Keppel Telecommunications & Transportation (KPTT SP) - UOB Kay Hian 2017-09-08: Supercharging Growth Will Lead To Short-term Uncertainties

Keppel Telecommunications & Transportation (KPTT SP) - UOB Kay Hian 2017-09-08: Supercharging Growth Will Lead To Short-term Uncertainties KEPPEL TELE & TRAN K11.SI

Keppel Telecommunications & Transportation (KPTT SP) - Supercharging Growth Will Lead To Short-term Uncertainties

  • KTT’s chosen datacentre (DC) development strategy will bring about faster DC development and related benefits, but create greater uncertainty in the short term. 
  • Nonetheless, datacentre demand remains strong and KTT, through Alpha DC Fund (ADCF), is primed to reap fee income from this trend. 
  • The challenging outlook for the logistics business is expected to persist until its transformation is complete. We opt for more conservative assumptions and lower 2017-19 earnings forecasts by 24-32%. 
  • Maintain BUY with a revised target price of S$1.90.



WHAT’S NEW

  • We caught up with Keppel Telecommunications & Transportation’s (KTT) management to get an update on the business post its 2Q17 results.

Datacentre fundamentals remain intact; one mega project believed to be in the w'orks. 

  • From our discussion, the fundamentals underlying the datacentre (DC) business remain intact. Demand for cloud-enabled DCs remains robust, with players demanding larger critical capacities and higher power densities. 
  • We believe at least one large-scale project, done through ADCF, is in the works, which will generate substantial fee income given its size. Hence, KTT will continue to see earnings growth (albeit delayed) despite the divestment of KDC SG4.

Challenging outlook ahead until logistics completes transformation. 

  • The logistics business is undergoing a revamp of its business model, and a complete turnaround is not expected till 2019. Its Courex acquisition stands at the core of its transformation as KTT captures additional parts of the value chain. 
  • Feedback from clients using its omni-channel management solution has been positive, and we believe earnings should improve over time as the service is expanded to clients in the region.


STOCK IMPACT


DC development strategy is to supercharge the development cycle. 

  • Our review of KTT revealed that its chosen DC development strategy was different from what we originally expected. While we had expected KTT to focus primarily on developing its own DCs, the focus is now on supercharging the development cycle together with Alpha DC Fund (ADCF).
  • While this increased speed of development cycle will likely be beneficial in the long run, it will result in short-term earnings uncertainties. We want to take a conservative stance, and thus have removed our original assumptions for operating earnings in divested and future DCs.

Scalable fee-based income from development of DCs with Alpha DC Fund. 

  • As highlighted before, KTT can supercharge its growth through the Alpha DC Fund (ADCF). Through the fund, KTT can simultaneously develop more than two projects at a time, and reap fee-based income. This comes in the form of development fees, sub-advisory fees and management fees. 
  • Furthermore, these fees are a percentage of each DC’s project cost or income. The more projects undertaken by ADCF, the more KTT stands to gain, without having to utilise its own balance sheet.

Development fee income to benefit from rising critical capacity in the region. 

  • DCs in the region are seeing a rise in critical capacities as rack density increases. Recent news have seen players such as Apple and Microsoft committing to build DCs in the region costing > US$1b, implying critical capacities in excess of 50MW. This compares against DCs in Singapore, which are typically limited to 25MW. 
  • Assuming a 3% development fee (on total project cost), similar to that at Keppel DC Reit (KDC Reit), a 50MW development can easily yield fee income of S$15m-18m, recognised over the construction period of 2-3 years. Applied over several concurrent developments, this could easily replace the earnings from divested DCs.

Fee income continues post development. 

  • Post-development, KTT stands to gain a management fee income of 3-5% (referencing KDC Reit again) on EBITDA for DCs it develops for ADCF. As the critical capacities of DCs rises, fee income will scale alongside.
  • To put things in perspective, the recently-divested KDC SG3 (T27) had an annual EBITDA of ~S$20m and only a critical capacity of 4MW. With capacities of > 25MW being mooted, KTT stands to benefit greatly from this trend.

Balance sheet leaves flexibility for KTT to pursue various strategies. 

  • Having novated the associated debt for KDC SG4 (T20) to Thorium DC and refinanced its S$120m due 2019 MTN with a smaller S$100m due 2024 MTN, KTT’s net gearing is expected to fall to ~20%. 
  • With additional debt headroom of up to S$600m, KTT could either choose to pursue additional DC projects using its own balance sheet, or allocate resources to accelerate the logistics business turnaround.


EARNINGS REVISION/RISKS 


Reduce 2017-19 earnings forecasts by 24-32% as only development fee is included.

  • We have combed through our earnings forecasts, and updated accordingly to reflect the impact of this strategy. A large part of the earnings cut stems from our revision to the DC business earnings, which we have reduced by 31-48% as we remove operational earnings assumption for divested and future DCs. 
  • For the logistics business, we have assumed losses for 2017, breakeven in 2018 and a turnaround in 2019. Our revised earnings forecast for 2017-19F is S$47m (-24%), S$55m (-26%) and S$55m (-32%).

DCs: Only development fee income assumed. 

  • For DC earnings, we have conservatively assumed earnings contribution from three DCs (Almere 2, KDC SG4 and Frankfurt) and only fee income from the development of at least 50MW of DCs in the next 2-3 years. 
  • Management fees and advisory fees have been excluded as this requires a difficult estimate of the appropriate “rental” rate on a power density per unit area (W/sqft) basis. However, to provide a sense of the hypothetical impact, we have provided an earnings sensitivity table on the right.


VALUATION/RECOMMENDATION


Target price revised to S$1.90. 

  • Our SOTP target price of S$1.90 values the respective businesses on a PE/P/B basis, and market value for its investments. 
  • Given the weak earnings for the logistics business, we have switched over to a P/B valuation, ascribing a 0.5x 1-year forward P/B multiple. 
  • The DC business remains valued at 30x 1-year forward PE. 
  • Its investment in M1 is valued at our in-house target price of S$1.98.

Maintain BUY. 

  • At the very core, KTT’s fundamentals for its DC business remains intact, with earnings growth slightly delayed as the business undergoes a transformation for the better. 
  • Earnings are expected to pick up towards end-17 on the back of KDC SG4 earnings kicking in, and positive developments on the ADCF front. 
  • Current valuations price the DC business at 15x 1-year forward PE, which is unwarranted given that peer SUNeVision is trading at 31x 1-year forward PE. Maintain BUY.




Edison Chen UOB Kay Hian | Foo Zhi Wei UOB Kay Hian | http://research.uobkayhian.com/ 2017-09-08
UOB Kay Hian SGX Stock Analyst Report BUY Maintain UNDER REVIEW 1.90 Down 2.510



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