Highlights/ Comments

The Water Services Regulation Authority of England and Wales (Ofwat), has released a new guideline for the water industry operating in United Kingdom, limiting the return or WACC for their water assets at 3.85% (a range of 3.09% to 4.61% after taking account of incentives/penalties) over the next 5 years regulatory period (FY15-FY20).

Additionally, extra pressure is envisaged to come from retail competition in the sector in 2017.

However, the proposal is still under development, pending finalization in Jan 2015 by Ofwat.

Following the guideline release, Fitch Rating

agency has revised the UK water sector's Rating

Outlook to Negative from Stable.

For FY10-FY15, Wessex (100% owned subsidiary of YTLP) enjoyed a return of 5.5% based on WACC, which is comparatively higher than the proposed 3.85% benchmark by Ofwat.

With the new policy in place by 2015, Wessex is expected to experience potentially lower returns (margins) due to regulatory constraints as well as higher cost of borrowings (post rating downgrade by Fitch Rating). Furthermore, Wessex will need to ensure improvement in operation efficiencies to enjoy the incentives rate.

Risks

• Appreciation of RM against other foreign currencies.
• Higher fuel cost.
• Regulatory constraints.
• YTLC facing strong competition from existing telcos.

Forecasts

Unchanged at this juncture, pending finalization of the policy by Jan 2015.

Rating

HOLD 

Positives –

• Strong and stable cash flow.
• Large cash piles (RM8.1bn) allowing YTLP to look for more value accretive acquisitions

Negatives –

• The increasing competitive environment for YTLC especially with the implementation of LTE networks.
• High operating cost environment in United Kingdom (inflationary pressure) and Singapore (high fuel cost).
• Expiry of Malaysia PPAs by Sept 2015.

Valuation

Maintained Hold with lower target price of RM1.66 (from RM1.85) as we factor in a 10% holding discount to SOP, for the potential earnings impact toWessex.

Source: Hong Leong Investment Bank Research - 14 Apr 2014