KEY INVESTMENT HIGHLIGHTS

• Ranhill invited by MoF to conduct due diligence on Indah Water Konsortium for the latter’s proposed disposal  Takeover of IWK by MoF in year 2000 was meant to be followed by eventual divestment and restructuring
• Deal could be structured similar to water services industry i.e. asset light – PAAB as the asset owner and the private sector as operator
• Positive development for Ranhill; BUY maintained at unchanged TP of RM1.25

What’s new? Ranhill has been invited by the Ministry of Finance (MoF) to conduct due diligence on Indah Water Konsortium (IWK) for the proposed disposal of MoF’s interest in IWK.

About IWK. IWK operates and maintains the majority of sewerage assets and services in Peninsular under a centralisation cum privatisation of national sewerage services in 1993. It was originally awarded a 28- year concession in 1994 for the provision of sewerage services in Malaysia, but was taken over by MoF in year 2000 from its previous private owners for RM193m (equity value) given its dire financial state. Based on historical AG report (2011), IWK had accumulated losses of RM888m up till end-2010, while in 2016, it is reported that sewerage industry losses amounted to RM330m, which is partly due to extremely low rates (unchanged in more than 2 decades) and to a certain extent, poor collection. The Government has been reported to inject ~RM150mRM200m annually into IWK’s operations.

Some context on the takeover. The takeover of IWK by MoF in year 2000 was meant to be an interim measure and was to be followed by divestment or restructuring in privatisation arrangements to enable the Government to own the capital assets, while the private sector remains as operator of the services. Under WSIA 2006 (Water Services Industry Act), one of the key push for the water services industry is to incorporate joint billing of water and sewerage services, which in turn is expected to pave the way for integration of water supply and sewerage services.

How the proposal could be structured? We think the idea is to replicate the water services industry’s asset light structure whereby PAAB takes over IWK’s sewerage assets while the operator (in this case, Ranhill) in return will lease these assets and earn a regulated profit margin against revenues that are collected (basically, a cost-plus model for the operator). Both IWK (owner & operator of national sewerage asset) and PAAB (owner of national water asset) are currently 100%- owned by the MoF. A certain tariff revision is also likely to be proposed given sewerage rates have remained unchanged since 1997. While it is still early days, this is broadly a positive development for Ranhill in its effort to expand into sewerage operations, which is a natural extension to its existing water supply business.

Recommendation. Maintain BUY on Ranhill at unchanged SOP-derived TP of RM1.25. Potential catalysts: (1) Expansion into Indonesia source-to-tap water supply (2) Potential extension of RP1 concession (3) Scheduled rate hike/lease re-negotiation for Johor water operations. (4) Expansion into sewerage operations.

Source: MIDF Research - 2 Dec 2020