CitySpring – OCBC

Exposed to regulatory risk

4Q10 outperforms on Basslink. CitySpring Infrastructure Trust (CitySpring) posted S$118m in 4Q10 revenue, up 21.3% YoY and 23.9% QoQ. Cash earnings also rose 7.4% YoY and 115% QoQ to S$23.4m. This was 16.5% above our estimate, despite continuing poor performance by City Gas due to the timing mismatch between City Gas’ tariff revenue and fuel costs; cash earnings at City Gas fell 47% YoY but increased 28.7% QoQ to S$8.5m. Basslink was the key contributor that lifted 4Q10 results due to positive Commercial Risk Sharing Mechanism (CRSM) payments and contributions from its telecoms services business. The trust will distribute 1.05 S cents per unit to unitholders for 4Q10, flat QoQ but down 40% YoY on the enlarged unit base post-rights issue.

Exposed to regulatory risk. While the inherent nature of the three businesses owned by the trust is fairly stable, we believe CitySpring is exposed to regulatory risk on two fronts. The lesser of the two risks stems from the ongoing1 discussions with Australia’s Hydro Tasmania (owned by the State of Tasmania), which is demanding an additional A$6.9m in CRSM payments from Basslink for CY2009. While the amount is relatively small, if Hydro Tasmania’s interpretation of the agreement has merit, it could have negative implications for future CRSM calculations. The greater of the two risks is on the talks with regulator Energy Market Authority (EMA) regarding the conversion, and ensuing liberalization, of the City Gas town gas network. The key negotiation uncertainties are: 1) grant of franchise monopoly status during the conversion period; 2) recovery of costs incurred in the conversion project; 3) the magnitude of any return on capital allowed through a levy determined by the EMA; and 4) the regulatory climate post-conversion and post-liberalization. We expect both these issues to play out over the next 12 months, creating (in our opinion) a significant overhang on the unit price.

A more cautious valuation. The manager said it is targeting for a DPU of 4.20 S cents or 1.05 S cents per quarter (unchanged from current level) for FY11. This is equivalent to a yield of 7.06% on yesterday’s closing price of S$0.595. Our DDM-derived valuation of CitySpring is now utilizing a higher discount rate of 7.2%, up from 6.4% previously. We believe investors should demand a higher risk premium, both on broader market uncertainties and the regulatory risks discussed earlier. Downgrade to HOLD with a revised fair value of S$0.60 [prev: S$0.68], or an estimated total return of 7.9%.