KEPPEL INFRA TRUST WEF 2015 (SGX:A7RU)
Keppel Infrastructure Trust - M&A Activity Likely On The Horizon
- Keppel Infrastructure Trust's 3Q18 DPU of 0.93Scts steady as expected.
- Trust could be nearing its first acquisition under new CEO, key future catalyst if deal is finalised.
- Close to 7.5% dividend yield and portfolio of utility assets attractive amid current market volatility.
- Maintain BUY with Target Price of S$0.58.
High dividend visibility; maintain BUY.
- Keppel Infrastructure Trust (KIT) maintained its record of steady DPU of 0.93 Scts in 3Q18, as expected. Most of KIT’s assets derive revenue from availability-based payments, independent of actual offtake.
- Hence, cash flows are highly predictable and not exposed to economic cycles. Concession agreements are long term in nature, of up to 20 years, and mostly with government entities, thereby minimising risk.
Where We Differ:
- We believe Keppel Infrastructure Trust is sufficiently protected from ongoing troubles at Basslink, where the State of Tasmania is demanding indemnification to the tune of over A$100m for losses incurred during the Basslink outage in 2016.
- While Basslink has referred the dispute to arbitration, even in the worst case scenario, Keppel Infrastructure Trust will not be liable to pay any damages as any claims against Basslink are ring-fenced at the Basslink level.
- In any case, Keppel Infrastructure Trust does not depend on cash flows from Basslink for current distributions, and project loans are also non-recourse to Keppel Infrastructure Trust. We ascribe zero value to Basslink in our valuations for Keppel Infrastructure Trust, hence the negative newsflow from Basslink is an irritant at best and does not affect fundamentals for Keppel Infrastructure Trust.
Potential catalyst.
- We look forward to the Trust kicking off its M&A ambitions in the near-to-medium term under the new CEO.
- Keppel Infrastructure Trust has announced that it is in the race to acquire Ixom, an Australian chemical distribution company, in a deal which could be worth more than US$1bn according to media reports.
WHAT’S NEW - 3Q18 distributions in line, M&A activity on the horizon
3Q18 distribution of 0.93Scts in line.
- Keppel Infrastructure Trust (KIT) declared DPU of 0.93Scts for 3Q-FY18, at par with previous quarters.
- Group revenue was up 1% y-o-y and 13% q-o-q to S$162m in 3Q18 as service fees resumed at Basslink for the full quarter after a disruption in 2Q18, when the Basslink interconnector had been out of service between 28 March and 5 June 2018, owing to equipment damage caused by a third-party contractor.
- Distributable cash flows came in slightly lower than expected at S$34.6m for 3Q18, flat q-o-q, owing to time lag in adjustments of gas tariffs to reflect underlying fuel costs at City Gas.
- Owing to the sharp rise in crude oil prices YTD in 2018, tariff adjustments have lagged at City Gas, despite three consecutive hikes during the year. This effect will smoothen out over time. Cash flows from other key assets including KMC power plant remained stable.
Dispute between Basslink and counterparties has gone into arbitration.
- Keppel Infrastructure Trust's wholly-owned subsidiary Basslink Pty Ltd (Basslink) has announced that it has referred the dispute with offtaker Hydro Tasmania to arbitration on 8 October 2018, after following the dispute resolution procedures under the Basslink Services Agreement (BSA) in good faith to try and resolve the dispute.
- Through the arbitration process, Basslink hopes to recover the withheld amounts from Hydro Tasmania. To recap, Basslink had received a letter from the State of Tasmania earlier in the year alleging that it had breached the Basslink Operations Agreement. The State had alleged that warranties about the design and construction of the Basslink Interconnector were breached, leading to the six-month outage in 2016. The State has also alleged that it has suffered various losses and that Basslink must indemnify it for those losses (including alleged losses incurred by Hydro Tasmania arising from the cable failure in December 2015), amounting to over A$100m.
- Basslink meanwhile continues to stand by the independent investigation that was undertaken by independent cable expert, Cable Consulting International (CCI), who concluded the actual root cause of the cable failure in December 2015 as “cause unknown”, and hence, Basslink maintains the cable failure as a force majeure event. Thus, Basslink denies that it is liable for any losses incurred by the State and hence, has gone into arbitration proceedings.
We believe KIT is sufficiently ringfenced from troubles at Basslink.
- We believe Keppel Infrastructure Trust is sufficiently protected from ongoing issues at Basslink.
- Even in the worst case scenario, KIT will not be liable to pay any damages as any claims against Basslink are ringfenced at Basslink level. In any case, KIT does not depend on cash flows from Basslink for current distributions, and project loans are also non-recourse to KIT.
- We ascribe zero value to Basslink in our valuations for KIT, hence any negative newsflow from Basslink is an irritant at best and does not affect fundamentals for KIT.
Acquisitions the key future catalyst, could involve equity fund raising.
- According to recent media reports, KIT is nearing an agreement to acquire Ixom, an Australian chemical distribution company currently controlled by Blackstone Group. KIT has confirmed through an announcement that it is participating in the sale process for Ixom, but a deal may or may not materialise.
- Based in Australia and New Zealand, Ixom manufactures as well as distributes essential water treatment chemicals and other chemicals. Ixom owns an extensive infrastructure network that includes chlor-alkali plants, import and storage terminals, and distribution assets. With the new CEO in place, this acquisition could pave help the Trust kick off its M&A ambitions.
- Blackstone had bought Orica Ltd.’s chemical business for A$750m (US$536m) in 2015 and renamed it Ixom, and press reports indicate that the sale price could be around US$1bn or more. It remains to be seen how this business fits in with the Trust’s long-term cash generative defensive infrastructure asset portfolio and how the Trust will look to fund this acquisition.
- Current net gearing (debt/ asset) stands at more than 40%, and net debt/ EBITDA stands at 7.0x, including Basslink, and does not leave debt headroom of more than S$300m in our opinion. Hence, any acquisition of US$1bn (S$1.37bn) could involve significant equity fund raising, in our opinion. Despite this, we believe acquisition story will be a key catalyst for future re-rating.
Maintain BUY with Target Price of S$0.58.
- Based on our DDM-based valuation methodology (cost of equity : 5.3%), we derive a valuation of S$0.58 for Keppel Infrastructure Trust.
- Keppel Infrastructure Trust is currently trading at a healthy yield of close to 7.5% based on annual distribution forecast of 3.72Scts in FY18, and provides a decent entry point for investors amid current market conditions, as the Trust’s utility-like businesses should not be affected by global market volatility.
Key Risks to Our View:
- Key risks include
- plants not meeting availability thresholds owing to operating issues,
- increasing debt refinancing risks for the asset portfolio as the assets age, and
- exposure to increases in inflation and interest rates.
Suvro SARKAR
DBS Group Research
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https://www.dbsvickers.com/
2018-10-17
SGX Stock
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