Old issues remain
• Due to the timing mismatch in City Gas fuel’s cost pass-through (rising costs) and the lag in tariff adjustment upwards, bottomline has remained volatile. We expect bottomline losses to persist in FY13, as City Gas continues to seek tariff increases as needed in order to catch up with the rising fuel costs.
• Basslink’s income contribution continues to vary due to the Commercial Risk Sharing Mechanism (CRSM) with HEC in which if Basslink transmits more electricity to Victoria, it will share in the added revenue from the sales and vice versa.
• CitySpring is targeting FY13 DPU of 3.28 S-cts (8.7% yield). While CitySpring’s bottomline remains in the red, cash earnings do catch up. With a cash balance of SSGD161m, distribution payments are expected to be sustained, at least in the near-term. Key downside risk, in our view, is a deteriorating credit environment which elevates borrowing/refinancing costs.
Background: Listed in 2007, CitySpring Infrastructure Trust is Singapore’s first infrastructure trust that invests in Infrastructure assets. The Trust, through its subsidiaries, produces and retails town gas (City Gas) as well as supplies desalinated water to PUB (SingSpring), transmit electricity (Basslink), and in its capacity as trustee-manager (CityNet) of Netlink Trust, manages telecoms assets. In FY12, City Gas made up 73.7% of total revenue, followed by Basslink with 18% and the balance from SingSpring and CityNet. Key costs consist primarily of fuel, transportation, depreciation and finance expense, making up 87.5% of FY12 revenue.
Why are we highlighting this stock? The utilities businesses are largely driven by economic activity and population growth. With population growth projected to slow down to 1.7% and 1.5% p.a. in 2011-2015 for Singapore and Australia respectively (CitySpring’s markets), fresh investments through new service opportunities (potentially telecoms space) are probably warranted. The appointment of a new CIO in Nov 2011 attests to CitySpring’s growth commitment. We visited the management recently post-FY12 results to get an update on the trust’s existing operations and expansion plans.
Delayed tariff adjustments skew bottomline. Due to the timing mismatch in City Gas fuel’s cost pass-through (rising costs) and the lag in tariff adjustment upwards, bottomline has remained volatile. City Gas has obtained three rounds of tariff adjustments in FY12. Nonetheless, we expect bottomline losses to persist in FY13, as City Gas continues to seek tariff increases as needed in order to catch up with the rising fuel costs.
Basslink remains a drag. Basslink’s income contribution continues to vary due to the Commercial Risk Sharing Mechanism (CRSM) with HEC in which if Basslink transmits more electricity to Victoria, it will share in the added revenue from the sales and vice versa. So far, we have seen cooler summer temperatures and more autumn rain and we expect CRSM payments to stay negative. The next CRSM review is scheduled in 2016, but management has started approaching HEC to renegotiate the terms.
Adequate buffer to support distribution. CitySpring is targeting FY13 DPU of 3.28 S-cts (8.7% yield). While CitySpring’s bottomline remains in the red, cash earnings do catch up. With a cash balance of SSGD161m, distribution payments are expected to be sustained, at least in the near-term. Key downside risk, in our view, is a deteriorating credit environment which elevates borrowing/refinancing costs.
CitySpring Infrastructure last week appointed a new chief investment officer to lead its hunt for fresh investments. But this move has had no positive impact on the unit price as the company’s balance sheet is still not strong enough for M&A activities despite the recent capital injection. Having underperformed the STI by 12% since the rights issue, CitySpring’s unit price is at an all-time low – 12.7% below the rights price – and it offers a dividend yield of 9.5%. Maintain HOLD and target price of $0.35.
CitySpring bought Basslink, its first and only acquisition post-IPO, for about S$1.5b in July 2007. Approximately 75% of the acquisition price was funded by the A$ bonds while the remaining 25% was initially funded by a bridge loan then. Since then, the company called two rounds of equity fundraising to address the Basslink-related loans. The dismal acquisition track record and existing debt obligations will make the closing of future deals highly challenging.
Under the new rule 704(31) of the SGX-ST listing manual, CitySpring disclosed several conditions that would cause a default of its loan agreements with DBS Bank, interest rate hedges and other facilities. These include a cessation of Temasek Holdings’ ownership of all units in CitySpring, removal/resignation of trustee-manager and/or more than 50% change in board directors (after Temasek’s stake slips below 20%). Currently, Temasek’s unitholding in CitySpring is 37.4% and the risk of a sell-off weighs on price performance.
Action & Recommendation
CitySpring’s underlying businesses are defensive in nature and have remained stable. Management guided for a full-year DPU of 3.28 cents per share. Our target price of $0.35 is based on the discounted free cash flow-to-equity model using a higher cost of equity of 10.4% (previously 8.3%). Maintain HOLD.
• It was unfortunate investors ignored news that CitySpring through Basslink, bought back on Sept 30th A$170 mln worth of bonds issued by the latter at A$155 mln, ie there should be a gain to be booked in, interest expense correspondingly reduced and cash flow boosted by the release of the A$20 mln escrow account.
• The 1- cent drop on Oct 3rd to 38 cents underscored the extent of the loss in confidence in this business trust. And Basslink has been a headache since CitySpring bought it just over 4 years ago.
• (The funds for the redemption came from the S$204.8 mln proceeds from the rights issue.)
• Hopefully, news that S&P has removed the Negative outlook rating and reinstated it to Stable will be better received. (The overall rating remains at BBB minus.)
• Key point is that CitySpring’s cash flow is stable enough to more than enable it to continue with its distribution policy, even though with the continued poor stock market performance, prospects for growth via acquisition are not bright.
• Treat CitySpring then as a utility stock / trust, offering yield of >7%.
Staying one step ahead
• CitySpring Infrastructure has proposed a renounceable 11‐for‐20 rights issue at $0.39 per rights unit to raise $205m in net proceeds. The proceeds will be used to fund a partial buyback of the A$486m floating rate bonds ahead of their maturity in August 2015. Taking into account the interest savings from debt reduction and the enlarged base of 1,519m units, we lower our target price from $0.540 to $0.46. Maintain HOLD.
• The proposed capital injection is a preemptive move intended to deflect the effect of a negative outlook on Basslink bonds’ rating and to ensure that Basslink’s distributions to CitySpring will not be disrupted in the event of a rating downgrade.
• Even though the use of the rights proceeds to partially buy back the A$ bonds will result in net interest savings of about $8.5m, the capital raising exercise is still viewed as a negative on the whole as there is no financing of any yield‐accretive acquisition.
• Temasek Holdings, the sponsor, has committed to subscribe for up to 85% of the rights units. If it were allotted the entire undertaking, the Singapore investment company will hold 48% of all units following the rights issue. However, the rights units are not subject to any lock‐up agreement that precludes their subsequent disposal by Temasek.
Action & Recommendation
Assuming that the amount distributed to unitholders in FY Mar12 is kept at around the same level as in FY Mar11, we estimate full‐year DPU to be 3.3 cents in view of the enlarged unit base. While the dividend yield is still attractive, there does not seem to be any major driver for a re‐rating. Management is seeking organic growth in distributions to unitholders through the gas network conversion project for City Gas. However, the project’s timeline has yet to be determined. Maintain HOLD with a target price of $0.46.