Water sector
The federal government on the basis of national interest has agreed to invoke Section 114 of the Water Services Industry Act 2006 (WASIA) to assume control of all water concession companies in Selangor to ensure security and sustainability of water supply in the state as well as Kuala Lumpur and Putrajaya.

The federal government said it did not wish to allow the protracted negotiations between the Selangor government and the water concessionaires, as well as the ongoing water rationing in the state, to affect the people.

The energy, green technology and water minister has been mandated by the Cabinet to decide on the commencement date of the invocation of Section 114.

The minister said the invocation was conditional upon the federal and state governments signing a heads of agreement in respect to the water industry restructuring, financial facilitation and completion of the Langat 2 treatment plant project.

While the news flow is negative for both Gamuda Bhd and Puncak Niaga Holdings Bhd, we note that the current share prices have reflected the expectations that Section 114 will be invoked by the federal government while the concession holders as well as the federal and Selangor governments continue to work on an amicable outcome (in terms of asset pricing).

We opine the concession holders may attempt to challenge the invocation through the court via an injunction. At the same time, we also believe that the water players are willing to migrate the water assets at a fair price. The real risk to the invocation of Section 114 is the potential deterioration of the current retained earnings of the water concessions as the appointed manager of water assets (by the federal government) will have the power to change the current concession agreement (CA) alongside the existing bulk supply rates.

Importantly, all concession holders will lose board representation as the invocation may see a total change in the board of directors (who will be appointed by the federal government, and potentially, the Selangor government).

For Puncak Niaga, we maintain our “add” rating and target price (TP) of RM3.55 per share (RM2.90 per share for its water asset value and 65 sen per share for its oil and gas division, based on 5 times forward earnings). We see limited downside to Puncak Niaga’s current market capitalisation of RM1,203 million and believe that its current share price has already factored in a bear case water asset value of RM2.90, as per the Selangor government’s fifth offer.

As for Gamuda, the invocation of Section 114 of WASIA is the worst possible scenario. The concession holders are all in unfamiliar territory and Gamuda will weigh its options after it is officially informed by the federal government. Other than an injunction, its management is likely to negotiate with the federal government for a fair price for concessionaire Syarikat Pengeluar Air Sungai Selangor Sdn Bhd (Splash, in which Gamuda has a 40% stake) that is closer to the net asset value of RM2.54 billion.

We maintain our “buy” call on Gamuda with an unchanged price target of RM5.60. Key risks to our recommendation for Gamuda include: (i) delays in the implementation of Lines 2 and 3 of the klang-valley mass rapid transit project; (ii) sharp spikes in construction costs; (iii) further government measures sharply cutting property demand; and (iv) low valuation for its concession assets. — Affin Research, April 8

This article first appeared in The Edge Financial Daily, on April 9, 2014.