The proposed acquisition of Alam Flora is mildly despite the RPT nature, given: a) fair acquisition at 8.5x PE; b) potential earnings uplift of 5%; and c) importantly, anchors future waste-to-energy power projects for Malakoff. Alam Flora adds 5% to our SOTP valuation. Management maintains 70% dividend payout ratio. As share price has rallied 18%, we downgrade the stock to HOLD. Target price: RM1.05. Entry price: RM0.90.

WHAT’S NEW

• Proposed acquisition of Alam Flora at 8.5x PE is fair…Malakoff proposed to acquire 97.37% of waste management concessionaire Alam Flora (concession ends in 2033) from DRB Hicom for RM944.6m cash. Stripping out Alam Flora’s net cash of RM320m, the purchase consideration of 8.5x (net profit estimated at RM74m) is deemed fair. The balance 2.6% stake is owned by the Pahang state government. The acquisition is expected to be completed by 1Q19. Given that Malakoff had gross cash of RM5b as at Mar 18, the proposed acquisition may be internally funded.
• ... albeit the transaction being a related party transaction (RPT). We acknowledge that the proposed acquisition is a related party transaction (Tan Sri Dato’ Syed Mokhtar is an indirect major shareholder in both companies) and DRB Hicom’s original cost was only RM93m, dating back to 1996. On a brighter note, we note that: a) the acquisition price is fair; b) earnings uplift is about 5%; and c) importantly, the acquisition opens up opportunity for Malakoff to enter the waste-to-energy (WTE) power plant business in Peninsular Malaysia. This is in line with the government’s aspiration to increase renewable energy generation from 2% to 20% (that is approximately 4,000MW) by 2025.

STOCK IMPACT

• Positive as the acquisition is earnings accretive (acquisition PE is lower than Malakoff’s PE). Based on the acquisition PE of 8.5x, the earnings yield from Alam Flora is 12% (inverse to PE). This exceeds the company’s interest income rate (cash yield) of 4%. As such, the acquisition is earnings accretive. We estimate a 5% uplift to Malakoff’s 2018 net profit (see assumption and calculation overleaf).
• Acquisition will lift our SOTP-based target price to RM1.10. In tandem with the potential earnings uplift, our SOTP-based target price will increase by 5% to RM1.10/share upon the completion of the acquisition.
• Stock offers net dividend yield of 5%. Management reiterates its commitment to maintain at least a 70% dividend payout ratio of net profit. We also believe the successful acquisition of Alam Flora could provide dividend upside as the business is asset-light and highly cash generative.
• Rationale for the acquisition. The proposed acquisition requires the approval of shareholders and MMC will abstain from voting. Importantly, management believes the acquisition will pave the way for Malakoff to venture into renewable energy power project while enjoying a stable high cash-generative concession business (in waste disposal and waste management concession for Kuala Lumpur, Putrajaya and Pahang).

EARNINGS REVISION/RISK

• No change to our earnings estimates at this juncture.
• We project 2018 and 2019 net profit of RM256m and RM314m respectively. We are penciling in “normalised” capacity payment of RM600m for TBE for 2019 – following our recent meeting with the company which is confident that TBE’s unplanned outage rate (UOR) will reach 6% by end-18. We note that while the 2Q18 TBE’s UOR is likely in the double-digit region, the UOR is trending down and will be able to meet the 6% UOR threshold set out in TBE’s power purchase agreement (PPA) by this year-end. To recap, 1Q18 UOR was 15% and this resulted in a 17% yoy drop in TBE’s quarterly capacity payment to RM124m. The run rate for TBE is approximately RM600m.
• Sequentially stronger associate earnings expected. We expect associate earnings to normalise into 2Q18. Note that associate earnings fell 52% yoy due largely to a one-off RM12m higher tax expense recorded at the Shuaibah water treatment plant. Stripping this out, Shuaibah would have contributed a net profit of RM9m to 1Q18 associate earnings.

VALUATION/RECOMMENDATION

• Downgrade to HOLD following an 18% share price rally in the past month, which we believe has largely priced in the upside from the acquisition of Alam Flora. Our SOTP-based target price of RM1.05 remains unchanged. The successful completion of Alam Flora acquisition will add a further 5% to our target price. Entry price is RM0.90.
• At our target price, the stock trades at 16.8x 2019F PE and 7.3x EV/EBITDA. The 3,000MW coal-fired power plant in Tanjung Bin accounts for 60% of our RM5.3b SOTP valuation. Key re-rating catalysts include: a) brownfield power plant acquisition; and b) greenfield power plant awards in Malaysia, Southeast Asia and the Middle East.
• The stock offers modestly attractively net dividend yields of 5% and 6% for 2018 and 2019 respectively.

Source: UOB Kay Hian Research - 2 Aug 2018