This article first appeared in The Edge Financial Daily on July 19, 2018 - July 25, 2018

YTL Power International Bhd
(July 18, RM1.23)
Maintain buy with a higher target price (TP) of RM1.35: Our TP reflects the discounted cash flow (DCF) valuation of YTL Power International Bhd’s upcoming plants, for example in Tanjung Jati, Indonesia, and the Attarat Power Plant, Jordan. The Tanjung Jati plant has secured a power purchase agreement (PPA) from the Indonesian government, but financing details are not disclosed yet. Still, we are confident that it will secure financing this year, since PPA terms have been agreed upon. We have also trimmed our financial year 2019 (FY19) and FY20 earnings forecasts by 2% to 8% after imputing a lower Paka power plant contribution, as it is on an extended contract. YTL Power still has a sturdy earnings base despite recent headwinds from the downward revision of Paka power plant rates. However, the full potential of its upcoming power assets — which we believe are highly likely to commence operations — has not been priced in.

YTL Power’s fourth quarter of FY18 (4QFY18) financial results, scheduled to be announced next month, should not bring any major surprises — assuming that all power assets are operating at full capacity. Wessex Water, its UK asset, should continue maintaining its pricing mechanism, where prices are linked to the Retail Price Index (RPI). Its Paka power plant is already in its three-year-and-10-month extension, with revised down capacity payments that have been booked since 2QFY18. Therefore, we believe the company should maintain its earnings base in the upcoming quarter and more — until its 45%-owned Jordan plant kicks off operations in 2020. Operating margins of PowerSeraya (Singapore) are expected to remain subdued due to a generation capacity oversupply in the wholesale electricity market.

YTL Power has yet to cross a major hurdle in its 80%-owned Tanjung Jati project, with financial closing yet to be completed after having finalised its PPA with Indonesian regulators in July. It is a 1,320mw coal-fired power plant, scheduled for commercial operation in 2021, coupled with a 30-year PPA. Total investment cost is estimated at US$2.7 billion (RM11 billion), with an indicative internal rate of return (IRR) of 12% to 13%. We have included its DCF value in our valuation of the company. Its DCF value of 42 sen per share is premised on: i) a 10% weighted average cost of capital (WACC); ii) a 30-year concession period starting from 2022; iii) a project IRR of 12.2%; and iv) an 85% earnings before interest, taxes, depreciation and amortisation margin.

Meanwhile, the Attarat Power Plant in Jordan has got financing from China Export & Credit Insurance Corp worth US$1.6 billion. This power plant is fuelled by shale oil, and YTL Power has other working partners (Guangdong Yudean Group Co Ltd and Eesti Energia AS) — which should dilute the project’s risks. Our valuation reflects an 11% WACC, pegged at 20:80 equity, as well as a debt ratio with an implied project IRR of 9.5% (significantly lower than typical power projects which yield 12% to 13%) to account for higher project and country risks. As a result, we arrived at a DCF value of four sen per share.

We cut our earnings forecasts to account for slightly lower tariffs from the Paka power plant, which is already running on an extended contract. We have also included DCF valuations of the Tanjung Jati and Attarat power plants, but decreased our DCF valuation of Wessex Water, as we believe a water tariff increase (now pegged at the UK’s retail price index RPI) could be pegged at the Consumer Price Index instead, which is usually lower than the RPI. Post-adjustments, we have arrived at a new sum-of-parts-driven TP of RM1.35 and keep our “buy” call. We believe YTL Power still has a solid earnings base despite recent headwinds caused by a downward revision of Paka power plant rates. On top of that, the full potential of its upcoming power assets — which we believe are highly likely to move ahead — has not been priced in.

Risks to our call include delays in the Tanjung Jati financial closure and government-related risks affecting its Jordan power plant. — RHB Research Institute, July 18