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This article first appeared in The Edge Financial Daily on November 12, 2018

Ranhill Holdings Bhd
(Nov 9, RM1.07)
Maintain buy with a higher target price (TP) of RM1.30:
Ranhill Holdings Bhd, via 80%-owned Ranhill SAJ Sdn Bhd (SAJ), has finalised the joint-billing deal with Indah Water Konsortium Sdn Bhd (IWK) to implement a single bill system for water and sewerage services in Johor (excluding Pasir Gudang and Johor Baru, managed by the city council).

 

We expect the joint billing to commence early financial year  2019 (FY19) as we understand the water, land and natural resources minister intends to implement joint billing in Johor together with Melaka and Negeri Sembilan. The move should improve IWK’s collection given the possibility of imposing action against defaulting consumers and on the back of SAJ’s sterling 99.4% collection rate.

We estimate the joint-billing programme to enhance Ranhill’s revenue by around RM1.8 million per annum and net earnings by around RM1 million per annum, or 1.3% against our previous forecast, on conservative estimates. SAJ is understood to have spent around RM1.2 million on capital expenditure to improve back-room operations for the joint billing to proceed.

Most importantly, the joint billing paves the way for a complete integration of water supply and sewerage operations, which has been the aspiration of the Water Services Industry Act 2006. A switch to a volumetric tariff could bring in incremental RM300 million to RM400 million revenue and boost Ranhill’s earnings by 30% to 40%.

Integration is likely to involve a switch to a volumetric tariff (as current tariffs are too low and have not been revised for over two decades); there could be contemplation on whether to integrate sewerage operations with state operators first or to switch to a volumetric tariff prior to that. We think the water-sewerage integration could be done in phases based on the readiness of state operators, of which SAJ is one of the most profitable in the country. This could be part of the upcoming National Sewerage Plan announced in the Mid-Term Review of the 11th Malaysia Plan, 2016-2020 recently.

We raise our TP to RM1.30 (from RM1.15) as we factor in incremental earnings from the joint-billing programme and we reduce the discount to sum-of-parts to 10% from 20% previously. At just 10.5 times FY19 forecast price-to-earnings ratio (PER), Ranhill is deeply undervalued. At current market capitalisation, implied valuation for its water business is a mere nine times, below Penang-based peer PBA Holdings Bhd’s 10 times PER and the broader utilities sector’s average PER of 11 times. The balance sheet has been successfully de-geared since its 2016 initial public offering, while attractive dividend yields cushion downside. Key catalysts include: i) scheduled rate hike for Johor water; ii) Tawau Green Energy Sdn Bhd progress into production well drilling; and iii) Johor water-sewerage integration. — MIDF Research, Nov 9

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