ECM Libra Avenue, 24 January 2007
YTL Corporation Berhad
Current Price RM 7.40
Target Price RM10.50
An undervalued gem offering 42% upside to RM10.50
Our replacement cost approach values the stock at RM10.57, net of debt and assuming treasuries cancelled and full conversion of warrants.
New dividend policy and ROS to boost yield above 5%
To make shares more yield accretive, YTL Corp intends to bump up its cash dividend payout – from 15% to 45% in future. Additionally, the planned ROS of YTLPI shares at a steep discount should augment its value creation drive for YTLC shareholders. Together, these steps should raise overall cash and noncash yields to 5-6% going forward. Management intends to carry out the ROS exercise of its other subsidiaries for the next 25 years.
Construction to be the next earnings kicker
Whilst YTLPI, via contribution from its IPPs and Wessex Water, will provide earnings sustainability, group profit will receive a boost from the construction division following the rollout of the 9MP. To date, YTLC has already received 2 PFI projects totalling RM2bn in value. Construction profits will get an additional RM2bn boost with the award of the US$3.4bn (RM12bn) bullet train project, which has received strong support from both the Malaysian and Singapore authorities.
Strong financial support from international banks
YTL Corp’s debt currently stands at some RM15bn but almost all of this is project financing and, more importantly, non-recourse. The strong financial support and tie-ups of 4 blue-chip international banks with the group is testament to management’s credibility and capabilities in maintaining high margins for projects that are undertaken. Case in point, the land for “Sentosa Cove” was acquired by the banks whilst YTL would handle construction, management and sales for the project.
Expanding capacity either organically and/or via acquisition
Management stressed that they are always on the lookout for good and profitable assets and businesses at distressed values. Case in point is Wessex Water which was purchased at GBP1.2bn and is now worth GBP1.8bn.
You Read It Right… Undervalued!!
We believe there is immense unlocked values in the assets and businesses of YTL Corporation Berhad. Our indicative figure of RM10.57 is conservative in our opinion, as it has only ascribed value to its listed and notable assets. What have not been factored in are the numerous unlisted assets in the Group, which could potentially increase that amount further.
What we have done is to value the individual assets of three subsidiaries (YTL Power International, YTL Cement YTL Land), and correspondingly accrue it to shareholders of YTL Corporation. Starhill REIT was valued based on its latest Net Asset Value, while the remaining assets were valued at market rates.
As mentioned, our valuation leaves room for further upside as certain unlisted and not-so-notable assets have not been ascribed values. The RM10.57, in fact, is a minimal base valuation for the company.
HOW WILL THE VALUES BE CRYSTALLIZED?
By Continuing To Focus On Their Proven Strategy: Investing In Activities Delivering A Continuous Revenue Stream, And Enhancing Their Values
From the early days of the Paka and Pasir Gudang power plants, the Group has added the Wessex Water concession (purchased at a distressed value of GBP1.2bn and is now worth GBP1.8bn in little more than 2 years), the 200-year Electranet power transmission concession in South Australia and the 30-year Power Purchase Agreement with PT Jawa Power in Indonesia, amongst others.
The Group has always been acquiring cash-flow generating regulated assets and been holders of long term concessions for one major reason – predictable cash flows for the long term. What may seem “boring” is actually a plus point, in our opinion.
These assets are positive cash flow generators, and it only means one thing – positive contribution to the company’s earnings, and shareholders henceforth.
Improving Operational Efficiencies
Operating margins of certain businesses within the group are as high as 44%, and is perhaps unheard of in the industry especially for an entity with regulated assets and construction-derived profits driving its growth. We are not entirely surprised however, as management has also been committed to enhancing values in whatever project it embarks in. The unsparing and continuous use of technological advancements in its businesses have increased productivity (one of the highest in the world today) and correspondingly, profitability. We see this practice continuing.
An example of this is the Express Rail Link which was constructed at a cost of USD9mn (RM35mn) per kilometre, and is the cheapest in the world. Hence, it has been able to offer the cheapest fare per kilometre in the world for fast train travel, benefiting travels by and large. Powered by the same technology, the London Heathrow-Paddington Express Fare charges RM66-RM77 for half the journey.
Embarking On A New Level Of Growth
While cognizant of the stability and strength of its utility-led earnings, the Group is not resting on its laurels and has earmarked the construction division as its earnings growth driver for the intermediate term.
The RM1.6bn worth of projects (a RM600mn transport-related project and RM1bn 3-phase river clearing project) that it has garnered under the PFI scheme rolled-out by the government is testament to this drive. What is perhaps unknown to the community at large is the fact that YTL Corporation are pioneers and experts in the PFI concept, having “partnered” the government in numerous projects since the mid 1980s. With this strength and experience, we are confident that more is to come for the company when more initiatives are announced.
The potential awarding of the RM12bn Bullet Train Project could augment earnings by about RM 2bn over 3 years, a staggering amount by any standards. Our base value for the company could potentially increase to RM11.30.
WELL SUPPORTED BY “BLUE-CHIP” FOREIGN FINANCIAL INSTITUTIONS
Perhaps the greatest testament to the strength and capability of management and the company is the backing of a number of “blue-chip” foreign financial institutions in its USD100mn Sentosa Cove Project whereby the land cost is borne by the banks and construction/project management undertaken by the company. Profits will be split between the parties. Risk and investment cost is greatly minimized, with earnings potentially growing exponentially.
The said financial institutions have also indicated their interest in partnering the company in other projects, “Greenfield” or otherwise. Such tie-ups are to the benefit of both parties, leveraging on each others’ strengths and reputations to create greater value for the shareholders.
VALUE-ACCRETIVE CORPORATE EXERCISES
New Payout To Boost Cash Yields
YTL Corporation plans to start paying out higher dividends, from 15% to 30% and progressively to 45%. This will bring up gross cash yields from the current 1% to about 3%.
Restricted Offer for Sale (ROS) Of Subsidiaries
The group is also looking to doing an ROS of YTL Cement and Starhill REIT at attractive discounts. Management has indicated that shareholders can look forward to an ROS every year, for the next 25 actually. For example, YTL Corporation shareholders were recently rewarded with YTL Power International shares on a 1-for-10 basis at RM1.00 per share (a steep discount to market). YTL Power, incidentally, has indicated that they are keen to maintain a gross dividend per share of 10sen and make the distribution of treasury shares as dividend-in-specie an annual affair.
RISK AND CHALLENGES
Every business, no matter how efficient it is nor how capable management is, faces challenges and risks to the execution of its strategies. YTL Corporation is no different. While we believe in the inherent and intrinsic value of its businesses, we are also not naïve to be waxing lyrical about the merits of the company without stressing certain challenges and obstacles that the company faces in achieving continuous growth.
As mentioned earlier, the company’s acquisition strategy has always been to buy good assets cheaply from distressed companies, a good example being Wessex Water. The biggest challenge now, perhaps, is the dearth of these assets. Private equity firms are now competing for these assets as well, and are bidding up prices.
Nonetheless, we are not duly worried as YTL Corporation has always been rewarded for its patience in its acquisitions and we believe that management will make the right moves at the right time.
The much anticipated roll-out of the Ninth Malaysia Plan has yet to happen, and major projects yet to come by. While the company has managed to garner close to RM2bn worth of projects under the PFI scheme, much more is needed to boost earnings growth of the company. Whether YTL Corporation will be a big beneficiary of the Plan is yet unknown.
We think the company warrants a closer look. While it may seem “expensive” on a PE valuation basis, we feel the premium is warranted. The management style and acquisition strategy of the company is akin to that of Warren Buffet’s, and it has been exhibited in its growth numbers since the early days.
YTL Corporation has transformed itself, in the last 20 years, from a domestic construction-based company to a global company with assets and businesses in diverse industries. It has about 10 million customers globally, and close to 70% of its revenue is derived from offshore operations. Employee productivity is among the highest in the world, while superior civil engineering abilities have enabled it to enjoy higher-than-average margins.
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