YTL is the only remaining Malaysian infrastructure story
UEM is all but dead, Gamuda is saturated and has deviated into tech
YTL’s peers are falling by the wayside. Regardless of whether investors have faith in the YTL Corp (YTL) story, they cannot ignore that it is now the only real infrastructure story left in Malaysia. Its two biggest competitors are either falling by the wayside or losing focus. UEM, once the darling of all investors, has imploded with debt and from its relationship with Renong. Gamuda, although still a respectable player, is unlikely to take on more work since it is facing a saturation of projects and has chosen instead to diversify into cellular phone battery manufacturing.
It has remained steadfast in corporate governance. YTL’s position of default deserves some recognition because it highlights that throughout the 1997-1999 crisis followed by the temptation of the recovery and the new economy nonsense, the group has remained focused and steadfast in corporate governance (it still has all of its RM4bn in cash). During this period of adversity YTL pursued measured progress, mainly focusing on buying distressed property (the restructuring of Taiping Consolidated) a sector which offers the best opportunities in any recession. As for privatisation, it only concerned itself with rejuvenating the Express Rail Link (ERL) to the airport at the right time and on the right terms. To keep up with the new economy, it did launch an Internet strategy but this was to enhance its existing operations, principally to boost the profile of its property and leisure business where YTL is now almost a Malaysian household name.
Valuations do not fully reflect its virtuous qualities. The market to some extent has differentiated YTL from the vices of its peers but we believe YTL valuations have yet to be fully reflected in the share price in the light of the company’s robust earring, strong corporate governance and management credibility, all well illustrated by the ABN Real Risk Analysis index. We believe YTL should trade closer to the likes of Malayan Cement than be unfairly discredited for being in a disreputable sector. This is its greatest appeal – it offers exposure to all the robust characteristics of Malaysian infrastructure without the ugliness of weak management and the issues of corporate governance.
YTL should benefit from pump priming and a more politically transparent environment
YTL offers all the excitement of infrastructure without the risks. Infrastructure development will arguably be one of the best areas of growth despite the slowing economy. It continues to be the government’s main vehicle in pump priming especially since the country is still short of power, powers, water, schools and hospitals. The sector has received one of the largest allocations of the RM91bn 2001 budget at 5.1% and although details of the eight Malaysia plan have not been released yet, the momentum of spending is expected to continue for some time, especially since many of the projects defined in the seventh Malaysia plan have been deferred or shelved. These deferred privatisation projects and the inability of the concessionaire to carry them out, will offer another avenue of growth by grabbing privatisation market share.
The changing political landscape will be good for its prospects as an efficient player. With its track record and strong balance sheet to secure comfortable and cheap financing, YTL should benefit from this rich top down environment. More importantly we believe the changing political landscape will work in its favour which is ironic since YTL has invariably been accused of thriving on political goodwill. The truth of the matter is that YTL has been largely sidelined by the government since the crisis and that its merits and track record have meant little in the distribution of largesse. Indeed, the abuse of the system has reached such an intensity that not only is the opposition calling for greater transparency and accountability but, more notably, similar calls are coming from within UMNO itself. Igniting the controversy is, of course the recent MAS buy-back and the LRT buyout. However, more indignation has been stirred by the recent award of federal road maintenance contracts or the RM1.2bn National Exhibition and Convention Centre to little known construction units related to certain personalities.
YTL does not abuse its privatisation privilege. The workings of the political system have therefore in reality been a hurdle rather than a boon to YTL’s prospects. We do not have to look too far to illustrate this. Renong’s Kuala Lumpur Light Rail Transit (LRT) system cost RM190m per km to build while YTL is constructing the Express Rail Link to the international airport at RM30m per km. Even taking into account the fact that the LRT has a lot more stations, there still must have been huge inefficient inflationary cost pressures. Costing a total RM6bn, it was not surprising the project was not viable from the beginning and the recent government buyout at the same RM6bn could have easily been avoided if it had been handled more appropriately.
YTL has delivered to shareholders, the government and the country. The big difference here is that if YTL is given a concession, it does not rape the privilege by creaming the construction profits or sub-contract work out for the benefit of privately-held companies. Indeed it structured Malaysia Inc’s first successful privatisation template by negotiating long-term concessions, reinvesting the construction profits into equity, sourcing Ringgit bond-based debt, and defining sustainable cashflows to build a strong balance sheet. This formula will consistently ensure the best deal for shareholders, banks, the government and consumers. For YTL shareholders, turnkey construction profits have always remained within the group, followed by squeezing the best IRR out of the concession when it is completed by keeping the building costs low. The best case in point is the Paka power station which was built in a world record time of 22 months, bringing cashflows in earlier than expected, and as for Tenaga and the country, helping solve the 1992/1993 power shortage crisis as fast as possible. This feat is now being repeated with the ERL which will be completed at the end of this year almost six months ahead of schedule. Not only will this boost earnings for shareholders and bring in earlier than expected operating revenues, it will be appreciated by air passengers who badly need a fast link to the airport.
The eighth Malaysia Plan could offer significant opportunities. Whether YTL curries political favour is not the issue but the fact of the matter is that it truly represents what was supposed to be the success of privatisation in Malaysia which has unfortunately been polluted by the likes of the UEM-Renong, MAS and Bakun episodes. In any job it takes on whether sourced independently or given, whether it is building a power plant or rejuvenating a flagging retail district, it has never failed to deliver for shareholders, the government or the public. Our argument therefore is that as the political environment is forced to become more transparent and the checks and balances of a healthy two-party system emerge, the company that can show the best results should have a better chance to thrive regardless of its political allegiance and which administration is in power. We believe the eighth Malaysia Plan will bring precisely this period of maturity and an opportunity for YTL to move onto its next stage of growth.
Sustained four-year earnings CAGR of 23% – initial target price of RM7.00 per share
Investors do not have to bet on future prospects, just on existing fundamentals. The next level of in YTL’ s evolution may be beckoning but investors do not have to wait to believe in the story before taking a serious look at the company. Without factoring in any future opportunities, the company already has enough on paper to generate momentum for an earnings CAGR of 23% over the next four years which, against a background of a slowing economy, is compelling. The main driver of growth will be the expansion of the non-power businesses after a period of hibernation during the crisis. YTL Power used to represent as much as 80% of net earnings of the group but we expect this to drop to as much 49% by FY03.
Cyclical businesses will drive growth. Initial earnings growth of 19% this year will be driven mainly by the early completion of the ERL project where 75% of the RM2.2bn contract will be booked in as YTL’s portion of turnkey construction revenue between FY99 and FY02. We have assumed that the bulk of the work, around RM1bn will booked in this financial year in 06/01 yielding a 10% margin with RM500m remaining for FY06/02. Once completed, equity accounting for its 40% stake in the ERL may not be as spectacular as the construction profits but earnings contribution will grow strongly starting from RM9m in FY06/02, to as much as RM72m by FY06/05.
YTL Cement to leverage on in-house and external demand. Property and cement will initially play lesser roles to YTL’s growth this year but their performance going forward is promising coming from a low base. YTL Cement will particularly benefit from the multiplier effect of the ERL where in-house demand from construction can represent as much as 70% of its volume sales. However, future growth will come externally where its plants are strategically located near massive infrastructure projects, namely the East Coast Highway. Transport cost is one of the single biggest factors in the supply of cement and YTL Cement, already one of the most efficient producers in the sector will be positioned very competitively,
Property division to book in overwhelming demand of medium cost housing. As for property, the overwhelming take up of its joint-venture medium and low cost residential developments in Puchong, Ipoh and Johore Bahru totalling 2,782 units will continue to be booked in. As for supporting rental income RM77m will come from Bintang Walk which has been transformed into a thriving prime retail district. The ROI of the RM403m investment (including refurbishment costs) is expected to be in the range of 19% given that area is fully occupied and the property was bought for 20% below replacement value.
Sentul Raya project the medium term motivator. After the 19% earnings growth for the overall group this year, the momentum will not only continue but is expected to accelerate. The main driver for the longer-term will be property, where the Sentul Raya project will bring in an estimated RM8bn in sales over the next seven years. The projected sales should be achievable since the commercial segment will be re-designated into more appropriate lower cost products where there is prevailing demand. There should also be little concern on the high-end residential units as they were already taken up when the project was first launched under the previous owner. Confidence in the RM8bn sales figure for Sentul Raya will be significant because the company – Taiping Consolidated (which will be renamed) is debt free and has no land holding cost. YTL can expect gross margins as high as 60% which means that pre-tax profitability in that seven-year period will average RM428m a year – almost as high as the contribution from YTL Power.
In house construction division to benefit from resurging activity throughout the group. It could be argued that this pre-tax contribution will be diluted at the bottom line since all the activity will take place in 51%-owned Taiping Consolidated. However, the significance of Sentul Raya is not just in its individual contribution, but like the ERL, its multiplier effects to the group is expected to be substantial. Construction and cement obviously stand out as prime beneficiaries and we expect a contribution of at least RM3.5bn to the group revenue line spread over the seven years with around RM625m in pre-tax profit.
Non-power valuations should be at a peak not at the trough. Against this backdrop of across-the-board growth are the valuations, which on an historical basis, have rarely been this reasonable. We illustrate this by looking at the trading movement of its non-power multiples, whether it is price-to-book or PER, and we find that is at the low-end of the range. This should not be the case since non-power earnings are all in a period of expansion and valuations should in fact be at a peak of 30X – the level non-power earnings are forecast to grow to. If we value YTL stock according to the future growth of non-power earnings, YTL shares are worth RM7.00 each, which is the basis for our target price. This is backed by the group’s mark-to-market RNAV value of RM6.80 per share.
Confidence in growth reinforced by share buy-backs
Share buy-backs to be returned as special dividends to shareholders. Management is showing unbridled confidence in the group’s growth going forward. Aggressive share buy backs have been carried out in all three listed YTL companies – YTL Corp, YTL Power and YTL Cement. Investors may have an issue with this but we feel they should be even more encouraged by this clear indication that the shares in all three companies are undervalued. The biggest case in point is YTL Cement, which is trading at 4X FY0l earnings. The shares bought and held in treasury are likely to be given out as a special dividend in specie to shareholders along with the usual cash dividend at the end of the year.
Total dividend yield could be 6%. This special dividend is a way to leverage on cash, i.e. by buying the shares at low depressed prices and then giving them out will allow shareholders to realise significant gains when the respective companies achieve their true value or full potential. Looking at the average prices of the buy backs to date, shareholders already stand to make a gain if the shares were dividend out at current market prices. If all the treasury shares were given out and assuming that YTL Corp continues with its 5 sen per share cash dividend, the overall dividend yield is expected to be 6%.