Asia Pacific Equity Research, 25 May 2007
Price Target: M$10.35
3Q07 in line stripping out accounting issues; we raise our PT
3Q07 normalized EPS in line. Reported earnings of M$96MM look alarmingly low. This was due to two factors: i) provisioning for ESOS under IFRS accounting standards; and ii) stripping out minority interest in YTL Power’s (YTLP) capital gain in the sale of YTL Cement (YTLC) ICULS to YTL. YTL cannot recognize YTLP’s M$89MM gain since a subsidiary is selling the ICULs to the parent, yet it has to strip out 40% of the capital gain from its own P&L to account for its MI in YTLP.
The inter-related group transaction of YTLC ICULS emerged because the ICULs were under-subscribed. YTLP decided to “underwrite” the issue because the group recognized the value of the ICULs. The sale of ICULs to YTL is part of the terms of the subscription agreement. Despite the capital gain YTLP is making, YTL is paying a fair price for the ICULs as it allows YTL to increase its stake in YTLC at a deep discount (more than 50% to the current market price).
M$33MM for sub-contractors. Another inter-related party transaction involved M$33MM going into a “money lending” unit. Investors should not be alarmed. This has been a normal course of business for YTL’s construction unit for some time. As a turnkey contractor, YTL provides working capital support to its sub-contractors.
Raising PT from M$9.20 to M$10.35: We reduce the holding company discount to RNAV from 20% to 10%, in line with its infrastructure peers to get our new PT. We believe the re-rating is timely given that the valuations of key subsidiaries have re-rated closer to our fair values. We also expect a very strong 4Q07 as YTL begins to book in profit from the M$600m Batu Caves double-track contract, signaling the start of the next earnings cycle. We are also raising our DPS estimates by 50% as management has guided for a minimum 45% payout going forward. Risk to our PT is execution and cost-push margin pressure, evident in 3Q07.