We reiterate OVERWEIGHT on the Water sector despite the recent dispute between Selangor State Government (SSG) and Federal Government (FG) on some clauses in the master agreement. We gathered that both SSG and FG are still committed to conclude the agreement as soon as possible. More importantly, this is not going to affect PUNCAK’s share purchase agreement (SPA) with SSG to sell its water assets, which have been signed earlier in November 2014. We believe that PUNCAK’s deal will be sealed once the dispute is settled. Hence we reaffirm our view on special dividend payments from PUNCAK (OP; TP: RM3.99) that will be distributed the nearterm. As for SPLASH, we understand that the SSG is still in negotiation with the concessionaire to resolve the pricing issues. We expect a final conclusion in the near-to-medium-term. As for PUNCAK, the company has already agreed to distribute RM1.00/share to the shareholders as special dividends. All in, we advocate investors to accumulate PUNCAK now given that its current price is below SSG’s offer price of RM2.89/share.

SSG and FG returning to the negotiation table after minor dispute... To recap, on 9th March 2014, SSG revoked its water agreement with Putrajaya signed in September last year, claiming that the FG had failed to honour the master agreement. Nonetheless, recent media reported that Selangor MB’s Azmin Ali mentioned that he is willing to finalize the agreement on the water industry restructuring if the FG agreed to the main requirements.

... but nothing to do with PUNCAK deal. We gather that the above issue has nothing to do with the concession holders’ valuations and terms in the SPA that was signed with SSG (through PASB) in November 2014. Hence the PUNCAK’s price tag of RM1.56b to sell its water assets remains intact. Nonetheless, since signing of the Master Agreement has to take place first, PUNCAK announced on 16th March 2014 that it agreed to the 3rd extension of time (EOT) with SSG (through Pengurusan Air Selangor Sdn Bhd (PASB)) to complete the deal to sell its water assets. PASB has given the EOT until 9th April 2015 to fulfill all the conditions precedent set out in the SPA. We admit that there are still risks of further delays in completing the whole deal. Nonetheless, due to the pressure from all stakeholders (i.e. contractors of Langat 2 WTP, concession holders, investors and the public), we do not think the SSG and FG can afford to delay the whole restructuring plan for another year. “Special-D play” still valid for PUNCAK. Due to the fact that the dispute is at FG and SSG level, our initial view on special dividend payout is still valid. Out of RM1.56b cash proceeds that are expected to be received by PUNCAK, RM534.3m will be distributed to shareholders and the remaining RM1.02b will be kept for future investments. The special dividend is equivalent to RM1.00/PUNCAK’s shares (fully diluted). Dividend payment of RM1.00/shares implies a huge 40% yield based on PUNCAK’s current price. Nonetheless, post-special dividend payout (est. 3-6months henceforth), we might consider reviewing our call and valuations with downward bias as we could not ascertain yet the group’s future direction after the sale of its water assets.

SPLASH is still in negotiation with Selangor MB. On the other hand, SPLASH, the only concessionaire that has yet to ink the deal with SSG, is currently in active negotiation to resolve their valuation issues. We expect they will reach the final conclusion soon in the near-to-medium-term. To recap, Sweet Water Alliance Sdn Bhd (30%-owned) and GAMUDA (40%- owned) (MP; TP: RM5.29) rejected the SSG’s offer to take over their concession assets SPLASH due to pricing issue. SSG has only offered them 10% of the SPLASH’s book value of RM2.5b. Note that we have already factored in SPLASH’s book value of RM1.0b (at GAMUDA’s level) in GAMUDA’s SoP-derived TP. For illustration purposes, if GAMUDA is to settle its 40%-owned SPLASH to SSG at 50% below than book value, our SoP will be revised downward to RM5.09 from current TP of RM5.29. To recap, GAMUDA has already made a decision that they will not accept anything lower than book value.

Maintain OVERWEIGHT, accumulate PUNCAK (OP; TP: RM3.99). Hence, all in, we are maintaining our OVERWEIGHT call on the water sector premised mainly on the expectations of special dividend payments from PUNCAK that will be distributed in the near-term. At current price, PUNCAK looks attractive as it is trading at below its offer price of RM2.89/fd shares. We view any share price weaknesses as opportunities for investors to accumulate the stock as investors could enjoy huge yield of 40% as a result of the special dividend of RM1.00/fd share to the shareholders pursuant to the group’s water assets sale.

Risks to our recommendation include: (i) further delay in water restructuring exercise, (ii) absence of special dividends, and (iii) downward revision in the takeover valuation of the water assets.

Source: Kenanga Research - 3 Apr 2015