INVESTMENT HIGHLIGHTS

• 1HFY17 earnings of RM313m met ours but missed consensus

• Earnings grew sequentially on better performance of multiutilities and lower broadband losses

• Wessex Water impacted by weak GBP but might improve in subsequent quarters given a recovery in the GBP.

• Maintain NEUTRAL at unchanged SOP-derived TP of RM1.40/share

2QFY17 met ours but missed consensus. YTL Power (YTLP) reported 2QFY17 earnings of RM167m, which brought 1HFY17 earnings to RM313m. This is within our estimates but below consensus accounting for 46% and 40% of FY17F respectively. Core earnings were up 51%qoq (+14%yoy) given lower operating cost for the multi-utilities division and lower losses at the broadband division.

Multi-utilities division. Despite the overcapacity in Singapore power generation, earnings improved 69%qoq mainly due to lower interest and operating expense, while revenue also grew by 9%qoq. Rates would have stabilised given that the last major capacity addition was in 1Q16 i.e. Hyflux’s ~400MW Tuaspring plant, but gencos have committed to longterm, take-or-pay piped gas supply from Indonesia and Malaysia up till 2020, which means players are unlikely to adjust generation meaningfully in the near-term to balance supply-demand.

Power Seraya benefits from vesting volumes sold to Singapore Power Services as this is on a cost plus basis, hence guarantees profit margins which is valuable in the current situation. Only the three largest gencos get to contribute to vesting volumes, which accounts for at least 25% of demand in the country. Other than this, Power Seraya is also supported by non-power businesses (accounts for ~4% of revenue) e.g. steam supply which comes at almost no additional cost as this is a by-product of its existing power plants.

Wessex water was impacted by the weaker GBP but performance should improve in subsequent quarters given a recovery in the GBP. As YTLP relies heavily on cash flows from Wessex to pay dividends, the impact from the weaker GBP is likely to be realised in the near-term. YTLP’s domestic power unit has yet to get a PPA renewal as Tenaga is insisting on a new land lease agreement prior to signing the PPA extension. While the EC has issued a directive on Tenaga to remove the condition, Tenaga has applied for a judicial review to quash the directive. The case is still pending. Domestic power registered a RM26m loss in 2QFY17 given the absence of revenue coupled with depreciation and overheads for the plant.

Broadband division reported narrower losses vs. 1QFY17 on the back of a 5%qoq increase in revenue. Subscribers should now be over 600K and we suspect churn has stabilised while new subscribers would have started to generate some revenue by now. To achieve breakeven, YES has a target of 1m subs (which is not too far off from the current base) but target ARPU of RM60 compares to incumbents’ ARPU of just RM41 (Digi) – RM50 (Maxis). YES is however generating ARPU of RM60 and above from corporate clients i.e. YTL Hotel group, but in the long run, will have to rely on the mass consumer segment.

Shortlisted to bid for water desalination plant. YTL Power was recently shortlisted to bid to build and operate Singapore’s 5th water desalination plant. The new plant is expected to be located at Jurong Island under a Design, Build, Own, Operate (DBOO) contract with a capacity of 137,000 cu m/day and is to be completed by 2020. Singapore’s national water agency, the Public Utilities Board (PUB) will be the offtaker under a 25-year concession. Other shortlisted applicants include Keppel Infrastructure, Sembcorp Utilities and Tuas Power. Desalinated water is Singapore’s 4th water source other than water from local catchments, imported water from Johor and NEWater (high-grade reclaimed water). Other water desalination plants that are already operating are the SingSpring plant (130,000 cu m/day) and the Tuaspring plant (318,500 cu m/day) (built and operated by Hyflux). A third plant in Tuas is to be completed this year while the 4th plant in Marina East is expected to be ready by 2020. The 2 operational plants meets up to 25% of Singapore’s current water demand and PUB expects desalinated water to account for 30% by 2060.

Attractive returns, lower risk venture. Hyflux’s Tuaspring plant (commercial operation started in 2013 under a similar DB00 contract) involved a project value of SGD890m, which translates into circa SGD2,794/cu m in capex. Assuming similar cost for the winning bid, the 5th plant (which is much smaller in capacity) might fetch a contract value of around SGD383m (RM1.2b). Hyflux’s Tuaspring plant was previously estimated to generate equity IRR in the low teens over a similar concession period of 25 years, which is considerably attractive relative to Power Seraya’s existing power generation business which is hit by oversupply. A concession and offtake by PUB lowers the project’s risk profile and should be positive for Power Seraya, if successful.

Recommendation. Pending the outcome of the bid for the water plant, we maintain our NEUTRAL call on YTLP at unchanged SOP-derived TP of RM1.40/share. Dividend yields are attractive at 6%-7% (FY17F-18F)

Source: MIDF Research - 24 Feb 2017