Water Sector oh Water Sector

I have little bit of PUNCAK and KPS.

Back to the negotiating table on water
By Kenanga Research / Kenanga Research   | April 6, 2015 : 9:59 AM MYT   

Water Sector
Maintain overweight: The Selangor and the federal governments are returning to the negotiation table after a minor dispute. To recap, on March 9 this year the Selangor government revoked its water agreement with Putrajaya signed in September last year, claiming that the federal government had failed to honour the master agreement. Recent media reports have it that Selangor Menteri Besar Azmin Ali had said he is willing to finalise the agreement on the restructuring of the water industry if the federal government agrees to the main requirements.

We gather that the above issue has nothing to do with the concession holders’ valuations and terms in the sales and purchase agreement (SPA) that was signed (through Pengurusan Air Selangor Bhd [PASB]) in November 2014.

Hence Puncak Niaga (M) Sdn Bhd’s price tag of RM1.56 billion to sell its water assets remains intact. Nonetheless, since the master agreement must be signed first, Puncak anounced on March 16 this year that it agreed to the third extension of time with the state government through PASB to complete the deal to sell its water assets. PASB has given an extension until this Thursday to fulfil all the conditions precedent set out in the SPA. We admit that there are still risks of further delays in completing the whole deal. Nonetheless, due to the pressure from all stakeholders (contractors of the Langat 2 water treatment plant, concession holders, investors and the public), we do not think the state and federal governments can afford to delay the whole restructuring plan for another year.

Because the dispute is at the federal and state level, our initial view on special dividend payout is still valid. Out of RM1.56 billion cash proceeds that are expected to be received by Puncak, RM534.3 million will be distributed to shareholders and the remaining RM1.02 billion will be kept for future investments. The special dividend is equivalent to RM1 per Puncak share (fully diluted). Dividend payment of RM1 per share implies a huge 40% yield based on Puncak’s current price. Nonetheless, post-special dividend payout (estimated three to six months hence), we might consider reviewing our call and valuations with downward bias as we could not ascertain yet the group’s future direction after the sale of its water assets.

On the other hand, Syarikat Pengeluar Air Sungai Selangor Sdn Bhd (Splash), the only concessionaire that has yet to ink the deal with the Selangor government, is currently in active negotiations to resolve its valuation issues. We expect talks will reach the final conclusion in the near to medium term. To recap, Sweet Water Alliance Sdn Bhd (30%) and Gamuda Bhd ( Financial Dashboard) (40%) rejected the state government’s offer to take over their concession asset Splash due to a pricing issue. Selangor has only offered them 10% of Splash’s book value of RM2.5 billion.

Note that we have already factored in Splash’s book value of RM1 billion (at Gamuda level) in Gamuda’s target price. For illustration purposes, if Gamuda were to sell its 40%-owned Splash to the state government at 50% below book value, our sum-of-parts will be revised downward to RM5.09 from current target price of RM5.29. To recap, Gamuda has already made a decision that it will not accept anything lower than book value.

Hence, all in, we are maintaining our “overweight” call on the water sector premised mainly on the expectations of special dividend payments from Puncak that will be distributed in the near term. At the current price, Puncak looks attractive as it is trading at below its offer price of RM2.89 per fully-diluted share. We view any share price weakness as an opportunity for investors to accumulate the stock as they could enjoy a huge yield of 40% as a result of the special dividend of RM1 per fully-diluted share to the shareholders pursuant to the group’s water asset sale.

We expect a final conclusion in the near to medium term. As for Puncak, the company has already agreed to distribute RM1 per share to shareholders as a special dividend. All in, we advocate investors accumulate Puncak now given that its current price is below the state government’s offer price of RM2.89 per share.

Risks to our recommendation include: 
(i) further delay in the water restructuring exercise; 
(ii) absence of special dividends; and 
(iii) downward revision in the takeover valuation of the water assets. 

— Kenanga Research, April 3

This article first appeared in The Edge Financial Daily, on April 6, 2015.