etc. Due to such a high rating, my theory is that “top-rated stocks” are worth holding through volatility, and should not be sold, only acquired in periods of loss until the company’s rating starts to decline. In the first three months of TTS, top-rated stocks (seven stocks with a score better than 90) traded higher by more than 9% versus a loss of 1% in the S&P 500. Therefore, these stocks tend to perform well both in short and long term, which is why they are such a staple in my portfolio. For investors considering my portfolio strategy, 35% of your holdings would be allocated to those stocks where you have the most confidence, and are the best of the best, however it is that you determine “the best”. Dividend And Income stocks provide some balance to my portfolio, as these are typically low beta, safe investments. Seeing as how 40 of the potential 100 points for TTS stocks are tied to business growth, macro outlook, and the amount of short and long-term upside in a stock, large companies with high dividends don’t typically rank as “top rated stocks”. Therefore, I hedge those types of investments with stocks that don’t necessarily have tons of upside or growth (i.e. AT&T (NYSE: T ) or Corning (NYSE: GLW )) but have high yields. These are companies that would rank high in other areas, but just don’t have the growth upside of a top-rated stock. Furthermore, this is where I put REITs like the Vanguard REIT Index Fund (NYSEARCA: VNQ ) and ETFs that have high yields. The key with the dividend and income section is to invest in entities that pay a high yield. The average yield of my holdings that fit into this section is 4.6%. With 30% of my portfolio allocated to dividend and income, that 4.6% yield for 30% of my portfolio translates to a 1.4% yield for the entire portfolio. Not to mention, often times a company that pays a dividend will fit into another category, thereby not considered part of the dividend & income section. A good example is Apple (NASDAQ: AAPL ) and Schlumberger (NYSE: SLB ), which fit into the top rated and deep value sections of the portfolio, respectively. All in all, the yield of my total portfolio is 1.8%, just about equal to the SPDR S&P 500 ETF Trust (NYSEARCA: SPY ). That gives me a downside cushion while also hedging my top rated holdings. With that said, the top rated stocks and dividend & income sections serve as a natural hedge against the other, limiting downside risk in the face of a market correction. The Deep Value and Growth And Momentum sections tend to do the same. Albeit, I don’t worry about how many holdings in each sector are in my portfolio, but by allocating my portfolio based on goals, you end up owning stakes in most industries. For example, energy and financial stocks trade at the lowest multiples and are mostly cheap because of macro-related factors, whether it be oil prices or low interest rates. This gives investors an opportunity to cherry pick top companies in those respective industries, those that have fallen below their worth because of macro-related concerns. My belief is that once those macro-related concerns stabilize, those top companies like Schlumberger, EOG Resources, JPMorgan (NYSE: JPM ), and Goldman Sachs (NYSE: GS ) will be the ones to outperform their peers. However, if those macro factors don’t improve, then not much of your portfolio is tied to such stocks. That said, there is certainly no valuation considerations for stocks included in my growth and momentum section. This is where I own companies like FireEye (NASDAQ: FEYE ), Facebook (NASDAQ: FB ), or speculative biotechnology companies. As explained in a recent blog , this is where I trade stocks based on their score in TTS. This is where I buy momentum stocks when volatility makes them cheap, and then sell when that price gets too high. Notably, if the market turns for the worse, these are usually the first stocks to go lower, and that’s why when owning such stocks it is good to keep a close eye and set stern stop-loss and limit orders. Finally, I keep a cash stake that equates to 20% of my total portfolio, which too fluctuates depending on the performance of the market. Believe it or not, cash is where investors can really hedge the performance of the market, and use volatility to their advantage. Below is a chart that I follow as a way to determine the size of my cash stake. Cash as percentage of portfolio S&P 500 performance 15% bull market 20% 2% to 5% off highs 25% 5% to 8% off highs 30% 9% to 12% off highs 35% 13% to 30% off highs 50% 31% or more off highs We are coming off a five year bull market that has seen very little economic growth, one that I fear has been driven by lower interest rates and multiple expansion. I have said on many occasions that I expect a correction. The problem is that there’s no way to know when that correction will come or how bad it will be. So, when the market starts to dip, I start cutting my growth and momentum stocks. If it keeps falling, I will trim value stocks that are hurt by macro conditions. Finally, if the market keeps going lower, surpassing that 30% from market high levels, I will start cutting dividend stocks. However, unless something changes the outlook for those high rated stocks, I will not sell, not until my price target is reached. With that said, this is a hedge that I have found to be very useful over the years. For one, both times that the market has exceeded a loss of 30% off its high since the year 2000, it continued to dip significantly lower. Therefore, I protect myself from future losses, and by quickly increasing my cash position and removing high beta stocks, while retaining low beta stocks (dividend), my portfolio tends to outperform the market. Then, by decreasing cash and increasing my stake in high beta momentum stocks, my gains tend to outperform the broader market as it recovers. However, the final and most important piece of the puzzle are those high rated stocks, because as I already explained, those stocks consistently outperform the market due to having the total package in those 10 essential categories. All things considered, the buy-and-hold, complete diversification strategy by owning all industries of the market is not a bad way to structure a portfolio, but I don’t think it is the best way, and neither does Warren Buffett. Instead, it is best to determine what you want from a portfolio, and then create it from those goals. Over the years, as my net worth has grown larger, I’ll be the first to say that my appetite for risk has diminished, and where I used to own more momentum stocks, I have since found high yield to be most important. However, the one thing that has not changed is my desire to own as many high quality companies as possible. In any market, those are the ones that thrive, and that’s why I would tell anyone to diversify by owning what’s best, and not to own a little piece of everything. Disclosure: I am/we are long AAPL, GS, T, JPM, SLB, GLW. (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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