CitySpring – OCBC

DPU surprises on the upside

Time lag impacts 2Q10. CitySpring Infrastructure Trust reported a 11% QoQ increase in 2Q10 revenue to S$92.1m but a 31% fall in cash earnings to S$9.6m. The negative variance was primarily due to the short-term timing mismatch between changes in City Gas’ tariff revenue and fuel costs, which we understand have shot up significantly over the last six months. City Gas raised its tariff by 7.5% effective 01 Aug and by 13.8% effective 01 Nov. Over time, City Gas should be net neutral to fluctuations in fuel costs. Basslink’s telecoms network made its maiden contribution to cash earnings this quarter.

DPU surprises on the upside. CitySpring declared 1.05 S cents in 2Q10 DPU, down 40% YoY and QoQ because of the enlarged post-rights unit base. This was 5% higher than the pro forma 1 S cents estimate. The manager said CitySpring will target the same quarterly payout for the remainder of FY10. The 4.2 S cents annualized payout outperforms our 3.9 to 4 S cents annual estimate. The manager said that the trust increased the absolute level of payout (S$41.2m versus S$34.3m) because of its “comfort” with the performance of the three businesses.

Looking ahead after the cash call. We believe CitySpring will likely be able to deliver gradual (but modest) organic growth in distributions in the long term, driven by increasing City Gas volumes and the fledgling telecoms business at Basslink. Still, significant income growth will (in our opinion) have to be fueled by external growth. The rights issue has improved CitySpring’s ability to consider such growth. One major project coming up is the City Gas network conversion project, where discussions continue with the regulator. At IPO, the project cost was estimated at S$200m (over a period of five years). The manager continues to explore acquisition opportunities but reiterated its skepticism of hard-and-fast yearly targets and its insistence on acquiring on its own terms. Our interpretation: don’t expect anything too soon.

Defensible yield. Our earning estimates now reflect actual 1H10 results. We note the manager is still in discussions with DBS Bank on the terms of the planned new revolving credit facility. Our DDM-derived valuation assumes a 6.4% discount rate and a 0% terminal growth rate. On this basis, our fair value estimate for the trust is 68 S cents (unchanged). The annual yield of 7.3% is fairly defensible in our view, because of the stability inherent to the business models of the three regulated assets. Maintain BUY (29% total return).