YTL Corp: Growth Unwrapped
ECM Libra, 5 May 2004
YTL Corporation Berhad
TARGET PRICE: RM6.50
- Market under-appreciates its non-utility earnings growth
Window to buy asset to raise earnings yield
"Capable & able to acquire"- a plus under current M&A frenzy
Non-utility earnings to grow by 86% in FY05
The market appear to have overlooked this potential 13% boost to FY05 EPS, which is driven by a combination of rapid replenishment of its construction order book, buoyant property demand in the Klang Valley and strong recovery in cement demand.
Window for YTL to acquire assets...
Armed with a war chest of RM6.2bn (USD1.6bn) and an excellent track record in acquisitions, we believe the YTL-led consortium is in a very strong position to pick up more utility assets (e.g. Edison International's assets for sale in Australasia and Europe) at attractive prices. YTL has also been short- listed for acquiring some of Transco's gas networks in the UK.
... which should raise earnings yield and valuation
Assuming an acquisition by YTL Power which raise the return on its RM5bn cash pile by 6-7%, YTL Corp's EPS could be enhanced by as much as 21%. This excludes additional benefits from the appropriate use of gearing, which the YTL Group has demonstrated in previous transactions. The incremental EPS from such additional earnings yield, if valued at a PE of 12.0x, would translate into additional value of RM1.25 or 27%. Moreover, an acquisition is expected to trigger a PE re-rating. YTL Corp is currently trading at the low end of its historical PE band and a 20% discount to the market PE of 15x.
Now is the time to buy
Buying YTL Corp today offer investors the opportunity to ride the upside from such acquisitions with little downside, as YTL Corp's current share price is well supported by its RNAV of RM5.09 and its PE discounts to the market. Given similar PEs we prefer YTL Corp over YTL Power, due to YTL Corp's better stock liquidity, higher beta as well as the exposure to the buoyant domestic economy.
Current M&A frenzy will put YTL in the limelight
Excited by deals such as Sime Darby's bid for Hyundai-Berjaya and the ongoing M&A deals in the banking and plantation sectors, the market will likely accord a premium for cash-rich shrewd potential suitors, especially given YTL's impeccable track record in making sizeable acquisitions.
1. NON-UTILITY EARNINGS TO GROW BY 86% IN FYO5
With YTL Power contributing over 75% of its group pretax profits, it is not surprising that the market may have overlooked this potential 13% boost to FY05 EPS, which is driven by a combination of rapid replenishment of its construction order book, buoyant property demand in the Klang Valley and a strong recovery in cement demand. Pretax contributions from these three divisions are expected to increase from RM161mn in FY04 to RM300mn in FY05. This will raise core EPS by 13% to 43.8 sen in FY05, which will lower core FY05 PER to 10.6x only.
Construction: Syarikat Pembinaan Yeoh Tiong Lay has raised its orderbook from RM150mn at end CY03 to over RM1bn currently. Assuming the additional RM850mn contracts are spread over 2 years and a margin of 10%, the incremental EPS of 2.1 sen is equivalent to a RNAV per share of 25 sen on a PE rating of 12x.
Properties: The group, which has a land bank of 2,000 acres with no holding costs, is expected to benefit from the surge in property demand. Projects in Kuala Lumpur and Puchong are in good demand and especially profitable. The key investment properties (JW Marriott, Starhill and Lot 10) are believed to be yielding 12-16% following recent renovation and upgrades. The group stands to reap substantial gains if it decides to consolidate these properties in property trusts, which are currently yielding around 6%.
Cement Manufacturing & Trading: Riding on the surge in property development and construction activities, this division should do substantially better, especially from the recovery in demand for cement and mixed concrete products as well as selling prices.
2. WINDOW TO ACQUIRE ASSETS AND RAISE EARNINGS YIELD
More intense efforts by global power companies to unload power assets to reduce debts will work to the advantage of the cash-rich YTL Group. It has just been confirmed that the YTL has teamed up with another savvy regional investor to bid for power plants in Australia, Asia and Europe owned by Edison International and valued at US$7bn. Edison is joining its rivals, CMS Energy Corp and EI Paso Corp, in selling overseas power plants to reduce debts.
YTL is also bidding for National Grid Transco's gas distribution assets in the UK and has been short-listed amongst 12 bidders. Press reports in the UK suggested that YTL may be particularly interested in the networks that overlap with existing areas covered by Wessex Water to allow for further operating synergies. Apparently, the regulator is allowing the successful bidders to use more leverage to finance these acquisitions, which will enhance yield further.
The impact of another utility asset acquisition is substantial as the group cash pile of RM6.2bn (inc. YTL Power's RM5bn) is currently generating a yield of only 3%. For instance, by acquiring a power asset with a 10% return, YTL Corp's EPS can be enhanced by 21 % -and that is before the additional benefits from the appropriate use of gearing, which the YTL group has demonstrated in previous transactions.
Applying YTL Corp's FY04 PE rating of 12.0x, the incremental EPS of 10.4 sen would translate into an additional value of RM1.24 or an upside of 27% from current price. This is before taking into account the fact that an attractive acquisition usually triggers a PE re- rating.
The YTL group has an impeccable track record in making sizeable acquisitions as well as funding such acquisitions using appropriate gearing in order to enhance overall equity return. (Note: 78% of total group debts of RM14.2bn are non-recourse project financing. Forex exposures are also minimised by matching debts financing to revenue streams.)
3. REASONS FOR BUYING YTL CORP TODAY
By buying YTL Corp today, investors get to ride the upside from acquisitions or new contracts – but with little downside, as YTL Corp's current share price is well supported by its RNAV of RM5.09 and its PE discounts to the market.
Also, given the latest Sime Darby bid for Hyundai-Berjaya as well as the ongoing M&A deals among banks and plantation companies, YTL Corp will receive investors' attention once again given its huge war chest and impeccable acquisition track record.
Given similar PEs, we prefer YTL Corp over YTL Power today because YTL Corp offers:
a) better stock liquidity, with 1.35mn shares turnover daily vs. YTL Power's 0.63mn; b) higher beta of 1.13 vs. YTL Power's 0.52 (strategic given consensus bullish market outlook);
c) broader exposure to the buoyant domestic economy (properties, cement, retail and tourism).
d) direct exposure to benefits of potential new contracts secured by the Group as the construction division is wholly owned by YTL Corp.
Current valuation of YTL Corp at a FY2004 PE of 12.0x is inexpensive compared to the market average of 15x and its historical average of 19.6x. Furthermore, this valuation assumes no new projects or asset acquisition and is at the lower end of its historical PE band.
Based on current rating of 12x FY04 net EPS and assuming no utility asset acquisition, we expect YTL to trade up to RM5.26, a gain of 13.4% from the current price of RM4.64. A new utility acquisition yielding 10% and priced at 12x PE will raise its valuation to RM6.50 - without use of appropriate gearing to enhance overall equity return and taking into account any role in water supply projects in Malaysia.
RISK & MITIGATING FACTORS
Main income contribution is from YTL Power, which may not be successful in acquiring more utility assets. Increasingly number of regulated assets for sale in Europe and Asia is however positive for a cash rich company like YTL Power
Earnings from YTL Power are subject to regulatory and geopolitical risks. This is mitigated substantially because YTL Power's investments are located in politically stable and developed nations.
Overseas profits of the Group are subject to volatility in exchange rates, which is currently to the Group's advantage. Forex exposure of the Group is mitigated by matching foreign debts with revenue streams.
Property projects are subject to implementation risk as well as cyclical risk of the property industry.
YTL Corp is one of the largest diversified groups listed on the Malaysian Stock Exchange. With a market capitalisation of RM6.8bn, its core business division are as follows:-
High Speed Rail
Hotels & Resorts, and
Four of these divisions are held through listed YTL Power International, YTL Cement, YTL Land & Development and YTL e-Solutions - which together has a combined market capitalisation of over RM8bn.
Utilities (through 60.6%-owned YTL Power): YTL Power owns and manages regulated utilities assets in Malaysia, the UK and Australia with long term concessions:-
as an Independent Power Producer (IPP) with two gas fired combined cycle power plants in Paka and Pasir Gudang with a combined capacity of 1212MW. The concession period is 21 years, expiring on Sept 2015.
100% of Wessex Water, one of the most efficient water and sewerage operators in the UK, serving the south west of England covering an area of 10,000 sq km. The concession is in perpetuity and can only be terminated by the giving of at least 10 years notice
33.5%-owned ElectraNet owns and operates the power transmission grid for the State of South Australia under a 200-year concession.
YTL Corp provides O&M services to YTL Power, for which a management fee is paid.
Cement Manufacturing (through 67.So/o-owned YTL Cement): YTL Cement operates the only cement plant in the East Coast of Peninsular Malaysia. The installed capacity of its state-of-the-art plant is 1.2mn tonnes p.a. YTL Cement also owns two slag cement plants with a capacity of 0.5mn tonnes each in Westport and Pasir Gudang. It is also the largest mixed concrete company in the country with over 70 batching plants and 700 mixers as well as owns stones quarries throughout the Peninsular.
Construction Contracting (through 100%-owned Syarikat Pembinaan Yeoh Tiong Lay): Pembinaan YTL has a strong reputation for constructing buildings (hospitals, office buildings, hotels, schools, etc) and large scale infrastructure projects (power plants, cement plant and rail link) on time and on budget. YTL Power's gas fired power plants were constructed in a record 22 months. This construction arm is aggressively building up its orderbook, which is now over RM1 bn.
Property Development (through 64.4%-owned YTL Land & Development): YTL Land has a landbank of over 2,000 acres with an estimated sales value of RM12bn and no holding costs. Currently, its largest project is the 294 acre Sentul residential and commercial development in Kuala Lumpur. This project is expected to generate a total sales value of RM8bn over the next 7 years. The prime Lot 10 and Starhill shopping complexes are held by YTL Corp.
High Speed Rail (through 50%-owned Express Rail Link): ERL owns and operates the high speed rail link between the center of Kuala Lumpur and the Kuala Lumpur International Airport in Sepang. This service currently transports 3mn to 5mn passengers p.a.
Hotels & Resorts: YTL Corp is also the owner and operator of the following 5-star hotels and resorts:-
JW Marriott Hotel, Kuala Lumpur
Pangkor Laut Resort, and
Tanjong Jara Resort
YTL Corp also owns stakes in the Eastern & Oriental Express train service and the Vistana chain of hotels in Malaysia.
Technology Incubation (through 74.1%-owned Mesdaq-listed YTL e-Solutions): YTL e-Solutions owns, amongst others, stakes in a leading VOIP company, a real estate portal and a multimedia messaging service provider.
Segmentals: The main contributor to group profits is YTL Power through its power generation and water businesses, which together with the O&M fees paid to YTL Corp constitute over 85% of group profits. This is followed by the cement manufacturing and property development divisions, which contributed 5.0% and 4.6% of group profits.
Profitability: YTL Corp has been consistently profitable, recording a compounded annual growth rate in pretax profit of 55% over the last 15 years. The latest 1 HFY2004 results showed a high return on equity of 13.2%. Core earnings per share is expected to increase to 38.8 sen in FY04, giving a PE ratio of 12.0x at current price.
Gearing: Gearing is expectedly high at 2.6X due to the large portfolio of utility assets held by the group, but these comprise mainly of non-recourse project financing. Interest cover is very comfortable at 2.9x.
Cash Reserves: As at 31 December 2003, group cash reserves amounted to RM6.2bn, with RM5bn held at the YTL Power level, RM129mn at YTL Cement and the rest at the holding company.
Dividend: Over the years, dividend payment is consistent and increasing as group profitability rises. Net dividend yield is however 1.16% compared to 4.2% for YTL Power.
Share Repurchase: As at 31 December 2003, a total of 27.22mn shares were repurchased and held as Treasury shares at cost of RM137.96mn, implying an average cost per share of RM5.07. In Jan 2002, 28,425,050 shares valued at RM136.59mn were distribute as share dividend to shareholders on the basis of 1 for 50.
Forecasts: The power generation and water businesses have been consistently contributing over 75% of group profits. However, contributions from the other divisions are expected to grow strongly in the next 24 months. An orderbook of over RM1 bn is expected to boost contributions from the wholly-owned construction division in FY05 and FY06. The property division will see higher profits from buoyant property demand as well as higher yields from its investment properties. Sale of Portland and slag cement will continue to be boosted by higher property and public construction activities. Assuming no utility asset acquisitions, we expect these three divisions to raise group net EPS to 43.8 sen in FY05 and to lower prospective PER to 10.6x.