Posted by dragon328 > 2022-07-18 12:35 | Report Abuse

Observatory, thanks for highlighting the KKR deal in Northumbrian Water. KKR is paying £867m for 25% equity in Northumbrian Water, valueing the latter at £3,468m. I would like to point out that this is the equity value KKR is paying for. The Enterprise Value (EV) for Northumbrian Water would be:
EV = Equity value + Total Borrowings
= £3,468m + £2,962m
= £6,430m
Based on its RCV of £4,196.4m, this deal effectively values Northumbrian at 6,430/4,196.4 = 1.53x RCV
which is within my ballpark valuation of a top grade water company in the UK

Posted by dragon328 > 2022-07-18 12:41 | Report Abuse

It we look at the deal from cashflow perspective, KKR is getting quite a reasonable deal. Northumbrian reported operating cashflows of £239.5m before capex for FY2021.
Hence the equity money it is paying would be getting 239.5/3468 = 6.9% equity cashflow yield which is not bad.
Assuming the capex of £231.5m for FY2021 would have been funded 70% by debt, equity funding of the capex would have been £69.45m reducing equity cashflows to £170.05m or equity cashflow yield of 4.9% which is still decent relative to US short-term borrowing costs of 1.75% currently or US 30-year bond yield of 3.10%

Posted by dragon328 > 2022-07-18 12:45 | Report Abuse

As for returns to Li's CK group, it does look like a lower-than-expected return of 3,468m/2,400m or 44.5% returns in 11 years. I guess it all depends on the valuation Mr. Li or CK group paid for Northumbrian Water back in 2011. It might have paid for it at also 1.5x RCV then so it has only benefitted from the organic growth in RCV of Northumbrian Water in past 11 years.

Posted by dragon328 > 2022-07-18 12:49 | Report Abuse

YTL Power only paid 544m pounds for 100% equity value of Wessex Waters in 2002 or at 16% discount to RCV then. Wessex's RCV has increased by 142% from 1,£1474m in 2022 to £3,566m in 2022.
The discount YTLPower paid in 2002 would make a big difference in determining how much returns it will make from Wessex

Posted by dragon328 > 2022-07-18 12:54 | Report Abuse

If at 1.53x RCV that KKR is paying for Northumbrian Water, Wessex would be valued at 1.53 x £3,566m = £5,456m on Enterprise Value (EV).

Minus off net borrowings of £2,315m, the equity value of Wessex would be £5,456m - £2,315m = £3,141m or RM17.2 billion or RM2.10 per share of YTLPower

Posted by dragon328 > 2022-07-18 12:58 | Report Abuse

At equity value of £3,141m, potential investors in Wessex would be getting cashflow yield of £211.2m / £3,141m = 6.7% which is not too far off from the 6.9% KKR will be getting from Northumbrian Water

Posted by dragon328 > 2022-07-18 13:13 | Report Abuse

Assuming the £246.3m capex was 70% funded by debts, then equity cashflow would be reduced by 73.9m pounds and hence cashflow yield would be £137.3m / £3,141m = 4.4% which would be still higher than US 30-year bond yield of 3.10%

Posted by dragon328 > 2022-07-18 13:15 | Report Abuse

I hope I have not made any fatal mistake in the calculations above. Pls help me to check through the calculations and arguments above.
If the above calculations are right, then the latest KKR deal in Northumbrian Water would simply reinforce my conviction that Wassex Water would be valued at 1.50-1.60x RCV, which means YTLPower is very very much under-valued.

Posted by dragon328 > 2022-07-18 13:19 | Report Abuse

Whether a water asset in the UK should be valued at 1.04 - 1.08x RCV or 1.50-1.60x RCV, it ultimately bores down to how much an investor would get in terms of equity cashflows relative to its borrowing costs.
That is why I always like to check it from cashflow perspective if a deal would make sense.

Posted by dragon328 > 2022-07-18 13:20 | Report Abuse

I am sure Mr. Li or CK group would have evaluated the deal thoroughly and weigh it with any higher return it could get elsewhere, compared to a 4.9% equity return it would get from Northumbrian Water should it continue holding onto it

Posted by dragon328 > 2022-07-18 13:25 | Report Abuse

As water companies in the UK are experiencing high inflation and high capex phase, an investment holding company from Asia (eg. CK group) may find the 4.9% equity return low compared to potential opportunities in Asia or other emerging markets. But for a US or western fund, a 4.9% equity return would be decent compared to its low borrowing costs. Furthermore, KKR is buying into Northumbrian when pounds sterling is trading at decades low compared to US dollars. With its RCV increasing over time, Northumbrian would be worth a lot more few years later when pound sterlings appreciates against the US dollars.

Posted by dragon328 > 2022-07-18 13:27 | Report Abuse

From currently on parity with the USD, if pounds sterling appreciates back 30% to 1.30 against USD, KKR would be getting (4.9% x 4 ) x 1.3 = > 25% returns in 4 years

Posted by observatory > 2022-07-18 21:50 | Report Abuse

@dragon328, the case becomes much clearer now with your explanation. Yes, I overlooked. The RCV multiplier should be in EV rather than MC.

I like the way you check using equity cashflow yield. If I understand correctly, after netting off the equity's share of capex, what remains should be the free cash flow right?

I have a side question. I'm curious about how KKR could justify its investment case.

Based on your calculation, the KKR's equity yield is 4.9%. Presumably most of it will be paid out as dividends. Future capital gain is probably limited, not unless KKR can sell the asset at an even higher multiplier than 1.5X RCV (RCV organic growth is probably in low single digit, in line with CK group's return).

However private equities like KKR usually aim for double digit return. That is after their fat fee! At least this is the expectation of typical PE investors. This is only possible through leverage.

However KKR's borrowing cost will have to higher than 10Y Treasury yield, meaning at least 3%. With 4.9% equity yield for Northumbrian Water, every dollar of debt that KKR takes on can only earns 4.9% - borrowing cost (minimum 3%) = 1+% at best.

Does it mean KKR has to use maybe 7 times, or even up to 10 times leverage in order to achieve a desired double digit return? It looks quite crazy.

Posted by dragon328 > 2022-07-19 09:46 | Report Abuse

It is for sure that KKR will use heavy leverage to buy the 25% equity stake in Northumbrian. For a top class asset like Northumbrian, I think KKR could get 80%-90% debt financing for the stake purchase.
Being a PE investor, KKR obviously is taking advantage of the weak pounds sterling and the still low interest rates in the US to bet on a strong rebound in pounds sterling few years later. As from asset operations wise, I am not sure how much KKR could squeeze out of it besides the expanding RCV. One possibility is that KKR may see lower capex requirement than what Northumbrian has budgeted for the 2021-2025 regulatory period, hence potential higher dividend payouts. Northumbrian gearing is already at 69.8% close to the max 70% allowed, so there is little room for capital management to squeeze out more cash.
I can only think of the above 2 possible reasons. Perhaps KKR saw something we don't.

Posted by dragon328 > 2022-07-19 09:48 | Report Abuse

Perhaps they could find another bigger US or Canadian fund to flip it to at 1.6x RCV few years later?

Posted by dragon328 > 2022-07-19 09:54 | Report Abuse

Yes for regulated assets like Wessex and Northumbrian Water, operating cashflows netted out of equity share of capex for the year will be the equity free cashflows available for dividend distributions. There is a prescribed gearing ratio that these companies need to observe, around 68%-70% as set by some of their bonds or regulator determination.
For budgeted capex of the year, they can borrow money to fund the capex up to the max allowable gearing, the rest to be funded by equity.
As they spend on capex, the PPE increases and hence the allowed amount of debts also increases to maintain the same gearing ratio.
For some companies that have a lower gearing ratio than max permissible of 70%, they can borrow more for capex and hence allow more equity money to be distributed as dividends.

Posted by observatory > 2022-07-19 20:38 | Report Abuse

I wasn't aware that there was a 70% cap on gearing. But it makes sense that regulator doesn't want utilities to take on too much risk.

Compare to Northumbrian, Malaysia utilities' valuation is a lot lower. However foreign shareholding in Tenaga remains low, and even lower if passive funds like Vanguard, State Street and Blackrock are excluded. I've also counted probably just one foreign fund on YTL Power Top 30 shareholding.

Their lower valuations should have adequately compensated for the regulatory risk (Tenaga) and currency risk (Tenaga and YTL Power). But why foreign funds shun these Malaysian utilities while they chase after more expensive assets like Northumbrian or ElectraNet? Are there other risks that are putting them off?

Posted by geary > 2022-07-19 20:40 | Report Abuse

TQ! dragon328 ｡◕‿◕｡

Posted by dragon328 > 2022-07-20 14:15 | Report Abuse

Why foreign funds shun Malaysian utilities? One main reason is currency risk, as US Fed is aggressively raising interest rates while Bank Negara is struggling to catch up to defend ringgit.

UK pounds sterling is at decades low against the US dollar, so it makes UK assets attractive to US funds who may enjoy additional returns from any strengthening of sterling few years later.

Foreign funds who want to invest in Malaysian stocks or bonds need to consider the weakening ringgit. They see another 5% to 10% downside risk of ringgit to the US dollars. Hence they will need to get extra 5% to 10% upside in any Malaysian stock or bond before they will put their money in.

Posted by dragon328 > 2022-07-20 14:18 | Report Abuse

In the case of Electranet sale, it is unique as the buyer who bought over the 33% stake from YTL Power was already a major shareholder in Electranet. The super-annuity fund knows the asset and the regulated business well and being an Australian fund, the buyer would have no currency risk at all. So to them a 2.5% dividend yield at the onset but increasing over years would look attractive to the fund.

Posted by dragon328 > 2022-07-20 14:21 | Report Abuse

As for KKR, the investment in Northumbrian Water will look even more attractive with projected equity cash flows of 4.9% and potential extra gain from strengthening sterling later. And this is a perpetual asset in a AAA rated country with very strong regulatory framework, so there is no regulatory risk nor political risk.

Posted by dragon328 > 2022-07-20 14:27 | Report Abuse

But for Tenaga, the situation is not so rosy. Even though it enjoys monopoly in the electricity transmission and distribution, there is a huge risk associated with its generation segment in terms of fuel cost pass-through. As we know, the residential and commercial electricity tariffs are fixed here, so any fuel cost increase will need to be absorbed by Tenaga first then only it tries to claim back through the fuel cost pass-through mechanism which is to be approved by the government of the day. Given that coal prices and LNG prices have more than doubled since last year, Tenaga is having tough time in passing through the escalated fuel costs. There is no guarantee that it will be always able to claim back fully the extra fuel costs. To foreign investors, this represents a risk too big to take. But local analysts seem to be more comfortable with our government honoring the fuel cost pass-through. I would not take the risk.

Posted by dragon328 > 2022-07-20 14:44 | Report Abuse

In the case of YTLPower, why so little foreign fund has invested into it? The main reason is as I said above the currency risk. Another one is the holding company discount. Foreign funds which buy into an asset always prefer a sizable block of over 20% equity stake so as to be able to equity account for the earnings, eg. KKR for a 25% stake in Northumbrian.

However, YTLPower is tightly held by the Yeoh family and foreign funds know that it will be hard for them to get any sizable block of shares over 5% without going to Yeoh family themself. And to buy a sizable block of shares from Yeoh family would likely fetch a high premium over market price.
Furthermore, any fund that has over 10% stakes in YTLPower may not even get to appoint a director into the board which is tightly held by Yeoh family and allies. Hence the fund buyer would not get any control nor first hand information over the asset they invest in, they can only be a passive investor.

Posted by dragon328 > 2022-07-20 14:47 | Report Abuse

@Obsevatory, if you remember from the Daibochi privatisation saga, funds like Samarang that had a small stake in Daibochi did not have any say in the privatisation attempt by Scientex boss at a low offer price. What the fund could do was to reject the offer. So funds at most just keep a small 5%-6% stake to ride on the long term growth of the company which they have no say.

Posted by dragon328 > 2022-07-20 14:50 | Report Abuse

The depressed share price of YTLPower currently is due to foreign funds pulling out of Bursa in general and also partly due to weak earnings in past few quarters. But things may change for the better when its various assets start to deliver, starting with PowerSeraya and Yes 5G, then the green data centre park venture and hopefully power export to Singapore and Jordan power station commercial operation.

Posted by dragon328 > 2022-07-20 15:06 | Report Abuse

One recent example is the proposed acquisition of Genting Bhd's 53% stake in Genting Singapore by MGM US. Why MGM wanted to acquire the stake in Genting Singapore, and why not buy into the parent Genting Bhd which is trading at a huge discount?

There are a number of reasons:
1) the 53% stake would give MGM a controlling stake in Genting Singapore
2) Singapore dollar is seen to strengthen further and has little risk of devaluation
3) Singapore is stable with little country risk nor regulatory risk

Genting's 53% stake in Genting Singapore is worth more than its entire market capitalisation but to a foreign fund like MGM, the holding company discount means nothing if it cannot get a sizable block in Genting Bhd at such a discount.

Posted by dragon328 > 2022-07-20 15:09 | Report Abuse

The same logic applies to YTLPower-Wessex. YTLPower would be re-rated only if it disposed of an asset and bring back the money or the underlying asset performs well and contributes good dividends.
We can only rely on funds that buy as passive investors like EPF and retailers to push share price of YTLpower up as it starts to deliver stronger earnings and declare higher dividends.

Posted by dick20 > 2022-07-20 21:55 | Report Abuse

dragon328, thanks for the info

Posted by dick20 > 2022-07-20 21:57 | Report Abuse

we will just hold on a while and wait for EPF to buy more

Posted by observatory > 2022-07-20 22:38 | Report Abuse

@dragon328, thank you for sharing your thought. It's very educational.

Your last point is very important. Even EPF is just another passive investor like you and me. We depend on Yeoh family to not only manage the underlying assets well, but also to share the fruits through improved dividends. If they do that, the share price could go higher. If they don't, even EPF could not do much about it.

Because of such consideration, in my view there are two types of valuation. One type of valuation if for controlling shareholders like the Yeoh family. They can value YTL Power value like how KKR values Northumbrian. They can exercise power over the company while others can't.

As minority investors have to ride on the goodwill of controlling shareholders, their valuation have to be conservative. That is probably why YTL Power share price is driven more by the dividend yield (which is tangible to minority shareholders) rather than company's asset values (don't know when they will be unlocked).

But as mentioned before, at current dividend yield the share price should have support. When the Group MD Datuk Yeoh talked to the press about under valuation it also sent a positive signal that they care about the share price (in some companies the controlling shareholders don't). Hope Datuk Yeoh can back up his words with not only good results but also better dividends.

Posted by dragon328 > 2022-07-21 11:39 | Report Abuse

You are welcome, dick20 & Observatory.

As minority shareholders, we can only rely on the controlling shareholder to create more value for the company and declare higher dividends. When they create more value like buy assets cheap and sell it high to unlock value (eg. made a return of 24.8 times from Electranet in 20 years) then distribute more dividends or declare a special dividend. When they do that, all minority shareholders, passive investors like EPF and themself as major shareholders will benefit.
I agree with you that when Dato' Yeoh Seok Hong accepted the interview with media and grumbled about the low share price of YTLPower, he definitely wanted more parties to appreciate the value in the company.

As YTL Corp holds majority in YTLPower and relies a lot on dividend streams from the latter, and Yeoh Tiong Lay & Sons Sdn Bhd gets all cashflows thru dividends from YTL Corp, the family fortune relies very much on continued high dividends from YTL Corp and hence YTL Power.
To me and to them, cash flows of the companies and dividends are more important than share price, but as higher dividends are declared, the share price will move higher naturally. As long as dividend yields exceed 6.0% p.a., it will attract passive investors or funds like EPF to buy and hold.

Posted by geary > 2022-07-22 20:59 | Report Abuse

dragon328.
To me and to them, cash flows of the companies and dividends are more important than share price, but as higher dividends are declared, the share price will move higher naturally. As long as dividend yields exceed 6.0% p.a., it will attract passive investors or funds like EPF to buy and hold.◉‿◉

Posted by Rambutan9 > 2022-07-24 17:42 | Report Abuse

For years, the dividend declared is not impressive, how to expect investors to support this counter?I quit and move to Malakof and the return is better.

Posted by dragon328 > 2022-07-25 12:07 | Report Abuse

Malakoff used to be a good company too, but it has disposed off most of its RE assets in Australia and overseas, left now only with Tanjung Bin Energy which has a finite life of 30 years Power Purchase Agreement (PPA) with Tenaga. It does not seem like any much upside to Malakoff in near term besides the high dividends.
More so to worry about counter-party risk in Malaysia amidst high fuel cost environment.
I would prefer YTL Power that is enjoying strong rebounds in earnings from PowerSeraya, strong forex gains from weakening ringgit, perpetual assets in Wessex and PowerSeraya, promising outlook in its green data centre park, potential huge upside in digital bank venture, and strong rebounds in telecommunication division driven by 5G network, etc.
I am confident the dividend yields from YTLPower will catch up with that of Malakoff from FY2023 onwards.

Posted by Rambutan9 > 2022-07-25 18:03 | Report Abuse

D328,thank you for your opinions,I will relook into this counter again when opportunity knocks but not at the moment.

Posted by Rambutan9 > 2022-07-25 18:50 | Report Abuse

YTL group of companies is different from those days.When timing is right,they will privatize like what they done to YTL cement.

Posted by dragon328 > 2022-07-25 20:42 | Report Abuse

The privatisation of YTL Land and YTL cement was unique in each case, as both counters were illiquid and trading at deep discount to their respective NTA / fair value. The privatisation provided a good chance for the minority shareholders of YTL Land and YTL Cement to exit their position in exchange for the shares of YTL Corp which was far more liquid.
Many minority shareholders of YTL Land or YTL Cement complained of the low privatisation price, but from the other angle, it was not the fault of YTL management. The market ascribed a low value to YTL Land and YTL Cement and YTL Corp could not offer a big premium to market value, but a fair exchange of YTL shares so that minority shareholders could continue to ride on the growth of the company.

Posted by dragon328 > 2022-07-25 20:45 | Report Abuse

To me as a minority shareholder of YTL Corp, it was a good deal for YTL Corp to privatise YTL Land and YTL Cement at a substantial discount to their fair value. The subsequent move by YTL to buy over Lafarge Cement then inject it into MCement was a master stroke that created lots of value for shareholders of YTL Corp.

Posted by observatory > 2022-07-25 23:50 | Report Abuse

@dragon328, since we last spoke about Malayan Cement, the share price has declined by almost 30% from its recent height.
The bulk cement price hit almost RM330 per ton earlier this year before declining a bit. So the company should be be able to pass on most if not all of the rising input costs.
The market probably expects a decline in housing activities (as reflected in property sector share price) and the much talked about infrastructure projects not happening soon. But given the consolidated market, current price probably offer good safety margin for long term holding.

Posted by dragon328 > 2022-07-26 12:17 | Report Abuse

@observatory, I under-estimated the coal cost impact on MCement bottom line for the March 2022 quarter, coal cost & electricity costs should make up 50% of total operating costs instead of 40%.
If what I heard is right, the company should have done some hedging of the coal costs to mitigate further rise of the commodity price. I do hope that we can see much better earnings from MCement in this June quarter result.

Posted by dragon328 > 2022-07-26 15:42 | Report Abuse

Yes coal prices have almost doubled up since early of the year and I believe that has put off investors from MCement. Furthermore MCement reported a below par quarterly result for Mar qtr. I think they had not expected the big jump in coal prices too. Though they raised the selling price of bulk cement to RM270 per tonne in Jan-Mar 2022 but that was not enough to cover the coal cost increase.
I learn that cement prices have been raised further to RM320-330 per tonne since April but it all depends now on how much coal costs they have hedged for and at what coal price level the hedges were, in order to ascertain MCement could make a good profit for June qtr and for subsequent quarters.

Posted by dragon328 > 2022-07-26 17:23 | Report Abuse

I believe when the company prepared this Annual Report in late 2021 or early 2022, coal prices had not increased as much, and so the company did not enter into any hedging for coal costs in 2021.
But after seeing the spikes in coal prices in early 2022 and how it has impacted the bottom line, I think the management should have taken the necessary steps to hedge against further rise in coal prices.
There may be some difficulty in hedging its coal exposure in that the demand for bulk cement is not certain and is mostly covered in short term trades / wholesale volume, so it is hard to estimate the cement production volume for months ahead and hence coal requirements. But it is more likely to estimate the minimum production volume or get a firm / probable orders from customers for 2-3 months ahead, and to enter into hedging contracts to lock in the coal costs for the projected cement production for the 2-3 months ahead.
As the hedges expire in July and the company needs to enter into new hedges, the reference coal prices have increased again and so the hedged price is higher. Therefore, we are likely seeing another round of cement price hikes in coming weeks.

Posted by observatory > 2022-07-26 17:33 | Report Abuse

Refer to Note 36.4.1(c) in the 2021 Annual Report:
"The Group is subject to commodity risk with respect to price fluctuations in coal markets and attempts to limit its exposure to fluctuations in commodity prices by increasing its use of alternative fuels and renewable energies.
From time to time, and if a market exists, the Group hedges its commodity exposures through derivative instruments at the latest when a firm commitment is entered into or known, or where future cash flows are highly probable.
There is no outstanding commodity contract and commodity derivative instruments as at year end, accordingly, the Group is not exposed to commodity price risk."

The statement seems to imply difficulty in hedging its coal exposure. There was no outstanding coal contracts as of 2021 year end. There was also no derivative financial asset in the balance sheet as of Mar 2022.

During 2020-21, bulk cement ASP was in the range of RM200-250 per mT. ASP increased 30% to 65% to RM330. However coking coal price chart showed it had more than quadrupled from below USD100 per mT to above USD400 per mT.

If 50% operating cost consists of coal and energy (can't find the data), you're right it will be a problem, at least temporarily.

Posted by dragon328 > 2022-07-26 20:51 | Report Abuse

You are right, I do not see any derivative financial asset in Mcement balance sheet as of 31 Mar 2022. I think they only entered into hedges from April and these should show up in the 30 Jun 2022 accounts.

In Q3 ended 31 Mar 2022, the revenue was RM795m and cost of sales amounted to RM585m. Assuming 50% of cost of sales was coal cost and coal cost has increased by 53% to USD400/ton in Q4 from USD260/ton in Q3, cost of sales would have increased by RM585m x 50% x 53% = RM155m. The company would need to increase cement selling price by c.20% from RM270/ton to RM330/ton to cover the increase in coal costs, assuming no hedging on coal cost was done. Revenue would have increased by RM795m x 20% = RM159m, just enough to cover the increase in coal cost for Q4.

Posted by dragon328 > 2022-07-26 20:55 | Report Abuse

If the company had entered into financial hedges to cover 80% of the coal cost for Q4 at average hedged price of USD300/ton, then these hedges would have resulted in a derivative gain of RM585m x 50% x 80% x (USD400-300)/300 = RM78 million. These derivative gain would be extra gain if the increase in cement selling price had been sufficient to cover the coal cost increase as calculated above.

Posted by dragon328 > 2022-07-26 20:58 | Report Abuse

The company needs to make a good estimate on the financial hedges required for the months ahead vs projected cement production volume and production schedule and any planned increase in bulk cement prices, so as not to over-hedge at unfavourable high coal prices, otherwise it would result in derivative losses should coal prices fall below the hedged price.

Posted by cwc1981 > 2022-07-27 14:24 | Report Abuse

IPP time

Posted by dragon328 > 2022-07-27 16:59 | Report Abuse

haha it takes a big blackout in several states today to push up YTLPower share by 4%.

Posted by cwc1981 > 2022-07-27 17:11 | Report Abuse

Now ppl know how important is utilities companies

Posted by geary > 2022-07-27 19:57 | Report Abuse

dragon328

haha it takes a big blackout in several states today to push up YTLPower share by 4%.
Fair Value @1.10.◉‿◉