YTL Corp: Rebuilt, rejuvenated, and ready to go
BNP Paribas Peregrine, 6 May 2004
Target Price: RM5.55
By Choong Wai Kee
By Choong Wai Kee
Share price M$4.62
Target price M$5.55
Reuters/Bloomberg YTLS.KL/YTL MK
- Rebuilt, rejuvenated, and ready to go: Conglomerates have generally fallen out of favour because they diversify too broadly, then stumble on poor management and overly leveraged balance sheets. YTL, however, deserves reconsideration as it has diversified with consistently good results and still boasts a strong balance sheet.
- Catalysts and upside potential: We see as the key share price driver an imminent rebound in its bread-and-butter construction, property development, and cement manufacturing businesses. YTL's potential in taking part in Malaysia's water privatisation is another plus development.
- Trough valuation: Current valuations are nearing the lower end of YTL's historical channel. At M$4.62, it is at a PE of 13.5x 2004 fully diluted annualised earnings and close to its book value. At the peak, YTL traded at higher multiples, with a historical PE of 18.2x and P/BV of 3.9x. Globally competitive, with a strong balance sheet, it should trade 20% nearer our M$5.55 target price.
Rebuilt, rejuvenated, and ready to go
Conglomerates have generally fallen out of favour, mainly because they diversify too broadly, then stumble on poor management and overly leveraged balance sheets. YTL, however, deserves reconsideration as it has diversified with consistently good results and still boasts a strong balance sheet.
Benefits from crisis and emerges stronger
While many companies spent the last few years busily repairing their balance sheets and restructuring businesses, YTL's financial strength enables it to greatly benefit from the economic crisis and emerge stronger. At the peak of the 1997-98 Asian financial crisis, it bought a few prime hotel and retail properties at a 72% discount to book value and secured a leading role in the M$2.4b Express Rail Link (ERL) construction project.
YTL will not rush into a deal unless it offers a great value
YTL has the capacity to acquire or undertake new projects without taxing its balance sheet. It has ideas, which we believe it will pursue judiciously. Despite shareholders' mounting pressure and criticisms, YTL won't rush into a deal unless it offers great value.
In May 2002, acquired Wessex Water, which offers expertise in the water industry
There was a major acquisition made in 2002. Its power unit, YTL Power International (YTLP) took a bold step venturing into something completely new on acquiring Wessex Water from bankrupt Enron for £1.24b. By acquiring Wessex Water, YTL managed to:
- Successfully diversify from sole reliance on Malaysia's power generation business;
- Added another low-risk, high-quality, strong-cashflow business to its stable; and
- More important, acquired the much-needed water expertise that it can leverage off.
Locally, YTL has rebuilt into a very focused, more efficient conglomerate. It has spent the last few years reorganising its corporate structure, making it leaner and more cost- effective. A case in point is the reorganisation of its property division, which created YTL Development as the group's flagship property development arm.
Catalysts and upside potential
Investors pay more attention to cyclical business
In the past, the acquisition of megasized assets has been the single most obvious share price catalyst. This stock was re-rated shortly after it acquired Wessex Water in 2002. Unfortunately, timing the acquisition is almost impossible. While awaiting YTL's next big acquisition, we commented that investors should pay more attention to its overlooked cyclical construction, property development, and cement manufacturing businesses. And, its potential in taking part in the privatisation of Malaysia's water industry cannot be overlooked. We also see upside potential from the listing of its 50%-owned ERL.
· Upturn in cyclical businesses
Construction orderbook could hit M$1b
Since Malaysia's mega construction cycle ended in the early 1990s, YTL has been penalised for not being able to repeat its success. Its last megasized infrastructure project was the M$2.4b ERL project, with civil construction works of about M$800m. The market probably projected a M$300m construction orderbook but we believe it can hit M$1b by end 2004.
· Privatisation of Malaysian water industry
Well positioned for Malaysia water privatisation
In our opinion, YTLP is well-positioned to capitalise on Malaysia's move to 'federalise' or privatise the nation's water supply and distribution system as a new window of opportunity for companies with exposure and expertise in the water industry. The YTL group has extensive experience as contractor and operator of water projects. Development on this front could be a positive catalyst to the share price.
YTL group offers good track record and is financially able to undertake big projects
We believe the YTL group's value to the government -as contractor-cum operator -is compelling. The group has a strong track record as a contractor of large-scale utility projects. It has accumulated a wealth of experience from operating and managing water assets through Wessex in the UK.
It also offers one of the strongest balance sheets of any construction group in Malaysia today with an estimated war chest of M$6.2b cash at end-2003. Of its total group borrowing of M$14.2b, M$8.2b is sterling funding for the Wessex purchase. Net gearing is 147%, which looks high superficially, but most debts are ring-fenced within Wessex Water and have no recourse to YTL. Excluding Wessex, YTL is in a net cash position.
Government is working hard on water privatisation
Significant progress has been made since mooting the privatisation of water and wastewater. The industry White Paper is believed to have been submitted to the government and the recently formed Energy, Water, and Communications Ministry will ensure the proposed water privatisation is being implemented speedily.
Water privatisation offers long cycle
The water industry's privatisation offers players a much longer cycle. Based on initial government estimates, the next 50 years' capex works out to nearly M$100b.
· Listing of KLIA Express
Potential listing offers upside
Train operator Express Rail Link Sdn Bhd (ERL) recently expressed interest in listing its shares on the Kula Lumpur Stock Exchange -this is definitely another upside potential for the YTL group. Its investment as at end 2003 was roughly M$180m but its 50% stake in ERL is worth about M$800m in discounted cashflow (DCF) terms.
ERL turns profitable in 2003
ERL runs a high-speed, non-stop rail service, KLIA Ekspress, from Kuala Lumpur Sentral to Kuala Lumpur International Airport (KLIA) in Sepang. It also operates KLIA Transit, a rapid transit service that makes three quick stops at key townships along its route. Despite challenging market conditions, led by the SARS outbreak and war in Iraq, ERL turned profitable in 2003. To boost profitability, it targets to raise its daily traffic from 3,000 to 4,000 in 2003, to 6000 by end-2005.
Trading at 13.5x 2004 earnings, P/BV of around 1x
YTL's current valuations -PE and P/BV -are nearing the lower end of its historical channel. At M$4.62, it is trading at a PE of 13.5x 2004 fully diluted annualised earnings. In price-to-book terms, it trades only around its book value. At the peak, YTL had much higher multiples with the historical average for PE at 18.2x and P/BV of 3.9x.
Globally competitive, too cheap at 1x book
High valuations are deserved. Given that YTL is globally competitive, with a strong balance sheet, the stock should be valued at least 20% above its current valuations. Using our target price of M$5.55, YTL's valuations are better reflected at a PE of 15-16x 2004-05 earnings, still below its historical average of 18.2x.
Will YTL ever trade near its historical valuations? What is the catalyst?
What catalyst can push YTL near its historical valuations? The usual suspect is always another acquisition. Unfortunately, it is impossible to pinpoint the exact timing. Instead of deliberating about YTL's next big acquisition, consider two potential catalysts: the revival of its bread-and-butter construction and property development businesses, and its possible participation in the upcoming privatisation of Malaysia's water industry. Whether YTL trades closer to its historical valuations depends on how much the market believes it will be part of Malaysia's next wave of privatisations.
A conservative RNAV analysis yields a base-case support of M$5.55/share
By simply summing up the values of its quoted entities -YTL Power International, YTL Cement, YTL Land and Development, and YTL e-Solution -at market value to the value of its non-quoted assets and shareholders' funds at company level, YTL has an RNAV of M$8.684b or M$5.89/share after subtracting the respective holding cost of these assets. We were more conservative, fully diluting (regardless of chances of conversion) its EPS by all outstanding warrants. This translates into a fully diluted RNA V of M$5.55/share.
YTL Power vs YTL Corp
YTL offers the best of both worlds – cyclical and non-cyclical
Given that YTL Power (YTLP) contributes 75% of YTL's earnings, the easy way out is to simply put money in YTLP. But, we contend that YTL offers better value by way of better exposure to the cyclical part of the group's businesses -construction, property development, and cement manufacturing. Our analysis finds YTL's cyclical businesses set to grow 15-20% over the next 2-3 years.
YTL is cheaper exposure to YTLP
While YTLP is almost fully valued in DCF terms, YTL is still at a discount to its RNAV- derived intrinsic value of M$5.55/share. This clearly demonstrates that YTL offers a cheaper exposure to the group's utility businesses than going directly into YTLP.
The most successful Malaysian IPP
The group's involvement in the power generation business is via its Main board-listed subsidiary YTL Power International, the most successful of Malaysia's independent power producers (IPPs). It enjoys the highest internal rate of return, secured by the highest selling price and long-term fuel supply contract, and financed by borrowings fixed at a low 10% for 15 years.
Power generation capacity stands at 1,212MW
YTLP owns and run two power stations – in Paka, Trengganu, and Pasir Gudang, Johor – with a combined installed capacity of 1 ,212MW. Both are gas-fired combined-cycle plants, which means they are more efficient than single-cycle plants with higher thermal efficiency and lower fuel consumption.
YTLP’s 1st generation PPA guarantees minimum 72.5% offtake
YTLP's power generation business is backed by a superior power purchase agreement (PPA) with Tenaga Nasional, owner/operator of the national grid, which guarantees a capacity utilisation (minimum offtake) of at least 72.5% and average tariff of M$0.155 for every kWh of power generated by YTLP's plants.
First IPP in Malaysia to have 100% domestic funding
The project cost totals some M$4.3b, was wholly M$-financed, which was thought impossible at that time due to the project's sheer size. But YTLP secured a M$1.5b 10% 15-year bond from the Employees Provident Fund (EPF) and a M$1.16b floating rate 15- year credit facility from a consortium of banks at BLR+1.5%.
Not expanding locally, not adding on risk
Unlike its rivals, YTLP opted not to expand its power generation business locally. Its cautious view was premised on the falling return on investment in the domestic power business as evidenced by the declining IRR on second and third generation IPPs. The only expansion in its power generation was in a 3-year supplementary agreement to sell 190MW of extra power to Tenaga Nasional in FYOO during the supply crunch period where Malaysia's reserve margin hit a low 24%.
By not expanding domestically, YTLP is now least exposed to the brunt of negative side effects of the power demand-supply imbalance and shoulders no demand risk.
Water and sewerage services
Took a bold step in 2002 by acquiring Wessex Water
Consistent with the strategy of investing only in regulated utility assets, YTL, via YTLP, took a bold step into something completely new in May 2002 by buying the Wessex Water group, which has since contributed significantly to group profitability.
Acquisition was accretive
The acquisition was value-enhancing. Within the first year, the value of YTLP's regulatory asset base increased 8.8% to £1.47b from £1.36b y-y. The impact on EPS was clearly positive, even after accounting for goodwill and financing costs. Wessex Water's first full-year impact boosted EPS some 36% in 2003.
Risk profile intact despite foreign jurisdiction
The acquisition has not altered YTL's risk profile despite the huge investment offshore. Its multi-billion ringgit investment is protected by strictly enforced ring-fencing provisions, set and regulated by the Office of Water Services (OFWAT). These provisions ring- fenced or protect water utility assets in the UK from external distress, ensuring uninterrupted supply of water services while enabling promoters or owners to enjoy a reasonably attractive return on their investment.
YTL Land and Development emerged as the group’s property arm
Already an established niche developer best known for its Pantai Hil/park condominium enclave in Kuala Lumpur, YTL's property development activities are now undertaken by 64.4%-owned, listed YTL Land and Development (YTLL). YTLL emerged as the group's development arm following the restructuring and injection of the group's unlisted property development assets totalling M$262m into Taiping Consolidated in 2003.
Landbank of 974 acres
YTLL's land bank stands at 974 acres (395 hectares), 30% in Klang Valley, 30% in Ipoh, Perak, and 40% almost evenly distributed in Johor and Malacca. Key ongoing projects with an aggregate estimated gross development value (GDV) balance of M$1.2b include YTL's former flagship, Pantai Hillpark, which is approaching the tail end of its development life; the initial stage of the 320-acre Taman Pakatan Jaya in Ipoh, the mature Taman Cahaya Masai in Johor; and the recently launched Lake Edge high-end residential project in Puchong.
Developer of 294 acre Sentul, largest non-greenfield site in the city
And, YTLL is developing the 294-acre Sentul urban renewal project, the largest non- greenfield site in the heart of land-scarce Kuala Lumpur, which it inherited from Taiping Consolidated. Originally launched in 1995, the revived Sentul project is undertaken on a 70:30 JV basis with Malayan Railways (KTM) with an estimated GDV of M$6-7b, comprising a 35-acre park and some 7,000 high-rise residential and commercial units over its eight to ten year development life.
Well-poised to capitalise on resurgent demend for higher-end property
Despite YTLL's low property earnings base in FY03 -as a result of limited new launches in the past two years vis-a-vis the group's well-located Klang Valley product mix being biased towards the higher-priced segment (>M$250,000/unit) -we consider YTLL well- poised to capitalise on the resurgent demand for higher-end residential property. We expect it to accelerate planned launches to 1,700 new residential and commercial units over FY04-05 at average unit prices of M$411 ,000 for FY04 and M$605,000 for FY05.
Projecting strong 86% property EBIT CAGR to FY06 from FY03’s low base
Hence, we project a strong 86% property EBIT CAGR to FY06 from FY03's low base, driven by progress billings on the Maple condominiums at Sentul West launched in 1QFY04; the final phase of Pantai Hillpark comprising 830 high-end condos and commercial shop offices later this year, and the overwhelmingly successful new Lake Edge Puchong project. The inaugural April launch of 225 courtyard homes at Lake Edge were fully sold, locking in some M$100m in new sales over the launch weekend. We anticipate the launch of a limited number of townhouses, semi-detached houses, and bungalows totalling M$40m to be similarly well received.
In the medium term, we understand YTLL may be close to sealing a JV with a government agency for a strategically located residential/township project in Klang Valley, which could boost the aggregate GDV balance by another M$450m.
From government-linked public jobs to large-scale infrastructure projects
The group's construction arm is 100%-owned Syarikat Pembinaan Yeoh Tiong Lay Sdn Bhd (SPYTL), a Class A contractor since 1995. From building government-linked public schools, hospitals, army barracks, and domestic airports, SPYTL's civil engineering expertise has broadened to large-scale infrastructure projects -constructing a 1,212MW combined-cycle power plant in the mid-90s and the M$2.4b ERL high-speed rail link between Kuala Lumpur and KLIA in early 2000.
Orderbook set to expand
Contrary to the market perception that YTL was unable to secure external projects, more than half its current orderbook is made up of jobs won on open competitive bidding. We estimate the orderbook of some M$500m swelling to M$1b by FY04-05, as the group stands to benefit from the government's emphasis on open tenders for all new jobs.
Ongoing property projects to ensure a steady cashflow
One of SPYTL's strongest selling points is its enjoyment of strong recurrent contract orderflow from the group's ongoing large-scale property developments nationwide, including the construction of The Tamarind condominium in Sentul (498 medium cost units) and The Maple (318 units). These projects are slated for completion in May 2005 and June 2006 and will keep the construction arm busy for the next few years. Other projects include construction of double-storey, low- to medium-cost terrace houses in Taman Cahaya Masai in Plentong, Johor, and Taman Pakatan Jaya in Tampun, Perak.
Prospects – plenty of in-house and external projects
Apart from in-house projects -new phases of Pantai Hillpark, the Sentul urban renewal project featuring 7,000 condominium units to be built in the next 7-8 years, and the latest Lake Edge project in Puchong comprising 100 acres of residential development.
Doing well despite challenging market conditions
Despite challenging market conditions, led by cement oversupply, YTL's 68.3%-owned YTL Cement (YTLC) remains profitable. Its ability to enjoy strong demand for its products is attributable to their superb quality. This helps the company's dominant market position, especially in niche markets for products such as pre-cast and ready- mixed concrete, and blended Portland cement.
Raising exposure in the cement business
With the domestic cement industry already hitting bottom, and expecting a rebound in industry fundamentals, YTLC acted swiftly to raise its Pahang Cement Sdn Bhd stake by buying out the other 50% held by the Pahang state government. It will issue 36.8m shares at M$3.75/share, having secured regulatory approval. YTLC will control the 1.2m tonnes cement plant.
Better results ahead
After a seasonally depressed quarter ended December 2003, due to lower demand and consumption for its cement products during the festive and rainy reasons, YTLC is set to churn out better results. It is expected to perform well, especially in the ready-mixed concrete segment, where it was able to gain market share in Cyberjaya and Putrajaya.
From cyclical to defensive
YTL lost its appeal as the nation's proxy to the 1990s construction boom on deliberately shifting its focus to lower-risk defensive utilities. From power generation, it expanded its defensive business profile, putting money into water and sewerage services. The power generation and water businesses contributed 75% of FY03's turnover.
Outperformed the market, triggered by YTLP’s huge dividends
Despite its defensive characteristics, YTL shares outpaced the market in the past 12 months. The main catalyst, we believe, was the market's growing recognition of subsidiary YTLP's ability to stream up dividends. Since FY02, YTLP's dividends have a net yield of around 6% and the trend is sustainable, given its cashflow stream strengthening after the 2002 Wessex Water acquisition.
Share price catalysts
We expect the next big share price catalyst to come from: 1) the revival of its traditional bread-and-butter construction business -the market perception is that it has lost its touch in the sector but we think otherwise, and believe its orderbook could be three times the market's projection; and 2) securing a slice of the action in the upcoming multi- billion ringgit water privatisation project should boost its share price performance.