This article first appeared in The Edge Financial Daily, on June 28, 2016.

YTL Power International Bhd
(June 27, RM1.39)
Maintain add with a lower target price (TP) of RM1.50 from RM1.55: YTL Power International Bhd acquired Wessex Water Services Ltd, a water and sewerage water provider in the UK, in 2002. In financial year ended June 30, 2015 (FY15), Wessex Water contributed 74% of YTL Power’s profit before tax and accounted for 41% of YTL Power’s total assets. Wessex Water became an even more important earnings contributor to YTL power in the current financial year due to the decline in YTL Powerseraya Pte Ltd’s earnings and bigger losses in YTL Power’s mobile broadband division. In the first nine months of FY16, Wessex Water’s earnings made up 82% of YTL Power’s pre-tax profit.

Brexit will have a limited impact on Wessex Water’s operations as it is mainly a localised business that serves south-west England. While the economic impact of Brexit may reverberate for years to come, the UK’s economic climate has limited impact on Wessex Water’s earnings as its business is governed by a regulatory framework that enables it to earn a reasonable return on its capital.

Brexit, however, will affect Wessex Water’s earnings in ringgit terms. Already, the currency market swung wildly last Friday as traders and investors reacted to the exit vote. The movement of the British pound against other currencies may continue to be volatile in the coming weeks and months. We estimate that every 5% depreciation in the pound against the ringgit will reduce our FY16 to FY17 forecast earnings per share by 5%.

YTL Power’s valuation is less sensitive than its earnings to the changes in the ringgit or the pound. We estimate that every 5% depreciation in the pound against the ringgit will reduce our TP by only 2%. This is because while the weaker pound will reduce the ringgit value of Wessex Water’s assets, it will also reduce the ringgit value of Wessex Water’s borrowings and other liabilities denominated in the pound. Although Wessex Water accounts for 41% of YTL Power’s total assets, its net assets make up only 16% of YTL Power’s.

Despite the weaker earnings outlook due to the weaker pound, we continue to like YTL Power for its attractive dividend yield. We believe it still has the ability to generate sufficient free cash flows for dividend payments. Since almost all of its earnings come from its assets in the UK and Singapore, investors are effectively getting above 6% dividend yield from utility assets in these advanced economies. Weaker-than-expected pound and Powerseraya’s earnings are the key downside risks to YTL Power’s valuation. — CIMB Investment Bank, June 26