We gather that at least three major positive developments have happened in the sector for the past three months; (i) The Edge Weekly last weekend, quoting an official from SSG, reported that the proposed restructuring of the water industry will take place even without SPLASH, (ii) Puncak (OP; TP: RM4.30) has finally reached an agreement with the Selangor state government (SSG) for the takeover of the former’s concessions assets (i.e. 100%-owned PNSB and 70%- owned SYABAS) at a cash consideration of RM1.56b and (ii) the main package of Langat 2 Water Treatment Plant (WTP) had finally been awarded to the Salcon-MMC-AZRB consortium at a price tag of RM1.0b. Hence, based on these positive developments, we upgrade Water sector’s rating to OVERWEIGHT from NEUTRAL. Our upgrade is premised mainly on the fact that we are finally going to see the Selangor’s water industry consolidation soon. This has led us to return to our initial expectation of special dividends to be distributed to the shareholders once the consolidation goes through. As for SPLASH, we view that there are two likely scenarios namely: (i) either SSG or/and FG will top-up about RM2.0b of the shortfall of its equity value and (ii) SPLASH will continue its operations.

What has happened in 2Q14? Despite being the only water stock in our coverage, Puncak’s earnings came in below expectations (which is understandable due to higher start-up costs in its O&G business), we gather that at least three major positive developments have happened in the sector for the past three months; (i) The Edge Weekly, quoting an official from SSG, reported that the proposed restructuring of water industry will take place even without SPLASH. (ii) Puncak (OP; TP: RM5.10) has finally reached an agreement with SSG for the takeover of the former’s concessions assets (i.e. 100%-owned PNSB and 70%-owned SYABAS) at a cash consideration of RM1.56b and (ii) the main package of the Langat 2 Water Treatment Plant (WTP) had finally been awarded to the Salcon-MMC-AZRB consortium at a price tag of RM993m in April 2014.

The Selangor’s water consolidation will go through first without SPLASH. The Edge Weekly (by quoting officials from SSG) last Saturday reported that the Selangor’s water consolidation will go through without SPLASH. The Edge Weekly quoted the SSG’s officials: “The restructuring can take place without SPLASH – for now. The most important piece of the puzzle is Syabas because it has the records of users’ billings, which are what we really want to get hold of.” We view this positively since after 6 years of deadlock, we are finally going to see the sector consolidating.

Puncak finally reached agreement with SSG. Puncak announced on 10 June 2014 that it has reached an agreement in principle with SSG on the proposed acquisition of 100% equity in PNSB and 70% equity in SYABAS at a price tag of RM1.56b. Other fundamental terms and condition to be fulfilled by SSG are: (i) the proposed take-over of PNSB and SYABAS by SSG shall include the takeover of all assets and liabilities of PNSB in relation to its concession businesses only, (ii) the non-concession-related assets, liabilities and businesses of PNSB shall be returned to Puncak by SSG at no cost, (iii) the takeover is subject to due diligence inquiry being satisfactory to KDEB, Puncak and PAAB, (iv) the proposed takeover of PNSB and SYABAS by SSG is conditional upon the approval of the Puncak’s shareholders that is to be obtained at an EGM which is to be convened in due course. The announcement is consistent with the SSG’s press statement on 10th June 2014 stating that SSG also accepts in principle to takeover the group’s concessions assets and returns its non-concession assets.

Heavily focus on SPLASH. To recap, Sweet Water Alliance Sdn Bhd (30%-owned) and Gamuda (40%-owned) (OP; TP: RM5.50) rejected the SSG’s offer to takeover their concession assets, SPLASH, due to pricing issue. SSG has only offered them 10% of the SPLASH’s book value of RM2.5b. As all three concessionaires had already accepted the takeover offer from SSG, the focus now will be on SPLASH. As the sole distributor of Selangor and Klang Valley’s water has already accepted the takeover offer, it will be easier now for the FG and SSG to just focus on resolving SPLASH’s takeover pricing issues. There are two scenarios that we believe will likely to happen namely: (i) either SSG or/and FG will top up about RM2.0b of the shortfall of its equity value and (ii) SPLASH will continue its operations (which the Bulk Supply Rate (BSR) might be revised subject to further discussion). Either scenario will definitely benefit Gamuda (OP; TP: RM5.50). We have already factored in SPLASH’s book value of RM1.0b (Gamuda’s 40% stake portion) in Gamuda’s SOTP-derived TP.

Special dividends for investors soon? We believe Puncak probably will distribute part of its cash proceeds from the sale of its water concession assets as special dividends. We believe this is to reward its loyal shareholders who are still with Puncak after six years of deadlock. Assuming only 5% of the proceeds would be distributed, we estimate each shareholder will be getting about 19 sen cash per share as dividend. This translates into a decent yield of about c.5% based on current price of RM3.71/share. Meanwhile as for Gamuda, we also believe that if FG or/and SSG top up the RM2.0b to meet the required amount by SPLASH shareholders, including Gamuda, part or bulk of the proceeds will also be distributed to Gamuda’s shareholders.

Langat 2 finally awarded, more to come... In April 2014, Salcon-MMCB-AZSB JV Sdn Bhd, a jointly controlled entity of SALCON (36%), MMC (34%) and AZRB (30%) received the Letter of Acceptance (LOA) issued by Pengurusan Aset Air Berhad for the Phase 1 of Langat 2 Water Treatment Plant project. The project is worth RM993.9m and will take 36 months to complete. We believe that this is only one of many packages of Langat 2. It is widely reported in various news that the total Langat 2 project is worth about RM4.1b. We gather that LRAL2 project is broken into 4 components of LRAL 2 for Phase 1 namely: (i) Water treatment plant capacity of 1,130 MLD (which has already been awarded), (ii) balance tank (2 with a capacity of 80-92 million liters), (iii) Storage tank (5 units with capacities ranging from 23-80 million liters); and (iv) pipeline distribution (68km long with a diameter between 1.2 - 2.7m). Big chunk of the packages will be the pipeline distribution, which we estimate at about RM2.0b and this will definitely benefit the pipe makers including HIAP TECK (NR), ENGTEX (NR), YLI (NR), and JAKS RESOURCES (NR).

Our On Our Radar water-related stocks performed well. Our On our Radar stocks namely Engtex (first published on 12 September 2013) and Salcon (first published on 22 October 2013) went up 61% and 51%, respectively, since our recommendations. This is thanks to the commitment by the federal government in awarding the Langat 2 WTP project coupled with the commitment of SSG on resolving the industry’s consolidation issues

Upgrade to OVERWEIGHT. After a series of positive developments (as mentioned above) in the past three months ago, we upgrade the Water sector’s rating to OVERWEIGHT from NEUTRAL. Our upgrade is premised mainly on the fact that we are finally going to see the Selangor’s water industry consolidation soon. This has led us to return to our initial expectation of special dividends to be distributed to the shareholders once the consolidation goes through. In line with our sector upgrade, we upgrade Puncak’s rating to OUTPERFORM from MARKET PERFORM with higher Target Price (TP) of RM4.30 from previous TP of RM3.19 (see Puncak’s Company Update Report today). We also keep Gamuda’s OUTPERFORM call and TP of RM5.50 unchanged.

Source: Kenanga