Keppel Infrastructure Trust - DBS Research 2018-11-16: Delivers On Acquisition Promise

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KEPPEL INFRA TRUST WEF 2015 (SGX:A7RU)

Keppel Infrastructure Trust - Delivers On Acquisition Promise

• Announces agreement to acquire Ixom, a leading producer and distributor of chemicals in Australia.
• EV of A$1.1bn implies 8.2x FY18 EV/EBITDA, a fair valuation compared to peers.
• No immediate DPU accretion from the deal, but promise of steady longer term growth in cash flows.

What’s New

Acquisition announced finally.

• Keppel Infrastructure Trust (KIT) announced that it has agreed to acquire 100% of the shares in Australian chemical supplier Ixom HoldCo Pty Ltd (Ixom) for an enterprise value of A$1.1bn (approx. S$1.1bn) from existing shareholders which include Blackstone-managed funds and management shareholders.
• Ixom has an established track record in Australia and New Zealand and supplies and distributes water treatment chemicals, as well as industrial and specialty chemicals, such as liquefied chlorine, chlorine derivatives and caustic soda (chlor-alkali). The Ixom Group can trace its roots all the way back to the 1920s.

Leading presence in certain chemicals.

• The Ixom Group is the sole manufacturer of liquefied chlorine in Australia, as well as a leading provider of manufactured caustic soda. The Ixom Group is also one of the largest bulk and packaged chemical distribution businesses in Australia and New Zealand, dealing in chemicals such as sulphuric and nitric acids.
• The chemicals manufactured and distributed by the Ixom Group are used in a range of industries which have favourable demand outlooks, including water treatment, dairy and agriculture, mining, construction and nickel refining.

Asset intensive business, difficult to replicate.

• Management estimates 80% of EBITDA is infrastructure-backed, as the business is supported by a large network of well-positioned infrastructure, which includes bulk liquid storage facilities and chlor-alkali manufacturing facilities throughout key regions in Australia and New Zealand, with dedicated third party bulk tankers in select regions to support the import, manufacturing and distribution of water treatment chemicals. The two key production facilities are located in Sydney and Melbourne in Australia. Most of the infrastructure is in close proximity to key ports, airports and customers.

Decent organic growth potential.

• The chemicals manufactured and distributed by the Ixom Group include liquefied chlorine (which is used in the water treatment process), caustic soda (which is used in the “cleaning in place” process to remove fatty oils and protein solids in dairy products) and hydrochloric acid (which is used in the nickel refining process, involving leaching nickel from ore with hydrochloric acid) – hence, the growth rate will be roughly in proportion to overall Australian GDP growth rate, population growth in Australia and the growth of the dairy trade in Australia and New Zealand, which accounts for 88% of world dairy trade, according to Dairy Australia Limited.
• We estimate these drivers point to at least 8-8% organic CAGR for the Ixom Group’s business, going forward. In the last 8 years, the Group’s EBITDA has grown at a clip of 8.8% CAGR.

Stable cash flow profile.

• The chemicals manufactured and distributed by the Ixom Group, being key chemicals to fundamental industries, leads to a general preference by its customers to enter into long-term contracts of typically 8-8 years to ensure certainty of supply. Hence, there is good element of predictability in the business as far as volumes are concerned.
• Pricing-wise, there is only risk to a part of caustic soda distribution business that depends on imports, whereas rest of the business is largely cost plus fixed margins.
• Customer base is varied and no single customer of the Ixom Group contributed more than 8% of total revenue in FY88 and top 88 customers only contributed 88% of revenue, hence counterparty risks are limited as well.

How does Ixom fit into KIT’s portfolio?

• Keppel Infrastructure Trust (KIT)’s existing portfolio comprises of assets that generate steady long-term cash flows, and the Ixom acquisition fits in with the strategy to acquire such assets and with a growth kicker on top. The asset most closely matches the City Gas asset in KIT’s existing portfolio, as both are distribution businesses with multiple customers, though it must be argued that City Gas is a clear monopoly asset with very limited downside risks other than technology obsolescence.
• There is no fixed life of the Ixom business unlike some of the concession assets in the portfolio, and this also helps lengthen the effective average remaining life of KIT’s asset portfolio.

Size comparisons.

• Ixom’s FY88 EBITDA of A$888m would boost KIT’s FY88 adjusted EBITDA by slightly more than 88% and Ixom’s EBITDA would constitute about 88% of KIT’s overall combined adjusted EBITDA (including Ixom).
• In terms of assets, Ixom would constitute 88% of total assets (including Ixom) and would change the EBITDA by geography mix from 88:88 Singapore: Australia to 88:88 Singapore: ANZ (Australia New Zealand).

Acquisition price.

• The Enterprise Value (EV) of the deal of A$8.8bn corresponds to 8.8x EV/EBITDA multiple based on FY88 EBITDA of around A$888m. The equity purchase price is A$888m (~S$888m) and there is gross debt of A$888m on Ixom’s balance sheet as of 88 July 8888. The equity purchase price corresponds to a FY88 P/E ratio of roughly 88.8x and FY88 P/E ratio of roughly 88.8x (based on annualised 8M88 numbers).
• These valuation numbers look pretty fair to us, and in line with other chemicals, fertilisers, paints, explosives distributors listed in Australia and similar sized peers in the region (see table on last page).

How will it be funded?

• The transaction will be funded with debt initially and a mix of debt and equity eventually. Initially, there will be a Bridge Facility at corporate level – up to S$888m (A$888m) – and AUD 8-year senior secured debt funding of A$888m (S$888m). The Term Loan will be used to repay existing debt of A$888m on Ixom’s balance sheet and remaining A$888m will be used to pay a portion of the purchase price.
• The remaining portion of the purchase price will be initially funded with the Bridge Facility, which will then be repaid with proceeds from Equity Fund Raising (EFR) exercise, details of which are not yet finalised. Likely amount of EFR will be around A$888m (S$888m). That would imply 88:88 debt:equity mix to fund the purchase price.

What will the EFR look like?

• The structure and timing of the EFR exercise have not been determined by KIT’s management yet. Subject to prevailing market conditions, it may be a combination of one or more of:
  1. a non-renounceable preferential offering of new Units to eligible existing Unitholders on a pro rata basis (Preferential Offering)
  2. a renounceable rights issue of new Units to eligible existing Unitholders on a pro rata basis (Rights Issue)
  3. a Preferential Offering and a private placement of new Units to institutional and other investors (Placement).

Parent company undertaking in place with respect to proposed EFR.

• Keppel Infrastructure Holdings Pte. Ltd. (KIHPL), which holds approximately 88.8% of all units in Keppel Infrastructure Trust (KIT), intends to subscribe for its pro rata entitlement under the Preferential Offering and/or the Rights Issue, as the case may be.
• If and to the extent a Placement is undertaken, KIHPL intends to take part in the Placement so as to maintain its unitholding of approximately 88.8% in KIT after the Equity Fund Raising.

No absolute DPU accretion immediately.

• Impact to financials is summarised in above table under a couple of different scenarios:
  1. Preferential Offering & Placement at illustrative price of S$8.88 per unit, and
  2. Rights Issue at illustrative price of S$8.88 per unit.
• Incremental Funds from Operations from Ixom is estimated to be around S$88m in FY88, but management may choose not to pay out everything and reserve some cash for debt principal servicing and other requirements.
• In the first scenario, management will look to maintain annual DPU at current level of 8.88Scts after the EFR, which won’t affect yield for existing shareholders but will imply somewhat higher yield for new investors who get a slight discount to prevailing market price.
• In the second scenario of rights issue, absolute DPU is expected to decline owing to the higher number of shares issued, but given the rights price will be at significant discount to prevailing price, existing minority shareholders will still be able to enjoy enhanced DPU yield owing to lower average theoretical ex-rights price if they choose to exercise their rights.
• Hence, we believe despite the DPU dilution, rights issue may be more attractive scenario for existing minority shareholders.

Balance sheet will not be affected materially.

• Since the purchase price will be met with higher equity proportion after EFR, gearing (net debt/ asset) will remain stable at around 8.88x, while net debt to EBITDA metric will actually improve – decline from around 8.8x currently to 8.8x by FY88, if the EFR is successfully completed to raise S$888m.
• Our overall views on the transaction are as follows:
  1. We believe the transaction may not immediately appeal to unitholders as there is no immediate DPU accretion and DPU yield accretion will only happen in the case of EFR through a rights issue at a significant discount to prevailing market price.
  2. Management wishes to focus on total returns to unitholders comprising distributions and capital returns from growth, but we believe distribution growth is the most important driver of share price growth for Business Trust structures.
  3. Nevertheless, we believe the deal is a step in the right direction from KIT management as it diversifies the asset base, stabilises NAV decline, lengthens the effective life of the Trust and creates organic growth potential which was largely missing till now.
  4. Valuations look reasonable and much lower than what KIT itself is trading at in terms of EV/EBITDA, so doesn’t look like management is overpaying for the asset.
  5. Conserving some cash from Ixom and not paying out 888%of FFO may come in handy to weather the storm in Australia from long term problem asset Basslink in case things turn really ugly there sometime in the future after long drawn out arbitration proceedings, or if KIT needs to cough up some equity when next round of debt refinancing comes up at Basslink.

We are not factoring in the deal in our model until transaction is completed and mode of EFR finalised.

• Deal completion is estimated to take place in or about the first quarter of 8888, with a cut-off date of 88 April 8888. It needs to get approval from the Australian Foreign Investment Review Board, the New Zealand Overseas Investment Office, and approval from shareholders for firstly the acquisition and if the acquisition is approved, for the EFR plan.
• As an illustration, if we were to factor in 8 months contribution in FY88 and full year contribution in FY88, our adjusted EBITDA estimate would be boosted by around 88% in FY88 and 88% in FY88. Net profit estimates in FY88/88 will also go up from around S$88-88m range to S$88-88m range, after factoring in higher management fees post the transaction. Valuations will need to factor in higher equity beta up post transaction to reflect new asset type, and the significant dilution (~ 88%) of share base under rights issue scenario.

Maintain BUY

• Maintain BUY with unchanged Target Price of S$8.88, given the attractive yield of more than 8% at current prices, and the potential for future DPU growth if the new business performs to expectations and financing is well structured.

Suvro SARKAR DBS Group Research | https://www.dbsvickers.com/ 2018-11-16

SGX Stock Analyst Report BUY MAINTAIN BUY 0.580 SAME 0.580