Companhia de Saneamento Basico do Estado de S o Paulo, or SABESP (SBS), provides public water and sewage services in the State of S o Paulo, Brazil, which includes the city of S o Paulo, one of the largest cities in the world. The company distributes water to approximately 25 million people (70% of the urban population) and provides sewage services to more than 17 million people in 368 municipalities within the State of S o Paulo. The company has 193 water treatment stations, 423 sewage treatment facilities and 2,014 water reservoirs with a total capacity of 2.6 billion liters of water. The company is the largest water and sewer utility in the Americas and the third largest in the world in number of customers. Water and sewage services accounted for 57% and 43%, respectively, of the company's revenue. Residential, commercial, industrial, and public sector customers account for 84%, 10%, 2%, and 4%, respectively, of the company's revenue. The metropolitan, interior and coastal regions generate 75%, 16%, and 9%, respectively, of the company's total revenue. SABESP's principal shareholder is the S o Paulo government, which owns nearly 72% of the company.
SABESP has been improving its revenues and operating margin since the end of 2004. At the end of 2003 and continuing through most of 2004, the company faced a difficult situation regarding water rationing. Until September 2004, the company offered a 20% bonus to all customers who reduced consumption by at least 20%. Fortunately, this difficult situation belongs to the past due to better-than-expected rains during 2005, 2006 and the beginning of 2007 in the State of Sao Paulo. Currently, the dry season is over in the South of Brazil with the beginning of the summer. By the end of December, the hydrology situation is expected to improve considerably.
The outlook for the Brazilian economy in the short term remains promising. The Brazilian Central Bank started to cut interest rates in September 2005, after a long period of tight monetary policy. Currently, the Brazilian domestic interest rates remain one of the highest in the world at 11.25%, against an expected inflation rate for 2007 of just 4%. Indeed, Brazilian real interest rates remain among the highest in the world, still around 7% per year. Nevertheless, some considerable inflation pressures were the main reason behind the decision of the Brazilian Central Bank to leave rates unchanged for the first time in more than two years in the October meeting. Since the official inflation target is 4.5%, we believe this is just a temporary problem. There will be room for further rate cuts throughout the second quarter of 2008, may be even in the first quarter 2008. What's more, as a result of the improvement in the Brazilian economic environment, we believe Brazil will reach investment grade within the following 12 months, thus leading to a multiple expansion for Brazilian stocks. We understand SBS will benefit from this development in the short term.
Since 2004, the company has benefited from the continued strength of the Brazilian currency (real). Indeed, the strength of the Brazilian real during 2004, 2005, 2006 and the first half of 2007 helped boost SABESP's results, since the company still has more than 20% its total debt denominated in international currencies, mainly U.S. dollars. We believe the Brazilian real will remain strong in the very short term. The Brazilian real is now stronger than ever during the last seven years. We believe that a less benign monetary policy in Brazil coupled with falling U.S. rates are the main reasons behind this situation. Additionally, the basic fundamentals behind the strength of the Brazilian real, including the positive trade balance and current account surplus, remain in place.
Even better, the company's continued solid operating performance is more important than the positive effect of the Brazilian real and the lower interest rates. Indeed, we consider SABESP's operating results to be highly positive, including higher water and sewage volumes billed, strict cost discipline, high operating and EBITDA margins, and a solid net income. During the third quarter 2007 costs of sales and services increased just 4.9% compared to a revenue growth of 7.3%. This positive development was a direct result of lower thirty party expenses and lower write offs. Also impressive was the 14.4% reduction in selling expenses and the 5.3% reduction in administrative expenses. Even better, the company was able to increase its productivity in sequence and the number of connections per employee grew from 651 in 2005 to 667 in 2006 and 702 in the third quarter 2007. As a result of those positive figures, we are increasing our 2007 and 2008 earnings estimates.
Additionally, there were some interesting news items that we believe will benefit SABESP in the short-to medium term. During the first quarter of 2007, the Brazilian government announced an ambitious four-year US$235 billion infrastructure investment plan. One of the main points in this plan is to boost investments in the water and sewage sector. On June 26, 2007, the Government of S o Paulo and the Federal Government signed, a federative cooperation protocol for integrated sanitation and housing actions in the Sate of S o Paulo with investments of R$2.1 billion (US$1.1 billion) for the integrated sanitation and housing actions, R$700 million derive from the Union's budgetary transferences, R$600 million will be obtained through financings and R$512 million will be disbursed compensated with the State's own resources. The municipality of S o Paulo will also contribute with R$320 million.
For the following quarters, we expect continued good results. It is important to note that the dry season is now over in the State of Sao Paulo. Then the company is already entering a less challenging period. Moreover, on August 10, 2007, SABESP announced an adjustment of 4.12% in the water supply and sewage collection tariffs. The new tariff will be effective on September 10, 2007 and will have a positive full effect on the fourth quarters 2007.
At the end of 2007, the Brazilian Congress approved the new regulatory framework for the water and sewage industry. The legislation approved was not only as positive as we expected but also included withholding tax discounts in exchange of new investments reaching an amount of R$2.5 billion (US$1.4 billion). The regulatory measures do not define who is responsible for the water and sewage service (state or municipalities), a matter that will be defined by the Brazilian Supreme Court in the following months, but any new municipal companies will have to compensate existing state companies in case they want to become responsible for the service in a specific area. We believe that this rule is strong enough to avoid any attempt to create new local companies. We understand that, after this new legislation, private companies will be able to become partners of the state companies and to participate in some local specific projects. The regulatory framework is a great achievement for this industry in Brazil, making it possible new investments and more ambitious projects. Finally, during the first quarter 2007, the Brazilian government announced that a reduction on the vat tax for water and sewage operations is being considered and could be announced in the short-term.
The more positive environment for new projects and investments is already generating some news. On May 31, 2007 SABESP announced that its investment budget for the 2007-2010 period was raised to R$5.87 billion (US$3 million) from R$3.84 billion (US$ 1.97 billion). The most important targets are to increase the sewage collecting coverage to 84% from 78% and to threat 82% of all the sewage collected, currently the company threats only 63% of the sewage. The announcement of the new investment budget was not well received by the market, as it raised some concerns that dividend distribution might be reduced to allow a higher level of investments. While this is a relevant concern, it is important to remember that the company has been reducing its debt. Additionally, the previously mentioned tax benefits will make those investments more interesting. Finally, income-seeking investors should find the stock appealing, as SABESP is required to pay a minimum of 25% of its net earnings in the form of dividends and the stock has a long tradition of high dividends, even though dividend distribution was lower in the last quarters. For 2007, we expect a dividend yield close to 4.0%.
We believe the stock remains attractive. Our belief is based on the company's continued solid results, a better outlook for interest rates in Brazil, attractive valuation, and a decent dividend yield. Additionally, we believe the current economic environment is positive for utility stocks. The upgrade of Brazil to investment grade in the short-to-medium term will lead to a multiple expansion for Brazilian stocks, and the company will benefit from a more stable and clear regulatory framework. All considered, we maintain our Buy recommendation on the stock.