CitySpring – DBS

Lack of visible growth pipeline

CitySpring maintained its DPU payout of 1.75 Scts per share in 3Q09, and remains on track to meet its 7 Scts DPU guidance for FY09. While cash earnings of S$20.3m for the quarter, versus S$1.1m in 2Q09 and S$17.7m in 1Q09, was encouraging, non-cash fair value losses of S$22.3m on over-hedged portion of an interest rate hedge led to a net accounting loss of S$21.1m. To protect any future cash downside from this over-hedged portion, management had to purchase an interest rate floor in Nov’08. Given the lack of a visible acquisition pipeline, continuing accounting losses and declining NAVs, investor sentiment is likely to be stymied in the near to medium term. As such, we downgrade the counter to HOLD at a lower target price of S$0.57.

Over-recovering the fuel costs. The time lag between fuel price movements and tariff revisions led to strong cash earnings of S$20.5m at City Gas in 3Q09. Fuel costs retreated about 35% q-o-q while tariffs held steady in 3Q09. Gas tariffs have since been reduced by about 29% with effect from 1st Feb’09 and cash earnings from CityGas should normalise hereon.

No near term DPU concerns. Net cash earnings YTD amount to S$39.1m, and YTD DPU payout ratio is about 66%. We expect steady DPU can be sustained in FY10, and refinancing needs only crop up in mid-2011, when the S$370m term loan from DBS has to be repaid.

But cash call may be dilutive. While the Basslink acquisition was intended to be 25% equity-financed, delays in equity cash call has made any fund-raising prohibitively expensive amidst deteriorating equity markets. However, an equity issue is inevitable for future growth as well. While management feels current asset valuations are not low enough to justify acquisitions, we think that the absence of a visible growth pipeline and lack of financial flexibility may trap CitySpring in a vicious circle. Downgrade to HOLD, target price S$0.57.