What Happened?

• Malakoff (MLK) proposed a disposal of its entire 50% participating interest in Macarthur Wind Farm (Macarthur) for AUD357mn (RM1.02bn) in cash. The stake will be acquired by AMP Capital Group, with targeted completion by 1Q20.

• The sale price is based on discounted cash flow (DCF) for the remaining years of Macarthur’s offtake contract. Recall that MLK bought its stake from Meridian Energy Ltd. in Jun-13 at book value of AUD130.3mn (RM383mn). The disposal is expected to generate a net gain of estimated RM546mn.

• Up to 59% of sale proceeds will be deposited into a Disposal Proceeds (DP) account (Figure 1). We believe the latter could potentially be used for future investments in power and water projects

• To recap, Macarthur is a 140 X 3MW (total: 420MW) windfarm (capacity factor: circa 34%) located in Victoria, Australia. This facility (start: Jan-13) is currently the largest wind farm in the Southern Hemisphere. Macarthur supplies output of 1,240 GWh p.a. that is sufficient to power 181k average sized homes in Victoria. The facility is currently owned on 50:50 basis between MLK and H.R.L. Morrison Ltd.

• Macarthur has a long-term fixed offtake agreement with AGL Group until 2038 (remaining tenure: 18 years). Under the agreement, revenue payment is guaranteed by AGL and not impacted by plant availability, generation volumes or market risks. In addition, AGL also doubles as plant operator.

• To recap, AGL Group is an integrated energy player (total capacity: 10,413MW) listed on the Australian Stock Exchange (ASX). It is Australia’s largest RE player, which has a leading 20% market share in nationwide generation.

• In FY18, MLK’s stake in Macarthur contributed RM163mn in revenue and RM56.6mn in net profit (net of consolidation adjustment) to the Group’s bottomline. This translates to 2% and 26% of FY18 topline and core net profit respectively

Our Take

• In essence, we are largely positive on this deal, given asset monetization at attractive returns and valuations. Furthermore, there are limited operational synergies with Macarthur as it is solely operated by AGL outside of MLK’s base in Malaysia. Moreover, post disposal, MLK’s balance sheet would be substantially deleveraged to an estimated 1.06x (FY18: 1.5x). Nevertheless, our optimism would be boosted if MLK embarks on capital recycling using the sales proceeds. This would cushion earnings erosion arising from loss of Macarthur’s contribution.

• We view Macarthur’s sale price of AUD1.7mn/MW as fair versus development costs of AUD1.8mn per MW for upcoming large wind farm projects in Australia. The latter comprises: (1) AUD900mn (estimate) Stockyard Hill Wind Farm with capacity of 530MW (target completion: 2020) attached with long term power purchase agreement (PPA) until 2030, and (2) AUD400mn Yandin Wind Farm (PPA: 15 years) with capacity of 214MW (completion: Sept-20).

• On the flipside, based on our estimates, the enterprise and equity value for MLK’s 50% stake in Macarthur amounts to RM1.18bn and RM149mn (3 sen/share) respectively. Therefore, the disposal price of RM1.02bn implies a 14% discount versus our estimate. Key underlying assumptions include: (1) WACC: 8.5%, (2) 10% asset residual value, (3) Macarthur is eligible for RE tax incentives, and (4) no distribution of dividends. Nevertheless, the handsome net disposal gain of RM546mn translates to a 142% simple investment return (average return: 20% p.a.) over 7-years in 2013-19.

• Assuming that this deal materializes in Jan-20, we estimate core net profit erosion of RM37mn/40mn in FY20/FY21 (13% of Group profit). This is underpinned by the following assumptions: (1) the Group does not secure new investment assets, (2) interest savings from settlement of acquisition loan, and (3) interest income from monies in the DP account.

• We believe the Group should ideally plough back sale proceeds into new investments. Furthermore, if the Group secures brownfield assets, this would immediately plug the substantial earnings gap arising from Macarthur’s disposal.

• Recall that management expressed its intentions to expand beyond conventional power generation in Malaysia. We believe this is timely - given that recent MESI 2.0 reforms may lead to major changes in the domestic power industry. The latter will likely lead to generation companies (Gencos) losing out from: (1) freeze in new project tenders – as the next capacity auction will only be launched in end-2023 (delivery: 2029), and (2) a new competitive capacity market theoretically leads to lower tariffs.

• Given the above, the Group is actively evaluating investment opportunities at high growth countries or regions. In particular, management is eyeing international RE opportunities, as well as utility projects in the MENA region and South East Asia. To recap, the Group has been active on the M&A front lately, starting with: (1) acquisition of 94% stake in Alam Flora, and followed by: (2) purchase of an additional 12% stake in Shuaibah Phase 3.

Valuation

• We maintain our earnings forecast and target price (TP) pending completion of this deal. Maintain Buy on MLK with unchanged Sum-of-Parts TP of RM0.93. We expect improved FY19 earnings, underpinned by: 1) reduced logistic costs for coal procurement - following completion of jetty facilities, and 2) recovery of operations at Tg. Bin Energy plant. Additionally, MLK is a leading contender for new domestic Renewable Energy (RE) projects. This includes hydro, large scale solar, biogas and Waste-to-Energy projects etc

Source: TA Research - 30 Oct 2019