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.
• The proposed 11-for-20 rights issue at 39 cents each should be welcomed by investors, even though there could be some disappointment it is not to be privatized :
a. it removes a major overhang which has been bothering investors since the downgrade warning by S&P last November;
b. without this capital raising, CitySpring would be in no position to maintain its distribution, which has been kept at 4.2 cents a unit (or 3.28 cents on pro-forma basis);
c. management has given an undertaking there will not be need to raise further equity down the road (except in the event of CitySpring making yield accretive acquisitions);
d. Temasek, which owns 27.8%, has undertaken to take up to 85% of the new units, with the remaining 15% to be underwritten by DBS, Goldman Sachs.;
e. the $204.8 mln net proceeds will be used to reduce high-cost borrowings; and perhaps more importantly,
f. it better places CitySpring to “pursue organic and inorganic acquisitions and investment opportunities”.
• The subscription price represents a 19% discount to the theoretical ex-rights price of 48.35 cents (53.5×20+39×11/31).
• Temasek has obtained whitewash waiver in the event it ends up having to take up 85% of the rights units, which would raise its stake to 48.1%, and which would have triggered a mandatory general offer.
• We are maintaining BUY on 6.8% pro-forma yield now that major uncertainties have been removed.
CitySpring trust unveils $210m rights issue
CITYSPRING Infrastructure Trust is looking to raise $210.2 million through a renounceable rights issue to strengthen its balance sheet.
The trust, partly owned by Temasek Holdings, will issue about 539 million new units at a price of 39 cents per rights unit. The issue will be offered to unitholders on the basis of 11 rights units for every 20 units held, said its trustee-manager CitySpring Infrastructure Management yesterday.
Temasek, which owns 28 per cent of CitySpring, has irrevocably undertaken to subscribe for 85 per cent of all the rights units. The existing directors of the trustee-manager also intend to take up their entitlements under the rights issue in full, said CitySpring.
The rights issue is at a 27.1 per cent discount to CitySpring’s last transacted price of 53.5 cents per unit before a trading halt was imposed for the second half of the day yesterday.
Net proceeds from the issue, expected to be $204.8 million, will be used to reduce CitySpring’s net gearing, and give it the flexibility to pre-pay or refinance bonds that it previously issued to finance its acquisition of Australian undersea electricity transmission cable Basslink.
Funds could also be used for CitySpring’s general corporate purposes.
‘The rights issue will strengthen the group’s balance sheet and give it greater flexibility to reduce its gearing, whether at Bass-link or CitySpring level.
‘The trustee-manager is confident that following the rights issue, the negative outlook on the bonds’ rating can be removed, thereby ensuring that Basslink is not precluded from continuing to make distributions to CitySpring,’ it said.
Standard & Poor’s has a BBB- rating on the Basslink bonds and a negative outlook on them, citing Basslink’s vulnerability to refinance the bonds at a higher interest cost in 2015. When the bonds were issued, it was stated that if their rating falls to BB+/Ba1 or lower, Basslink will not have to make distributions to CitySpring.
Basslink generated cash earnings of A$10.8 million ($14.2 million) for the three months ended March 31, 2010, up 83.1 per cent from the same period a year ago. This helped to lift CitySpring’s cash earnings for the quarter, during which the trust upped its cash earnings by 7.4 per cent to $23.5 million for the fiscal fourth quarter.
Over the last three financial years, Basslink has distributed an average of A$4.7 million per quarter to CitySpring.
Lack of positive catalysts
At a Glance
• 4Q11 DPU maintained at 1.05Scts; no surprises
• Cash earnings down 9% q-o-q in 4Q11 as margins in CityGas were affected by higher fuel costs
• Negative risk sharing payments at Basslink continue to impact cash flows
• Guidance for FY12 stays flat at 4.20Scts; maintain HOLD with unchanged DDM-based TP of S$0.58
Comment on Results
Cash earnings down again. Cash earnings for 4Q11 came in at S$16.7m, down 9% q-o-q and almost 30% y-o-y, largely owing to higher fuel costs at CityGas and negative CRSM (risk sharing mechanism) payments at Basslink. Revenues were up slightly (3% q-o-q) to S$110m on the back of higher tariffs at CityGas, but it was not enough to counter the higher fuel prices during the quarter. Basslink again saw negative CRSM outflow in 4Q11 and FY11. Basslink recorded total negative CRSM payments of A$16.7m, impacting cash flows. Overall, total cash earnings of S$77m in FY11 were 30% higher than S$59m earned in FY10.
Payout maintained, guidance flat. The Group paid out 1.05Scts for 4Q11, in line with guidance, and a payout ratio of 54% for FY11. Total gross cash increased to S$159m at end-FY11, up from S$133m at end-FY10. This included restricted cash of about S$26m placed in escrow account earlier to meet S&P criteria and avoid a downgrade on Basslink’s credit rating.
Outlook and Recommendation
Refinancing secured. The Trustee-Manager also announced that DBS Bank has agreed to roll over the S$128m term loan at CityGas (Feb’12 to Feb’14) and S$142m corporate loan at CitySpring (from Aug’11 to Aug’14). The Trustee-Manager will complete its review of the Group’s capital structure by Sep 2011 to ensure sustainability of dividends. While balance sheet risks have subsided somewhat, given the lack of DPU growth or any other positive catalysts, we maintain our HOLD call at an unchanged TP of S$0.58.
Robust capital plan remains top priority
At a Glance
• 3Q11 DPU maintained at 1.05Scts; no surprises
• Receives temporary respite from S&P with respect to credit rating of Basslink bonds
• Catalysts only possible after management reviews capital structure; maintain HOLD with DDM-based TP of S$0.58
Comment on Results
Cash earnings down q-o-q. Revenues were up 12% y-o-y and 3% q-o-q to S$107m on the back of higher tariffs at CityGas and a stronger AUD. Cash earnings, while up 67% y-o-y owing due to better margins at CityGas, was down almost 20% q-o-q to about S$18m as Basslink cash earnings disappointed. Basslink again saw negative CRSM (risk sharing mechanism) payments to the tune of A$5.2m, which affected results. The Group paid out 1.05Scts for the quarter, in line with the guided 4.2Scts for FY11. About 56% of net cash generated was distributed in 3Q11, and gross cash buffer improved to S$123m.
Outlook and Recommendation
Bond rating concern diminishes in near term. To recap, S&P had put the senior secured debt issues at Basslink on CreditWatch negative. If the ratings on the outstanding bonds are downgraded, Basslink will be barred from repatriating distributions to CitySpring. Recently, the Trustee-Manager put A$20m in an escrow account to meet S&P criteria and subsequently, Basslink has been removed from the CreditWatch list and its BBB- rating affirmed (with a negative outlook). Thus near term concerns have been alleviated but the Trustee-Manager will still have to review the capital structure of the Group by September 2011 to ensure stable dividends from Basslink. In view of this uncertainty and the continued dispute with Hydro Tasmania regarding the interpretation of CRSM dues to the tune of A$6.9m – which could culminate in litigation – we maintain our HOLD call on the stock at an unchanged TP of S$0.58. The Trust will also have to refinance S$142m of corporate loan due in August 2011. Acquisition catalysts are unlikely in the near term given the management focus on putting in place a “robust” capital plan at the earliest.
Dispute resolution process starts
Dispute resolution process starts. CitySpring Infrastructure Trust (CitySpring) announced recently that state-owned Hydro Tasmania has invoked dispute resolution procedures. Hydro Tasmania is CitySpring’s counterparty on the 25-year revenue agreement for the Basslink asset. To recap, discussions were ongoing with Hydro Tasmania on its demand for an additional A$6.9m in commercial risk sharing mechanism (CRSM) payments from Basslink for CY2009.
What is CRSM? CRSM is designed to share the market risk of operating in the National Electricity Market between Basslink and Hydro Tasmania. Payments under CRSM are based on differences between the top 30 and bottom 50 electricity pool prices and can range from up to 25% of base power cable revenues or up to negative 20% of revenues depending on the volatility of electricity prices in Victoria. While the CRSM is designed to have a neutral effect in the long term, it creates a level of volatility in Basslink’s revenue (offering both upside and downside).
Could require resolution by arbitration. Hydro Tasmania’s demand for additional CRSM payments was first disclosed in Feb, at the 3Q FY10 results. In the latest announcement, CitySpring noted that the Basslink Services Agreement contains dispute resolution procedures which can be activated to resolve such matters. Hydro Tasmania issued a dispute notice on 17 Sep on the “CRSM matters and other alleged breaches” of the services agreement. It also noted that such procedures ultimately may require Hydro Tasmania and Basslink to enter into arbitration. While further details were not revealed, we note in a typical arbitration, a third party reviews the case and imposes a decision that is legally binding for both sides.
No provisions made yet. To date, CitySpring – after taking legal advice – had not made any provision for liabilities arising from the discussions with Hydro Tasmania. We note that with dispute resolution procedures invoked, there could a greater risk of CitySpring booking some sort of provision on its P&L. Separately, discussions with Singapore’s Energy Market Authority (EMA) regarding the conversion, and ensuing liberalization, of the City Gas town gas network are ongoing. The manager re-iterated that it was re-assured by the consistent and fair nature of EMA’s decisions so far as a regulator, especially in the electricity market. The manager also emphasized that the marginal returns per household create a natural barrier for newcomers to the residential market; City Gas serves 623,000 customers. We are suspending coverage on CitySpring as we see limited positive price catalysts in the near-term.