Keppel Infrastructure Trust (KIT SP) - Maybank Kim Eng 2017-04-12: In Cashflows We Trust

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KEPPEL INFRA TRUST WEF 2015 A7RU.SI

Keppel Infrastructure Trust (KIT SP) - In cashflows we trust

Defensible steady returns 

• Keppel Infrastructure Trust (KIT), Singapore’s largest diversified infrastructure business trust, generates resilient, predictable cash flows underpinned by long-term concessions for assets concentrated in gas distribution, power generation and transmission, water and waste-to-energy segments. 
• The portfolio holds organic growth potential, while the balance sheet has dry powder to consider acquisitions up to SGD1.5b as well (or c36% increase in assets). 
• In our view, the business risks are unforeseen asset downtime, exposure to interest rates and overpaying for assets.

Resilient to economic cycles; an alternative to REITs 

• Most of KIT’s revenue streams have end-demand hedged moat features derived from capacity-availability based payments that are largely inflation adjusted and have cost pass-through tariff-setting mechanisms.
• With variable revenues at sub-10%, KIT’s cash flows are arguably more predictable than even most property REITs. 
• Contracts are very long term in nature ranging from 15-25 years, typically with extension options with customers who are mostly governments or linked entities.

On the lookout for growth options 

• KIT’s has a three-pronged growth strategy: 
  1. organic growth upside from existing assets; 
  2. new asset injections leveraging on group synergies, such as an ROFR for mature assets in Keppel Infrastructure Holdings; and 
  3. acquisition of new assets. 
• Asset features that KIT seeks are long-term stable cash flow generation and operations in focus markets of Singapore, developed Asia and Europe. 
• Management indicates that the balance sheet has headroom to gear up by around SGD500m to fund new equity.

Trading at a FY17 indicative dividend yield of 7.02% 

• KIT trades at a prospective dividend yield of 7.02% versus 6.04% for the Singapore REITs index and 8.67% for Singapore business trusts. 
• While it is a thinly followed stock with just two contributors to consensus estimates, the FY17 net profit forecast is for 8.8% growth.

Company profile 

Business 

• Keppel Infrastructure Trust (KIT) manages a diversified portfolio of diversified infrastructure assets in Singapore and Australia. The key assets are town gas producer and retailer City Gas, Keppel Merlimau Cogen (KMC) power plant, two waste-to-energy plant concessions (Senoko WTE & Tuas WTE), two water concessions (Ulu Pandan NEWater & SingSpring Desalination), commercial property DataCentre One and submarine HV power transmission cable Basslink.
• KIT’s strategy is to manage and invest in infrastructure assets that deliver long-term, regular and predictable cash flows that are shielded from economic cycles. This is achieved through contracts that are capacity-availability based (somewhat similar to take-or-pay) and not actual volumes.
• KIT’s target markets are Singapore and countries in developed Asia and Europe with well-developed legal framework and contract-sanctity protection.

Company milestones 

• Pre May 2015 origins: CitySpring Infrastructure Trust was formed in Jan 2007 and listed on the SGX Main Board in Feb 2007. Keppel Green Trust was formed in July 2009 and listed on SGX Main Board in June 2010 – it was subsequently renamed Keppel Infrastructure Trust in Apr 2014 
• May 2015: Formation of the new enlarged CitySpring Infrastructure Trust, which was renamed Keppel Infrastructure Trust. Also raised S$525 million through a private placement and preferential offering to finance the acquisition of 51% of Keppel Merlimau Cogen (KMC) 
• June 2015: KIT completed its acquisition of a 51% stake in KMC from its Sponsor, Keppel Infrastructure.
• Apr 2016: DataCentre One commenced 20 year lease to client for 1-Net North Data Centre facility.
• July 2016: The Trustee-Manager, KIFM became a wholly-owned subsidiary of Keppel Capital.
• Sept 2016: Completed capacity upgrade of Senoko WTE plant by 10%.

Investment pros and cons 

The growth proposition 

• Existing portfolio growth potential: CityGas volumes typically see low single-digit organic growth, DataCentre One has the option of two more floors to be fitted out with low capital outlay and, over the long term, there should be a potential upward adjustment in tolling fees for KMC post the initial 15 year period which does not incorporate any inflation adjustments. 
• Keppel Group synergy: KIT has Right of First Refusal (ROFR) options on assets that the Sponsor, Keppel Infrastructure Holdings, may be looking to divest in the future. The pipeline includes 49% of KMC, Singapore’s fourth desalination plant expected to be operational in 2020 and stakes in District Cooling Systems (DCS) assets at various business and industrial parks.
• Third party acquisition potential: KIT is evaluating various assets in diversified sectors and geographies as well as selected greenfield investments.

The value proposition 

• Predictable and frequent DPU distribution, which is attractive for income oriented funds – while KIT does not have a fixed pay-out policy; the Trustee-Manager seeks to maintain stable quarterly distributions.
• KIT currently trades at a prospective FY17 dividend yield of 7.02%. 
• In comparison the Singapore REITs index offers a prospective yield of 6.04%, while the Singapore Government 5 year and 10 year bonds offer 1.68% and 2.21% yields, respectively.
• Singapore Business Trusts offer 8.67% prospective yield but this is somewhat skewed by two Trusts i.e. Asian Pay TV Trust (APTT SP; NR) and Hutchison Port Holdings Trust (HPHT SP; NR) at 13.83% and 10.56% yield respectively due to entity specific factors - excluding them, the basket offers 6.8% yield.

Risk factors 

• Operating risk: KIT not meeting asset availability thresholds owing to unforeseen asset downtime or operating issues.
• Input cost volatility: Volatility in energy prices may affect earnings as certain assets do not have a full cost pass-through mechanism, such as KMC, Ulu Pandan NEWater or have a have a time-lag to tariff adjustments, such as CityGas.
• Exposure to rising interest rates and inflation. Note that Business Trusts and REITs are asset classes which traditionally underperform relative to the general equity markets in a rising interest rate environment.
• Acquisition risk: KIT overpaying for new potential acquisitions.
• Related party transactions: In our view, Sponsor’s tend to have somewhat better bargaining power over REITs or Business Trusts in determining timing and structure of asset sales.

Peer comparisons 

• KIT does not have any direct listed comparable in the Singapore market or in the ASEAN region which has a dearth of listed infrastructure trusts. 
• The two most comparable non-property related trusts are APTT SP and HPHT SP but they operate in different sectors of telecom and port infrastructure respectively and also have different asset and cashflow dynamics as reflected by their much higher DPU yields.
• We find that investors broadly tend to compare the KIT more against property REITs and other high yield stocks in telecommunications and utilities sectors.

KIT asset profiles 

• Based on KIT presentation material and our meeting with the Trustee-Manager, the key features of each asset are detailed below: 

1. CityGas 

• Business: Sole producer and retailer of piped town gas in Singapore.
• Off-taker: Direct end users – over 750,000 commercial and retail customers.
• Contract tenure & terms: Not applicable.
• Nature of cashflows: Stable fees with fuel and electricity costs passed through to customer. There is typically a time lag in adjustments of gas tariffs with underlying fuel costs as KIT submits tariff adjustment proposal to the Energy Market Authority on a lagging quarter basis.
• Other information: Has the sole production facility of town gas in Singapore, Senoko Gasworks, with a capacity of 1.6m cubic metres per day.

2. Senoko WTE Plant 

• Business: 2,310 tonnes per day waste incineration concession.
• Off-taker: National Environment Agency of Singapore.
• Contract tenure & terms: 15 year contract from Sept 2009 and expiring 2024.
• Nature of cashflows: Principally fixed availability payments.
• Other information: The plant is the third incineration plant built in Singapore and one of four currently operating.

3. Tuas WTE Plant 

• Business: 800 tonnes per day waste incineration concession.
• Off-taker: National Environment Agency of Singapore.
• Contract tenure & terms: 25 year contract from Oct 2009 and expiring 2034.
• Nature of cashflows: Principally fixed availability payments.
• Other information: The plant is the fifth incineration plant built in Singapore and the newest of the four currently operating.

4. Ulu Pandan NEWater 

• Business: 148,000 cubic metres per day NEWater concession.
• Off-taker: Public Utilities Board of Singapore.
• Contract tenure & terms: 20 year contract from Mar 2007 and expiring 2027.
• Nature of cashflows: Approximately half fixed and half variable payments. Tariffs are set on a 3-year basis over the contract period.
• Other information: Second largest NEWater plant and the fourth to start operations in Singapore.

5. SingSpring Desalination 

• Business: 136,380 cubic metres per day seawater desalination concession.
• Off-taker: Public Utilities Board of Singapore.
• Contract tenure & terms: 20 year contract from Dec 2005 and expiring 2025 (underlying land lease until 2033 so contract extension could be a possibility).
• Nature of cashflows: Principally fixed availability payments. Tariffs are renewed annually over the contract life.
• Other information: Singapore’s first large scale seawater desalination plant with capacity roughly 10% of the country’s current water needs.

6. Keppel Merlimau Cogen (KMC) 

• Business: 1,300MW CCGT power generation plant capacity tolling agreement Off-taker: Keppel Electric, a part of Keppel Group companies.
• Contract tenure & terms: 15 years contract commencing from acquisition in 2015 and expiring 2030 with an option for a 10 year extension (underlying land lease until 2035 with option for 30 year extension).
• Nature of cashflows: Principally fixed availability payments with a maximum of SGD$108m annually over initial contract period.
• Other information: First IPP to enter the Singapore Electricity market since the New Energy Market (NME) was implemented in 2003. Located in Jurong Island, it is well positioned to supply nearby industries with electricity, steam supply and demineralised industrial water requirements.

7. DataCentre One 

• Business: Data centre.
• Off-taker: One-Net, a 100% subsidiary of MediaCorp, Singapore’s national broadcast company.
• Contract tenure & terms: 20 year contract from Apr 2016 and expiring 2036 with option for an 8 year extension.
• Nature of cashflows: Contractual lease revenue.
• Other information: Contract is on triple net lease basis and asset has potential for development of another two storeys. KIT does not own the land.

8. Basslink 

• Business: Owner and operator of high voltage submarine electricity transmission cable, Basslink Interconnector, between the states of Victoria and Tasmania in Australia.
• Off-taker: Hydro Tasmania, owned by the Tasmanian state government.
• Contract tenure & terms: 25 year contract from Apr 2006 and expiring 2031 with option for a 15 year extension.
• Nature of cashflows: 80% availability payment, 12.5% indexed to Australian CPI.
• Other information: Basslink is the only power transmission interconnector between State of Victoria and Tasmania. Basslink suffered an undersea cable fault due to which availability was affected between 20 Dec 2015 and 13 Jun 2016 (note that prior to this outage Basslink achieved an availability of 99.5% in the Jan-Nov 2015 period).
  The cable returned to service on the 13 Jun 2016. Basslink believes this is a force majeure event, to which customer Hydro Tasmania (HT) disagrees. As a result, HT did not pay Basslink facility fees for a period of 2016 although good faith payments from HT were received in Dec 2016 while negotiations are ongoing between the parties to resolve outstanding matters.
  
  Also, as announced on 18 July 2016, Basslink was unable to meet the minimum debt service coverage ratio covenant in its project financing contract and as a condition to waive this event of default, Basslink was required to agree with the banking syndicate a Long Term Financing Plan (LTFP) (note that there is no contractual recourse to KIT under the project financing contract). Insurers have confirmed that the physical loss and damage to the cable, as well as time element loss (i.e. business interruption loss) arising from the outage are insurable. Hence, the insurer made advance payments of AUD$40m, out of which, approx.
  
  AUD$13.5m was used to pay part of the repair costs of the interconnector. The focus for 2017 for Basslink is to work with the insurer on the remaining claims under the insurance policy, iron out payment issues with off-taker HT and renegotiate its long term project debt with its banking syndicate.

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Target Price: N/A

Neel Sinha Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-04-12

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