Another safe quarter

At a Glance

• 1Q11 DPU of 1.05Scts as expected; we maintain our DPU estimate of total 4.2Scts for FY11

• Outage at Basslink hit 1Q11 revenues.

• Cash earnings of S$18m was slightly above our estimates due to strong cash flows from CityGas

• Yield of close to 7% looks secure, maintain BUY with TP of S$0.67

Comment on Results

Outage at Basslink, other operations stable. Group revenue was up 25% y-o-y to S$104m in 1Q11, on the back of higher tariffs at CityGas, but slipped 12% q-o-q owing to an outage at Basslink, which led to lower facility fees. The facility fees can be recovered, however, if Basslink maintains an overall availability of 97% for the full year of CY2010. Basslink revenues were also affected by negative CRSM (risk sharing mechanism) payments to Hydro

Tasmania. As a result, cash earnings declined about 20% q-o-q to S$18m, but this was still slightly above our expectations and represented a sizeable improvement over the levels seen in the first 3 quarters of FY10, owing to the mismatch between CityGas tariffs and fuel oil prices.

Payout ratio leaves room for comfort. The Group paid out 1.05Scts for the quarter, in line with the guidance of 4.2Scts for FY11. Net cash distributed amounted to a conservative 57% of net cash generated in 1Q11, and hence we remain comfortable with our DPU estimates for FY11.

Outlook and Recommendation

Maintain BUY. CitySpring remains as a relatively safe yield instrument. We maintain our BUY call at an unchanged TP of S$0.67. With a gross cash of close to S$100m, risks like higher fuel prices at CityGas and ongoing discussions with Hydro Tasmania regarding a A$6.9m payment are unlikely to affect payouts. M&A remains a possible catalyst given the improved balance sheet following to the rights issue last year.

Updates on Basslink

New CEO at Hydro Tasmania. Effective 21 Jun, state-owned Hydro Tasmania has appointed Mr Roy Adair as its new CEO. Hydro Tasmania is CitySpring Infrastructure Trust (CitySpring)’s counterparty on the 25-year revenue agreement for the Basslink asset. Mr Adair was formerly the President and CEO of Singapore’s Senoko Power (previously owned by Temasek) for six years. With Mr Adair’s experience working with Temasek, we believe CitySpring’s relationship with Hydro Tasmania should remain intact under the new regime.

Inquiry into Hydro Tasmania. The Tasmanian state government has launched an independent inquiry into the operations of state-owned energy companies Hydro Tasmania, Transend and Aurora Energy. Apart from its relationship with Hydro Tasmania, Basslink also has an agreement with Aurora relating to its new telecoms business. A deal to increase Aurora’s profits, which is believed to be having some financial difficulties, by intervening in the regulation of power prices was apparently conditional on the establishment of this inquiry. The independent panel will investigate issues including the effectiveness of current regulation; the causes behind increases in power prices; and the impact of major infrastructure development issues. It will also give advice on the formation of a new energy strategy for the state.

Manager sees limited impact on Basslink. A major threat to infrastructure investments is the risk of expropriation or creeping expropriation, where the government squeezes a project by taxes, regulation, access, or changes in law. The local community’s perception and acceptance of the project and its owners (particularly overseas owners) – is another key risk. We met up with CitySpring’s manager this week, who does not expect any impact to its contractual relationship with Hydro Tasmania, especially in light of Basslink’s strategic importance to the state. We do note that discussions are still ongoing with Hydro Tasmania on its demand for an additional A$6.9m in Commercial Risk Sharing Mechanism payments from Basslink for CY2009.

City Gas negotiations continue. We have previously highlighted the ongoing discussions with Singapore’s Energy Market Authority (EMA) regarding the conversion, and ensuing liberalization, of the City Gas town gas network (refer to our 25 May report for more details). The manager told us it was re-assured by the consistent and fair nature of EMA’s decisions so far as a regulator. Still, we believe the uncertain outcome (whether positive or negative) merits a higher risk premium in the absence of greater information. Maintain HOLD rating and our DDM-derived S$0.60 fair value [7.2% discount rate, 0% terminal growth].

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%.

Looks to be a safe bet

• 4Q10 cash earnings of S$24m better-than-expected

• DPU of 1.05Scts for 4Q10 in line; maintains similar quarterly guidance for full year-FY11

• Secure yield of 7.2% thus promises relative stability amidst markets spooked by macro concerns

• Upgrade to BUY at a revised TP of S$0.67

Basslink contribution props up numbers. The Group recorded net adjusted cash earnings of S$23.7m in 4Q10, up 10% y-o-y and more than double of the S$11m generated in 3Q10. This strong performance was driven by higher revenue contribution from Basslink – as a result of higher availability fees, higher Commercial Risk Sharing Mechanism (“CRSM”) payments from Hydro Tasmania and Telecom revenues. City Gas cash earnings, though, failed to fully make up for the shortfalls recorded earlier in the year, despite recovering 29% q-o-q in 4Q10 owing to relative stability in High Sulphur Fuel Oil (“HSFO”) prices.

Maintains 4.20Scts DPU guidance for FY11. We expect FY11 cash generation to be stable, compared to FY10, while CityGas earnings could potentially be better, owing to full year contribution from customers in newly opened malls and Integrated Resorts, and lower HSFO prices. Hence, we remain confident of management meeting their DPU guidance for FY11, barring any major M&A activity. The CRSM issue with Hydro Tasmania or negotiations on CityGas’ gas conversion programme is unlikely to affect payouts. Gross cash of about S$100m provides a buffer.

Safe and steady is good, for now. Given the evolving macro uncertainties arising from the risks of a slowdown in EZ, CitySpring looks like a relatively safe investment with stable assets largely insulated from economic cycles. Given that financing concerns have been largely resolved as well, we upgrade the stock to BUY with a revised DDM-based TP of S$0.67 (as we lower our WACC from 8.0% to 7.5%).

CitySpring back in black with $7.8m profit

Q4 earnings at $1.78m; It declares DPU of 1.05 cents for the quarter

CITYSPRING Infrastructure Trust upped its cash earnings by 7.4 per cent to $23.5 million for its fiscal fourth quarter, lifted by contributions from its Australian asset, Basslink.

The trust said it uses cash earnings as a measure of its performance, since capital-intensive infrastructure assets tend to show accounting losses due to fairly large amount of non-cash depreciation charges.

It declared a distribution per unit for the quarter of 1.05 cents – after factoring in the rights issue that was announced in August 2009 – compared with 1.75 cents in the fourth quarter of last year.

Basslink – an undersea electricity transmission cable in Australia – generated cash earnings of A$10.8 million (S$12.6 million) for the three months ended March 31, 2010, up 83.1 per cent from the same period a year ago.

City Gas Trust’s cash earning contributions dropped 47.5 per cent to $8.5 million over the year.

CitySpring said that such short-term fluctuations in the cash earnings of City Gas Trust was due to a time-lag in the adjustment of gas tariffs to reflect actual fuel cost.

Its third asset, SingSpring, had its desalination plant recording cash earnings of $4.2 million in the fiscal quarter, inching up 5 per cent from a year ago.

For the full-year, CitySpring’s cash earnings dipped 5.1 per cent to $57.9 million.

The trust posted a quarterly net profit of $1.78 million, swinging from a net loss of $399,000 registered a year ago. Quarterly revenue rose 21.3 per cent to $118 million.

Net profit for the full fiscal year stood at $7.86 million, reversing from a net loss of $50.2 million. Revenue slipped 2.7 per cent to $388 million.

The underlying performance of the three assets is expected to remain stable, the trust said in its financial statement on Saturday.

‘Basslink’s telecoms services, which have turned in creditable results since its launch in July 2009, is expected to continue to perform to expectation,’ CitySpring noted.

The anticipated increase in demand for town gas – following the opening of the two casinos and prime shopping malls on Orchard Road – is expected to boost the volume growth of gas for City Gas, it added.