This article first appeared in The Edge Financial Daily on October 20, 2017

Mega First Corp Bhd
(Oct 19, RM3.48)
Maintain outperform with an unchanged target price of RM4.48: Mega First Corp Bhd (MFCB) has announced that it had decided not to seek an extension for its Shaoxing power concession in China despite being given the option to extend for another five years.

We are not perturbed by this development as we have already anticipated this happening. Any knee-jerk reaction to the company’s share price yesterday should have been taken as an opportunistic entry into an investment for the long term as we remain positive about its prospects, underpinned by the Don Sahong hydropower project in Laos.

Shaoxing Mega Heat And Power Co Ltd, which was established in the Shaoxing County of Zhejiang Province of China in 1996 with an operating period of 22 years, was 60:40 jointly owned by MFCB’s wholly-owned subsidiary, Mega First Power Industries Sdn Bhd, and a local state-owned company, Qixian Heat & Power Co.

Shaoxing Mega owns a 83mw coal-fired heat and power plant in Qixian Town, Shaoxing City, which generates both heating and electric power. Steam is supplied to the neighbouring factories, while electricity is transmitted and sold to the power bureau through the local grid.

Under the cooperative joint-venture agreement signed between the parties, Shaoxing Mega has the right to operate the power plant until Oct 22, 2017. In 2006, it was given an option to extend the concession until Dec 31, 2022. Under the expiry of the agreement, Mega First Power Industries will be entitled to recover its share of assets other than fixed assets.

Since early 2015, the Shaoxing power plant has experienced heightening pressure due to various external issues beyond the company’s control. The tightening environmental control on industrial zones by the China government had affected steam demand substantially, while the plant also required new investment to improve its equipment before the company was granted the rights to extend the concession.

Management has estimated additional expenditure of about 50 million yuan (RM32 million) by end-2017 in exchange for a further five-year operating period, deeming it not commercially viable given the challenging outlook in addition to stricter control, monitoring and surveillance procedures that have to be put in place, which would contribute to higher operating costs.

MFCB expects to recognise a small gain of RM600,000 as a result of the deconsolidation of Shaoxing Mega and also a reduction of RM62.9 million in net assets (16 sen per share). The non-extension is not subject to the approval of shareholders of the company. For the first half of financial year 2017, the China power plant made up 28% and 18% of the group’s revenue and core earnings respectively.

We think the financial impact will be minimal as the loss of income from the Shaoxing power plant will be mitigated by construction earnings contribution from the Don Sahong hydropower project in Laos. There is no change to our earnings forecasts as we had earlier expected this possibility of the company not to seek an extension. — PublicInvest Research, Oct 19