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This article first appeared in The Edge Malaysia Weekly on January 7, 2019 - January 13, 2019

WITH the consolidation of the water industry in Selangor almost complete, the question on investors’ minds is whether it is time to take another look at water infrastructure players that are listed on Bursa Malaysia.

This is because the upgrading of pipelines and other water distribution infrastructure is crucial to ensure water security and sufficiency in the state, which also supplies water to Kuala Lumpur and Putrajaya, the country’s administrative centre.

When asked whether the government would increase spending on water infrastructure, Affin Hwang Capital analyst Loong Chee Wei says he believes so, as not doing so would mean a severe water shortage should there be a drought. “It will be more urgent to upgrade the whole water infrastructure because in Selangor, water reserve margins are almost at zero. If there is a drought, there will be a water shortage.

“They [the government] need to upgrade water infrastructure on the capacity side (water treatment plants) as well as distribution to ensure water supply security in the Klang Valley. Many of our pipes are leaking, with some of them being over a century old.”

Based on analysts’ calls, it seems that many are bullish on the prospects of the water infrastructure players they cover.

Analysts covering Taliworks Corp Bhd, HSS Engineers Bhd and Ranhill Holdings Bhd have only “buy” calls on the counters.

In addition, Gamuda Bhd, KKB Engineering Bhd, Hock Seng Lee Bhd, Engtex Group Bhd, Salcon Bhd and Ranhill Holdings could also be “in play” for the water infrastructure development story.

Each of these companies has at least a 9% potential return over the next 12 months, according to the analysts.

Taliworks is projected to have a potential return of 34.2% over the next 12 months while Ranhill has a potential return of 9.2%, based on last Thursday’s closing prices.

There are two different themes that will drive investments in water distribution infrastructure. The first is the upgrading of ageing water distribution infrastructure in the Klang Valley to reduce non-revenue water (NRW) and increase water reserve margins.

The completion of the acquisition of Syarikat Pengeluar Air Sungai Selangor Sdn Bhd (SPLASH) by Pengurusan Air Selangor Bhd by the end of February will allow investments to be channelled to upgrading water infrastructure in the state.

An Air Selangor spokesman declined to comment how much will be invested to upgrade and maintain water infrastructure assets in the state this year. However, previous reports suggest that Air Selangor will invest almost RM1 billion over the next three years to replace water pipes as part of its efforts to reduce NRW to 28% by 2020 from the current 35.2%.

While Pengurusan Aset Air Bhd (PAAB), a federal government agency, will own the water assets in Selangor, Air Selangor will be the operator of the assets. Air Selangor will inform PAAB how much investment is needed to ensure sufficient water supply in the state.

The Selangor government has allocated RM223.35 million for water supply infrastructure development in its 2019 budget, of which RM130 million will be utilised for the construction of the Labohan Dagang Phase 1 water treatment plant and RM25 million for Labohan Dagang Phase 2 and a detailed study on the development of a water treatment plant in Rasau.

When the Labohan Dagang treatment plant is completed, it will have a capacity to supply up to 400 million litres of water per day (MLD) to the district of Kuala Langat. This is in addition to supply capacity of about 7,000 MLD in the state.

Analysts believe PAAB will be able to raise financing by issuing government-­guaranteed bonds to fund the development of water supply and distribution assets in the country. In March last year, PAAB said that it had the capability to finance up to RM40 billion worth of investments.

However, with a new administration, it is unclear whether the government has the appetite to allow PAAB to issue bonds because of the huge obligations it is already shouldering.

PAAB’s website shows that it has called for bids for three water pipe-laying works in Johor and Selangor. The jobs in Selangor are related to the Langat 2 water treatment plant. The value of the contracts are unknown.

The second theme on water infrastructure development is increasing water supply coverage in rural areas, especially in Kelantan, Sabah and Sarawak, which have the lowest coverage in the country.

As at 2017, Kelantan had the lowest water supply coverage with only 67.7% of households covered, followed by Sabah with 79% and Sarawak with 80.4%, according to the 11th Malaysia Plan Mid-Term Review.

Almost 30% of rural households in Kelantan have opted for alternative water supplies, which include water wells, tube wells and gravity feed systems, according to the report.

Under Budget 2019, RM734 million of federal development expenditure has been allocated for rural water infrastructure. It is believed that PAAB, which also owns water assets in Kelantan, will also invest in developing the state’s water infrastructure.


Sarawak plays

In Sarawak, the state government has tapped its large reserves of about RM30 billion to allocate RM9 billion in development expenditure in its 2019 budget, the highest in the state’s history. Some RM2.8 billion will be used to improve the state’s water grid. However, this allocation is unlikely to be fully spent this year, as often, the actual expenditure is spread over several years.

Nevertheless, companies like KKB Engineering and HSL, which are based in Kuching, are said to be beneficiaries of the drive to improve Sarawak’s water supply infrastructure, especially in rural areas.

An analyst with Hong Leong Investment Bank, Yip Kah Ming, says Sarawak is the place to be for construction players, including water infrastructure contractors, due to its large, self-funded development expenditure.

“Job flows in the peninsula slowed down significantly following the change in federal government. We understand that industry players are aiming for jobs in Sarawak as the state government has allocated about RM9 billion for development expenditure under the state budget 2019,” Yip says in a Dec 28 report on HSL.

As at last Thursday, HSL was traded at 12.8 times its trailing 12-month (T12M) earnings and 8.9 times its estimated earnings per share for its financial year 2020 (FY2020E), which is lower than KKB’s 14.5 times T12M and FY2020 price-earnings ratio.

However, KKB has a strong shareholder in the state government-linked Cahya Mata Sarawak Bhd (CMS), which owns 20.1% of its share base. The Sarawak Economic Development Corporation owns 5.67% of CMS.

CMS’ largest shareholder is Majaharta Sdn Bhd with 12.6% equity interest, followed by the Employees Provident Fund with an 11.12% stake. Majaharta is the vehicle of Jamilah Hamidah Taib and Datuk Hajjah Hanifah Hajar Taib-Alsree, daughters of Sarawak governor Tun Abdul Taib Mahmud.

If the government decides to invest more in water supply and distribution infrastructure, pipemakers such as Engtex and YLI Holdings Bhd could benefit, says Affin Hwang Capital’s Loong, apart from contractors Gamuda, Taliworks, and Salcon.



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