Merrill Lynch: YTL Corp: Things should only get better
Merrill Lynch Comment, 31 August 2001
Reason for report: FY01 Results, Opinion upgraded
By Jason Chong
YTL Corporation Bhd
Long Term BUY
· We are upgrading our intermediate call from a Neutral to an ACCUMULATE because:-
- Potential beneficiary of government’s effort to institute corporate restructuring. Armed with RM3.6bn cash, YTL is set to be a market consolidator, in our opinion.
- Likely beneficiary of the government’s pump priming efforts.
- Visible earnings stream with a conservative 10% p.a. earnings growth over the next 3 years. There could potentially be more upside.
- Valuations are also not demanding, with PEs at an 11% premium to market. We believe this stock deserves a higher premium given: 1) the above factors, 2) proven management track record, 3) earnings are at its cyclical low and appear set to improve going forward; and 4) premiums are close to their historical lows.
· YTL is one of the top 10 component stocks in both the KLCI and MSCI Malaysia index.
· In the meantime, we believe share price will be supported by our RM4.52 assessed RNAV plus RM0.19 in dividends (cash and shares).
As at 30 June 2001, the group had investible cash of RM3.6bn and a net cash position of RM185m.
The bulk of the group’s cash is in YTL Power while YTL Cement and newly acquired Taiping Consolidated are unleveraged (refer to Table 1).
The recent change in government mindset of wanting to institute real corporate restructuring in an open and transparent manner can only augur well for the group in so far as providing investmcnt opportunities, in our opinion.
An area of opportunity for the group is in the cement sector. It has always been YTL’s aspiration to be among the top 3 cement manufacturers in Malaysia. Currently YTL Cement ranks 5th out of the 6 local cement manufacturers in terms of clinker capacity.
Potentially CIMA, a 54% owned subsidiary of UEM could be up for sale if the government’s plans to nationalize and restructure the UEM group come through. If YTL is successful in buying CIMA, it would propel YTL Cement to become the second largest cement manufacturer after Malayan Cement.
With a healthy balance sheet, the power division is poised to grow. The group has recently teamed up with Jimah Power Holdings to jointly develop a RM6bn greenfield 1,400MW coal-fired power plant. The power plant to be located in Negeri Sembilan is earmarked for completion by 2006. We expect YTL to benefit from being one of the main promoters as well as being the operator and contractor. Assuming a 4-year construction period, physical work amounting to aboutRM34bn should commence by 2H 2002.
Based on an 80:20 debt:equity ratio, we estimate YTL Power will have to invest some RM600m in this project.
Management has also announced that it is teaming up Hong Kong’s CLP Holdings to jointly bid for Singapore’s power plants, The Singapore government is looking to sell 3 power stations with a total capacity of 6,721MW (2,860MW PowerSeraya, 2,661MW PowerSenoko and 1,200MW Tuas Power). Details of the asset divestment is still rather sketchy given the authorities are still working on the commercial terms of its new market pool.
Assuming YTL Power invests its entire RM3bn cash pile in new power projects with an estimated shareholder IRR of 12% over a 25-year concession period, the cash would generate returns of RM1.1bn (NPV assuming an 8.6% discount rate). This will add an estimated 46sen to YTL Corp’s RNAV and 50sen to YTL Power.
In April this year, YTL Corp took control of Taiping Consolidated (TC) as a result of the latter’s restructuring exercise. YTL Corp now owns 81.6% of the company. However its stake will be diluted to 55.9% upon full conversion of TC’s RM220m preference shares into new ordinary TC shares at RM3.90/share.
YTL plans to transform TC into the group’s property development arm by injecting its property development assets into the latter. In the process, YTL Corp would unlock some of its property values which have been overlooked by the market.
We estimate the group’s property assets to be worth about RM700m. This excludes the 3 prime properties the company acquired in 1997/98 i.e. Star Hill, JW Marriott Hotel and Lot 10 which was valued at a RM1bn before the financial crisis. Much of the group’s landbank is held through joint ventures with State governments where the latter would provide the land while YTL provides the capital and the expertise.
Having nurtured the group’s various internet initiatives over the last 2 years, management is looking to realize some of its values by listing the company. Both the Securities Commission and the Malaysian Exchange of Securities Dealing and Automated Quotation (MESDAQ) recently approved the IPO.
There will be a restricted issue of 34.0m new YTL e-Solution (YTL-eS) shares to YTL Corp shareholders on the basis of 1 new YTL-eS share for every 5 YTL Corp shares at RM1.10/share. The company will have an enlarged share capital of RM135m.
The "jewel in the crown" is its 80% owned subsidiary, Extiva Communications which is involved in the development and marketing VoIP telephony services and other advance network media appliance s. With a paid-up capital of only RM150,000, the company made profits of RM2.2m in the first year of operations.
Looking forward, the property development division should feature more prominently within the group. Currently the group has 3 projects (2 in the Klang Valley and one in Johor) with potential gross sales value of RM7bn to be developed over 10years. These projects, mostly low/medium cost housing are ready to be launched but have been held back because of the soft property market.
Herein lies the potential in our opinion. With all the groundwork done, the company is ready to take advantage of any upturn in the property market. The benefit will not only come from development profit but also from the construction works.
The 3 main projects are:
- Taiping Consolidated’s 70% stake in Sentul Raya (SR). SR is a joint venture with the national railway company (KTM) to redevelop 230 acres of prime land in the heart of Kuala Lumpur into a mixed property development project.
- Taman Puncak Kinrara, in Puchong, Selangor. A 140-acre mix property development project located next to Bandar Puchong Jaya, an established township developed by IOI Properties.
- Taman Cahaya Masai in Plentong, Johor. This is a joint venture with the Johor State government to develop some 220 acres.
We have not factored in any new property launches in our profit projections. Conservatively, these projects should be able to generate sales of about RM300m p.a. over the next 2 years.
FY01 results ending 30 June was in line with expectations.
Stripping out exceptional, group earnings surged by 53% in FY01 thanks mainly to the recovery in the cement industry. Contributions from YTL Cement tripped from RM20m in FY99 to RM66m in FY01 on the back of higher volume sales (arising from the government’s pump priming efforts) and the full year impact of higher selling prices. The price war (up to 50% discounting) in the cement industry ended in February 2000. Contribution from power also grew by 12% due to the sale of additional electricity to Tenaga from January 2001 (6 months impact).
However headline net profit declined by 17% to RM3 12m given the group enjoyed an exceptional gain of RM187m in FY00 arising from the sale of a 5% stake in YTL Power to CLP.
Looking ahead to FY02E, we expect group EPS to grow by 9% to 24sen. Earnings are expected to be driven by the completion of the Express Rail Link project by April 2002 and sustained earnings from the cement division.
We feel our earnings projections are conservative given they do not include profits from new construction contracts the group is bidding for nor from new property launches. The latter could add about RM30m p.a. to group profit over the next 2 years.
YTL is a potential beneficiary of the government’s pump priming efforts. In 1Q this year, the government came out with a RM3bn supplementary budget to further pump prime the economy. Projects identified for immediate implementation included the single school session programme (RM2 billion), community colleges (RM900 million), a university each in Perlis, Malacca, Pahang and Negri Sembilan (RM1.6 billion), housing for Armed Forces personnel (RM400 million), and subsidies for oil palm and rubber growers (RM600 million). The government has been slow in awarding these new projects and has only disbursed RM750m up to now. The construction of government buildings has been YTL’s bread and butter. YTL has so far benefited from securing some community colleges project worth RM100+m.
Valuation & Recommendation
YTL Corp is a component stock in both the KL Composite Index and the MSCI Malaysia Index. Since the market started to re-rate at the beginning of July, YTL has been a laggard, up 14% vs. 18% for the KLCI.
We are upgrading our intermediate call on the stock from Neutral to an ACCUMULATE because:
Potential beneficiary of government’s efforts to institute corporate restructuring in Malaysia. Armed with RM3.6bn in cash, YTL is set to be a market consolidator, in our opinion.
Also a potential beneficiary of the government’s pump priming efforts. Only 25% of the government’s RM3bn supplementary budget allocated for this year has been disbursed.
Visible earnings stream. We are looking at conservative compounded 10% p.a. earnings growth over the next 3 years based on existing-projects on hand. Earnings are expected to be driven by the construction of the RM6bn Jimah Power Plant. Our projection does not take into account new property launches nor new construction contracts the group may secure.
Valuations are also not demanding with PEs at an 11% premium to the market. We believe this stock deserves a higher premium given:
a) The above factors.
b) Proven management track record.
c) Earnings are at their cyclical low and appear set to improve going forward. We believe there is upside potential to our projections.
d) Current premiums are near their historical lows (excluding financial crisis period in 1997/98). Historically, YTL rolling PE premiums has traded at an average premium of 36% vs. 20% currently.
In the meantime, we believe share price will be supported by our RM4.52 RNAV estimate and RM0.19 in cash and share dividend of RM0.10/share plus one Treasury for every 50 ordinary shares held (worth RM0.09/outstanding YTL share).