Kenanga Research & Investment

S P Setia Berhad - RCPS-C to Refinance RCPS-B

Publish date: Thu, 28 Apr 2022, 09:30 AM

SPSETIA has proposed a cash call to raise RM1.035b from RCPS-C issuance with a dividend rate of 5.43% to refinance its existing RCPS-B which has a 5.93% rate. While the group gets to save RM5.0m in dividend distribution/annum, the new RCPS-C would cast a huge overhang for the stock at a lower conversion price level of RM1.39 (tentative) vs RCPS-B’s conversion price of RM3.70. Hence, we are negative on the exercise. Keep UP with lower TP of RM0.95 (from RM1.19).

Proposed RCPS-C. SPSETIA intends to raise RM1.035b (base case scenario) from a proposed redeemable convertible preference share rights issue (known as RCPS-C) at a dividend rate of 5.43% to refinance the previous RCPS-B (5.93%) which they had issued back in Dec-17. At this juncture, only the dividend rate is finalised while the entitlement ratio, issue price and conversion ratio for the RCPS have not been fixed. Nonetheless, in order to raise such quantum, SPSETIA had provided a tentative illustration whereby the (i) entitlement ratio would be 3 RCPS-C for every 10 existing shares held, (ii) RCPS-C issue price would be RM0.85, and (iii) conversion ratio would be 18 RCPS-C in exchange for 11 new shares. Based on these assumptions, the tentative implied conversion price of the RCPS-C is RM1.39 for every new share.

Rationale. As RCPS-B will see a step-up in dividend rate to 6.93% (from 5.93%) after its 5th year of issuance (i.e. after Dec 2022), SPSETIA has decided to refinance it at a lower rate of 5.43%. Despite possibly getting a lower rate from bank borrowings, SPSETIA has opted for RCPS-C for such refinancing as banks have been stringent in lending. Moreover, further bank borrowings would increase their net gearing way above their comfortable net gearing level of 0.6x (4QFY21 net gearing already at 0.67x). Note, RCPS-C is treated as an equity instrument and hence would keep net gearing level low.

Impact. Due to the lower dividend rates, SPSETIA gets to save RM5.0m/annum in preferential dividends post exercise. On the flipside, the RCPS conversion price is brought way lower to RM1.39 vs. RCPS-B’s conversion price of RM3.70. This would mean SPSETIA’s share price would potentially face huge dilution (of c.746m new shares or +18.3% in current share base) should it breach the RM1.39 share price level. Naturally, this would create an overhang for the counter with an invisible ceiling at the RM1.39 level. Thus, we are negative over the entire exercise.

Strong earnings needed to stand up against the dilution effect. In order to overcome such overhang, we believe strong and sustainable earnings trajectory coupled with improving ROE are needed to rerate valuations. Nonetheless, we find such an outlook unlikely based on the current challenging property climate and the group’s historical track record. Looking at its past 6-year historical record (table overleaf), SPSETIA’s borrowing levels has grown from RM5.8b to RM12.6b (excluding RCPSs), and ROE have declined from 8.2% in FY16 to 1.1% as of FY21. Due to the groups’ large borrowings, we feel that SPSETIA is forced to launch products to cover its overheads and repay lenders despite the challenging climate – sacrificing margins and earnings in the process.

Keep FY23E earnings unchanged given the negligible savings of RM5.0m from the exercise. Exercise to be completed end-FY22, hence no impact to FY22E numbers.

Underperform maintained with a lower Target Price of RM0.95 (from RM1.19) based on lowered FY22E PBV of 0.31x (-1SD from 5 year mean) from 0.40x. Should SPSETIA fail to reduce borrowings and improve its fundamentals 5 years from now, RCPS-C would be required to be refinanced and this could potentially bring the conversion price lower – imposing an overhang at an even lower level for the group.

Risks to our call include: (i) higher-than-expected property sales, (ii) margin fluctuations, (iii) changes in real estate policies and lending environment, (iv) cash-calls, and (v) timing of overseas/local billings

Source: Kenanga Research - 28 Apr 2022

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