Last  Friday’s  MAHB  conference  call  shed  some  details  on  ISG’s  cost structure and capex plans. Maintain BUY and DCF-derived MYR8.51 TP. We highlight the downside risk to this TP should a cash call materialise, in which case  we  could see  TP  dropping to MYR7.82.  The bottomline: management foresees more growth opportunities in  the airport  ahead. Funding options for ISG are expected to be finalised by year end. Malaysian Airports (MAHB)  organised a conference call  last Friday  to clarify further its full  acquisition  of Istanbul Sabiha Gokcen Airport (ISG). Below are the key highlights of the conference call: 

Airport tax hike outlook.  We had  factored in an airport tax hike  (on a blended  basis)  of  15%  for  2018.  Management  also  highlighted  of  a possible  increase  once  the  new  third  airport  in  Istanbul,  Turkeycommences operations by  the same year.  We understand  that  this  third airport will have an airport tax of EUR20/pax from the current EUR15/pax chargeable on international departures.

Concession fee. Management guided that the EUR89.3m  utilisation fee consists  of  two  components.  Firstly,  concession  fees  that  will  see  a EUR19m  hike  every five years. The next hike will be  in 2015  and,  as of last  year,  the  amount  paid  was  EUR88m.  Thus,  this  could  see  the payment bumping up to EUR96m next year.  Secondly,  the royalty share on  airport  tax  for  international  passengers,  where  the  Turkish Government  is  entitled  for  the  50%  share  of  EUR3  hike  charged  on international  passengers.  This  amount  reflects  the  airport  tax  hike  on international  departures  implemented  in  2010,  ie  EUR15/pax (EUR12/pax  prior  to  this).  The  ISG  concession  is  up  to  2030,  with  an option to extend by another four years if more investments are poured in.

More  upside  to costs  if borrowings are  successfully  restructured. Management guided that ISG' effective interest costs has been high  at 10%. But,  since acquiring the additional 40% earlier this year from GMRInfrastructure  (GMRI  IN,  NR),  ISG  will  have  stronger  backing  from  the company,  thus  allowing  room  for  lower  financing  rate  negotiations. MAHB guided that this could potentially see interest costs reduced to 6% and  provide  an  annual  savings  by  as  much  as  EUR10m  on  interest costs. We have yet to factor this into our estimates. We are waiting until the borrowings have been successfully restructured. This is also positive, should it materialise,  as the  lower borrowing costs would provide  further upside to our DCF-derived valuation due to the lower WACC.

Minimal  capex  ahead.  ISG  is  not  expected  to  see  substantial  capex  until  its traffic reaches 45m passengers. By then,  the airport will need to refurbish and restore its existing – but unutilised – old terminal. We only expect ISG to hit 45m passengers by 2019. Hence,  any substantial capex will need to kick in by 2018at the latest, assuming a lead time of 1-2 years to have the ol terminal restored and refurbished. The indicative allocation of capex for this terminal is estimated to be at EUR50m-60m.  For  ISG’s  second airport runaway, this capex allocation will be borne by the Turkish Government. We understand that  the tender  for thsis  out,  with  a  potential  award  by  year’s  end.  The  second  airport  runaway  is expected  to  be  completed  by  end-2016,  and  we  forecast  very  minimal maintenance capex. 

Will 100% ownership in ISG pass regulatory approvals?  Management does not  show  any  concerns  over  owning  100%  of  ISG  not  passing  regulatory approvals. This is given Turkey’s liberalised views  on foreign ownership. While we think that owning a majority share is not a concern, as this had been the case when MAHB owned  a 60% stake in ISG,  full ownership  of an airport asset does raise  concerns.  Should  government  approval  not  be  obtained,  MAHB  could possibly forego  exercising its rights of first refusal for the remaining 40% stake that was originally intended to be sold to  TAV Airports (TAV) (TAVHL TI, NR), in our view. This could see the latter becoming a partner in ISG. 

Still assessing its funding options. Management is still deliberating its funding options and  said that  there  was still room for  MAHB  to increase  its  borrowings,which would have the least impact in earnings dilution from the higher interest costs.  The  company  is  currently  in  the  process  of  raising  a  perpetual  sukukamounting to MYR1bn. This sukuk could lower the gearing level, as its perpetual nature is deemed  as  an  equity  injection  vis-à-vis  outright 100% debt. MAHB is expected to announce the optimal funding structure before the end of the year. 

FY14  projected  loss  of  EUR20m.  Management  guided  that  ISG’s  losses  for FY14 could amount to approximately EUR20m, ie  where its current 1H14 losses are  at.  For  FY15,  the  airport  could  possibly  break  even,  with  a  conservative target  of  achieving  profitability  by  FY16.  Our  numbers  estimates  that  ISG  will only be profitable by FY17, with a net profit of EU13m. For FY14/ FY15/ FY16,we estimate a net loss of EUR34m/EUR25m/EUR6m respectively. With margins improvement expected  from  this year onwards  via  economies  of scale achieved on  higher  passenger  numbers,  we  estimate  that  ISG  will  start  recording  a positive  free  cash  flow  to  firm  of  EUR22.8m  by  FY14.  This  is  on  the  back  of higher  EBITDA  of  EUR124.3m  (FY13:  EUR84m).  As  of  1H14,  ISG’s  EBITDA came in at EUR60m. 

Valuation for ISG.  We value ISG at EUR808.8m,  which is 13.5% higher than what MAHB is to pay for the 40% stake from ISG consortium partner Limak. This is premised on a WACC of 10% on its free cash flow to firm. 

BUY  maintained.  We  maintain  our  BUY  call  and  DCF-derived  MYR8.51  TP, which includes a 60% stake on ISG for now. This represents a 27.2% upside. However, we  highlight the downside risk to this  TP  should a cash call becomethe  likely  case  for  the  funding  of  MAHB’s  acquisition  of  the  40%  stake  from Limak. As we highlighted earlier, in a worst case scenario, a rights issue price of MYR5.36 (a 24% discount to the  current share price) could see a 16% increase in share base and decrease our TP to MYR7.82.

Source: RHB