-  We upgrade the water sector from NEUTRAL to OVERWEIGHT as progress on the water impasse in Selangor is finally gaining traction in recent weeks after several false starts. Our optimism stems from concerted efforts by various stakeholders to find a resolution – starting from the Selangor government’s RM9.6bil proposed buy-out of the state’s water concessionaires back in February 2013, its fourth and latest offer (See Table 1).

Just over the weekend, The Edge Malaysia reported that Putrajaya has given its reassurance to work together and facilitate the water consolidation process spearheaded by state-backed Kumpulan Darul Ehsan Bhd (KDEB). The flipside to this equation is for the Selangor government to give its blessings and carve out up to 150 acres of land in Serdang for the proposed Perdana University Graduate Medical School (JV with John Hopkins University).

-  More signs of a breakthrough. We see this latest development as the clearest sign yet of a renewed commitment between both the Federal and Selangor governments to resolve several outstanding issues; most notably on the longstanding water saga. To be sure, Selangor Menteri Besar Tan Sri Khalid Ibrahim had reportedly indicated that the Selangor government plans to conclude the water consolidation process by year-end. Furthermore, Khalid said the Selangor government may finally give its blessings for the proposed Langat 2 project if the price is right.

Our recent channel checks with various entities along Selangor’s water supply chain suggest a breakthrough in negotiations - although the final terms remain unclear. In fact, SPLASH and Konsortium Abass had indicated their willingness to accept the February 2013 offer by KDEB, according to The Edge Malaysia report).

And, we see more urgency going forward as the Water Treatment Operators (WTP) are already facing mounting receivables for treated water supplied to SYABAS (estimated at ~RM2bil as at 31 December 2012). On the other hand, we understand that SYABAS is only paying about 42% of their invoiced amounts due to delays in receiving its scheduled water tariff hikes (See Chart 1).

-  Water stocks still primed for a good run. Yes, water-related stocks in Selangor have enjoyed a decent run after the 13th GE on heightened expectations that a deal can be hammered through. Our upgrade is however premised on tangible developments recently towards a firm resolution; most notably, renewed federal-state joint-efforts that would finally unlock the deep embedded value of water concessionaires in Selangor.

Based on our revised estimates, major water-related players in Selangor – i.e. Puncak Niaga Holdings (Puncak), Kumpulan Perangsang Selangor (KPS) and Gamuda (BUY: FV=RM5.38/share) - are trading at average discounts of 17%-61% to their respective NAVs. Moving down the value-chain, Taliworks Corp (Non-Rated; operations & maintenance contractor for SSP1) and JAKS Resources (Non-Rated; sole domestic water engineering specialist capable of delivering large water-diameter pipes on a supply & lay basis) are trading at ~52% and 27% discounts to their respective book values (See Table 2).

-  Upgrade Puncak to BUY. Our revised valuations for the Selangor water concessionaires assume the following key parameters: (i) the KDEB proposal in February 2013 forms the basis of the appraisal process; and (ii) offers are net of debt. Along with our sector upgrade, we lift our rating on Puncak up one notch to a BUY with a higher fair value of RM4.03/share on a lower 40% discount (previously: 50%) to its NAV. This is inclusive of c.RM2bil worth of amount owing by SYABAS for treated water purchases (Puncak’s effective share – c.RM1.4bil).

Interestingly, property developer MKH Bhd announced last week that it had entered into a deal to acquire a 100% stake in Puncak Alam Resources Sdn Bhd (PARSB) for RM31mil in return for exclusive development rights to ~550 acres of land in Kuala Selangor, located just opposite the UiTM Puncak Alam campus. The latter is controlled by Tan Sri Rozali Ismail, who is also the controlling shareholder and Executive Chairman of Puncak.

Watch out for KPS too. We estimate KPS’ break-up value at RM4.23/share; pegging a similar 40% discount to its NAV would value the stock at RM2.54/share. Water assets make up c.90% of Puncak’s NAV, and 69% for KPS. We expect a further narrowing in the NAV discount for water plays, as newsflow on the sector intensifies towards end-3Q13/4Q13.

Source: AmeSecurities