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Thursday, April 2, 2009

Water Sector (Neutral)

Pak Lah’s last Cabinet meeting minus tariff hike decision

Malaysia’s Cabinet has requested for more information before announcing any approval for the proposed increase in water rates for Selangor and the Federal Territory, according to the Ministry of Water, Energy and Communications in a report by Bernama. In his last Cabinet meeting yesterday, Datuk Seri Abdullah Badawi told his ministers to back Datuk Seri Najib Razak as the new prime minister but there was no mention of a decision concerning the water tariff hike.

Education Minister Datuk Seri Hishammuddin Hussein, who spoke to the press as he was leaving - after the Cabinet meeting - said Pak Lah's last Cabinet meeting was cordial and civil. Hishammuddin said Pak Lah had spoken of the things close to his heart, including unity, ducation and human development. But no decision had been made about the water tariff hike.

We believe any decision would be made after the April 7 by-elections. Recall, the Federal Government had deferred tariff increase by three months from an earlier dateline of 1 January 2009. This was to facilitate the Selangor state government’s proposal to consolidate all the four
privatised water entities in the state .
More importantly, it was earlier reported that SYABAS would be entitled to compensation amounting to RM38mil/month (or RM456mil/year) if water rates were not to be raised. This follows an earlier decision by the Federal Government in 2006 to honour SYABAS’ first scheduled tariff hike of 15% although it was delayed by up to 10 months (i.e. until October 2006).

Tariffs aside, re-nationalisation of water assets from state water entities has gained traction over
the last three months. This follows Federal Government-backed Pengurusan Asset Air Bhd’s (PAAB) takeover of water assets from the states of Malacca, Negeri Sembilan and Johor. It was reported in the middle of last month that PAAB had engaged in direct negotiations with the four private water entities in Selangor to takeover their water assets. We understand that PAAB has completed an asset verification exercise on water entities in Selangor.

PAAB’s recent takeover of water assets in three states were based on one-time net book value. Nevertheless, we reckon that loss of future concession revenue should be somewhat compensated by recurring cash flows from Operations & Maintenance (O&M) contracts should private water entities in Selangor migrate under the new water framework. In addition, there is a strong likelihood that the water entities may adopt a more generous stance in returning excess
capital to their shareholders as capex needs - to a larger extent - are taken care of by PAAB.
We maintain our NEUTRAL weighting on the sector. Stock-wise, we re-iterate our BUY rating on Puncak Niaga Holdings Bhd (Puncak) to reflect our conviction of a potential takeover of water
assets by PAAB and recurring income streams from O&M contracts as evident from SAJ Holdings Bhd’s recent deal in Johor. Our fair value for Puncak remains unchanged at RM4.05/ share - based on a 10% discount to our break-up value of RM4.50/share. Kumpulan Perangsang
Selangor Bhd (KPS) remains a HOLD with a revised fair value of RM1.50/share - based on a 25% discount to its break-up value of RM2.00/share. Next leg up for KPS will come from any state-led consolidation of Selangor’s water industry and potential O&M contract for Langat 2.

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