We reiterate OVERWEIGHT on the Water sector on expectations that the Selangor water restructuring would be concluded soon. This is after both the Selangor State and Federal Governments have already met and discussed to resolve the outstanding issues in the Master Water Agreement. Hence we reaffirm our view on special dividend payments from PUNCAK (OP; TP: RM3.99) that will be distributed the near-term. 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 to sign the supplemental agreement to resolve outstanding issues. Media reported a few days ago that the Selangor State and Federal Government (FG) have met and discussed to resolve the water issues. There is a supplemental agreement which addresses all the outstanding issues in the Master Water Agreement. Once this supplemental agreement is signed with both governments committed, we understand the entire water master agreement will be concluded. To recap, on 9th March 2015, SSG revoked its water agreement with Putrajaya signed in September last year, claiming that the FG had failed to honour the master agreement.

“Special-D play” still valid for PUNCAK. Hence, since both governments are committed to close the deal, our initial view on special dividend payout is still valid. Out of the 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/share implies a huge 40% yield based on PUNCAK’s current price. Nonetheless, post-special dividend payout (est. 3-6 months 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 who 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: RM5.05) 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 book value, our SoP will be revised downward to RM4.84 from current TP of RM5.05. 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, 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 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 a 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.

Downstream water players could be in the limelight after restructuring? Once the state’s water restructuring is completed, we will be re-visiting the downstream players such as HIAPTEK (NR), ENGTEX (NR), YLI (NR), GKENT, and JAKS (NR). These players should benefit from: (i) potential RM2.0b pipeline distribution for Langat 2 (to be awarded/supplied after the treatment plant reach certain substantial completion stage, and (ii) NRW reduction program.

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 - 2 July - 2015