Analysts' Recommendation

YTL Corp: Cyclicals kick-start earnings upgrades

ABN AMRO Asia Equity Research, 15 October 2003

YTL Corp
BUY
Target price: RM5.30

Price: RM4.54
Market capitalization: RM6.72b (US$1.77b)
Avg (12 mth) daily volume: RM4.60m (US$1.22m)
Reuters: YTLS.KL
Bloomberg: YTL MK

YTL is at the start of another cyclical earnings cycle. The stock price has not yet favoured this in, as so far the re-rating has been driven purely by YTL Power. We are upgrading our forecasts on the back of property. We expect more to follow. Reiterate BUY.

Upgrading forecasts, but RNAV target price is unchanged
We are upgrading out EPS forecasts by 6.3% for FY04 and 13.5% for FY05 after a review of YTL’s property development projects. We are introducing FY06 estimates to five a 16.2% CAGR earnings profile over the next three years. Our target price for RM5.30 remains unchanged as it is based on a mark-to-market RNAV. There is scope for this RNAV to be raised by 70 sen if YTL’s 2,000-acre landbank is revalued instead of just using the prevailing market price of its listed property unit, YTL Land.

YTL Land a key earnings driver
YTL Land has the potential to be a major property developer in the market. We expect its earnings to surpass Gamuda’s property business from FY04 onwards. We believe there is as much as RM3bn in development projects not factored in by consensus and it could be the underlying reason why our FY05 forecasts are now 18% ahead of market estimates.

YTL Cement and the ERL could also surprise
The fixed-cost nature of the cement business and the Express Rail Link (ERL) to the airport provide extra leverage for further upgrades. YTL Cement has recently taken 100% control of its main cement plant just ahead of a pick-up in volume growth as industry demand from property grows. The ERL on the other hand, has surpassed it breakeven point of 7,000 passengers a day thanks to the pent-up demand in air travel and the success of domestic carrier, Air Asia.

Implied PERs of cyclicals are low
Stripping out the market cap of YTL Power in YTL Corp, the implied PER of YTL’s cyclical business is 15x, which is at the low end of its five-year historic trading range. Given that YTL seems to be entering a new earnings cycle, with a projected 36.5% three-year earnings CAGR in its cyclical business led by property, valuations are ready for the next re-rating.

Cyclicals kick-start earning upgrades

We are upgrading EPS forecasts on reviewing YTL’s property business. More upgrades could come not just from property but from cement and the ERL. Implied PER valuations of cyclicals are near lows despite entering a new cycle.

Table 1: EPS Upgrades

 

FY04

FY05

FY06

New fully diluted EPS

32.3

37.0

42.4

EPS growth

19.6%

14.6%

14.6%

Old fully diluted EPS

30.4

32.6

-

Upgrade

6.3%

13.5%

-

Source: ABN AMRO

Start of earnings upgrades from property

We are upgrading our full-diluted EPS forecasts by 6.3% for FY04 and 13.5% for FY05 and introducing FY06 numbers to illustrate a CAGR profile of 16.2% over the next three years. The upgrades are on the back of a higher-than-expected contribution from property and the corresponding in-house construction work. We were previously unaware that YTL Land, YTL’s listed property unit, had as much as 2,000 acres of landbank and RM3bn in development projects. Most of these projects are concentrated in the high end and the plans are to launch them over the course of the next three to four years. We previously only factored in the 10-year RM7bn Sentul Raya project solely driving YTL’s property earning. The market, we believe, continues to do the same. Our estimates, factoring the other property projects, are now 18% ahead of consensus for FY05.

Consensus is currently expecting a flat EPS growth profile for YTL Corp, reflecting the perennial argument that the company has gone ex-growth. The potential to surprise and re-rate from this misguided perception is therefore strong and we believe it is starting to happen. One of the key arguments for YTL is the pick-up in its cyclicals of property, construction and cement, which should happen simultaneously. We expect their contribution to move from 15% of net profit in FY03 to 40% in FY06.

Our target price remains unchanged at RM5.30, as it is based on the mark-to-market RNAV of the group. Although earnings of YTL Land and its landbank valuation are facing an upward rating, the share price of the listed property unit remains subdued, resulting in the RNAV of YTL Corp staying unchanged. Indeed, if we did revalue the landbank of YTL Land based on the current market price of its 2,000 acres that it owns, we estimate it should be worth around 75 sen per YTL Corp share, a value not reflected in our target price.

YTL Land is a key growth driver

YTL Corp’s property business has been under0rated for some time. Owning large tracts of land in Proton City and Genting Highlands were big surprises to us. Although much of YTL Land’s projects target the high end, this is an area where demand escalates as the economy shifts gear. Over the last three years, we have seen the likes of SIME UEP and IOI Properties benefit from the low-interest-rate environment in the mid-segment landed products. We have not seen the market above the RM500,000 per unit bracket really begin to take-off and YTL is well positioned to capitalise on this.

Other than a potentially robust top line in property, the other highlight is margins. Management’s target of achieving a 50% margin on sales is realistic when we consider that it does not have any holding cost on its landbank. Having an in-house construction arm is another advantage and adds another 10% in the construction margin to be kept within the group. Isolating the profitability of YTL Land, we expect considerable growth in the range of 50-100% a year in our forecast years. The bulk of earning is still coming from the locked-in sales of 730 units so far from the Sentul Raya project and the last phase of Pantai Hillpark inventory, which have both achieved an 80-90% take-up rate. We have also added, based on a 70% take-up rate, 500 units of the Puchong townhouse project, having an impact of FY05 onwards and the Genting Highlands bungalow homes being introduced in FY06.

Based on these assumptions, YTL Land could prove to be one of the bigger property companies in the KLSE, surpassing Sime UEP or matching SP Setia in earnings. As an infrastructure conglomerate, YTL’s property exposure is expected to exceed Gamuda’s, based on our forecasts for both companies. The illustration of leverage from property in the carth above is clearly in YTL’s favour. This reflects that despite YTL and Gamuda’s property divisions both concentrating on the high end, YTL’s cycle is just starting, whereas Gamuda’s seems to be maturing.

YTL Cement and the ERL are other factors to watch

YTL recently bought out one of the two cement plants it does not control by paying RM138m for a 50% stake in Pahang Cement from the Pahang state government. It now has 100% of the 1m-tonne-capacity plant. The acquisition was paid for with new shares of listed YTL Cement issued at a 17% discount to the current share price and the valuation of the plant was at book value. YTL Corp’s stake will fall from 67% to 55% and we have adjusted for this. Our forecast contribution from YTL Cement is flat over the next three years, but we believe the transaction could be very timely.

The cement sector seems poised for a significant pick-up with utilisation rates hovering at around 70-80% over the last three years on the back of pump-priming. However, cement demand has not really felt real growth coming through from the property sector, where cement build concentration is high. Industry volume growth is currently targeted12% for 2004 and with no plans for new industry capacity at all, utilisation rates can easily escalate to effective reach full capacity in the coming months. Meanwhile, the threat of AFTA is no concern as high transportation costs make imports uncompetitive. On the domestic scene, YTL Cement has the added advantage of owning the largest ready-mix business in Malaysia, which allows it to push cement sales to its downstream unit beyond the industry-agreed quota (there is currently a gentleman’s agreement on direct sales allowable according to share of industry capacity).

The best earnings leverage to YTL comes from the Express Rail Link (ERL) to the KL International Airport, where YTL has a 50% stake. A highly fixed-cost business, we estimate the ERL lost to close to RM45m in FY03. However, over the last few months, particularly with the pent-up travel demand post-SARS and the unlocking of a whole new air travel budget segment with Air Asia, the ERL could be making money as early as this year. The break-even point is 7,000 passengers a day and we are forecasting this to be achieved only in FY06.

Valuations of cyclicals are compelling

An unusual occurrence in the share price of YTL Power and YTL Corp is taking place, in that the market cap of YTL Power is now larger than its parent. This is probably reflective of YTL Power’s re-rating from the acquisition of Wessex Water and the generous dividend policy that followed. As a result, if we strip out the market cap of YTL Power in YTL Corp, the implied valuations of the cyclical businesses currently at 14-15x FY03 show that it is significantly undervalued based on its historic multiples of as much as 30x. if investors believe that YTL is poised to move into the next  cyclical cycle, valuations do look compelling.

Analyst:
Lucius Chong
Tel: +603-2165 8608
lucius.chong@my.abnamro.com

 

 

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