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.

Cash earnings recover in 3Q09

Cash earnings re-stabilize. CitySpring Infrastructure Trust (CitySpring) posted a 4.3% YoY gain in 3Q09 revenue to S$101.2m and a net loss of S$21.3m primarily due to non-cash items such as fair value losses. Most importantly, cash earnings recovered at S$20.3m versus S$1.1m a quarter ago. To recap, 2Q cash earnings were hit by one-off items; a timing lag between quarterly-adjusted tariffs and actual fuel costs at City Gas; a negative CRSM1 payment and lower facility fees at Basslink. The underrecovery at City Gas was reversed during 3Q09 as fuel costs fell. City Gas has since reduced its gas tariffs from 1 February 2009. Over time, the revenue model is designed to leave City Gas neutral to the effect of changes in fuel costs. Basslink also recovered A$1m in facility fees based on its cumulative availability at year end. However, the trust registered another negative CRSM payment of A$3.1m. Meanwhile, CitySpring’s NAV dropped 80% to 10.6 S cents from 52.4 S cents a quarter ago. This figure is an unreliable gauge of the trust’s performance because of volatility created by (non-cash) movements in the fair value of financial instruments like interest rate hedges.

Fairly defensive assets. CitySpring’s assets have been relatively untouched by the current economic environment. This continues to be a key differentiator against other yield instruments like shipping trusts and S-REITs, which are witnessing industry downturns that create either revenue or counterparty uncertainty. The trust’s assets are fairly defensive, enjoying either a monopolistic market position or strategic consideration. City Gas earns regulated tariffs from over 600,000 domestic, commercial and industrial customers. It is likely that some of its commercial customers such as restaurants and hotels may be affected by the current downturn but the business primarily earns revenue from household use. Over the quarter, City Gas recorded a 7.7% YoY increase in sales volume. Meanwhile, SingSpring and Basslink earn availability-based revenues from strong counterparties (Singapore’s Public Utilities Board and Australia’s Hydro Tasmania).

1.75 S cents DPU. The trust will pay out 1.75 S cents per share for the quarter, flat QoQ and up 9.4% YoY. This translates to an annualized trailing yield of about 13.5%. The trust said it expected to meet its projected payout of another 1.75 S cents in 4Q09. Our concerns remain intact: in our opinion the 100% debt financing of the trust’s Basslink acquisition is not a long term solution and an equity injection is inevitable at some point. Maintain HOLD with S$0.57 fair value.

2Q09 cash earnings hit by timing lags and one-offs

Cash earnings hit in 2Q09. CitySpring Infrastructure Trust (CitySpring) posted a 31.7% YoY gain in 2Q09 revenue to almost S$101m, and a net loss of S$36.7m, largely due to non-cash items such as fair value losses and depreciation charges. To track CitySpring’s performance, we typically look to cash earnings, which came in at S$1.1m, or 90.2% lower than the trust had projected in its January unitholders circular. In contrast, the trust had earned S$14.1m in 2Q08 and S$17.7m in 1Q09.

Timing lags and one-offs. The biggest hit to cash earnings came from the payment of a one-time upfront fee of S$7.8m for the recently secured S$370m loan. We estimate another S$4m hit is due to a timing lag between tariffs (which are adjusted quarterly) and actual fuel costs at City Gas. City Gas expects to recoup the under-recovered fuel costs in 3Q09. Lower facility fees, which will be partially recouped, and S$2.5m in negative CRSM payments at Basslink also impacted cash earnings. The trust will maintain its 1.75 S cents quarterly payout by utilizing retained cash. CitySpring estimates its accumulated cash surplus as at 30 Sept is about 3.7x the current quarterly distribution – a nice cushion against any further one-offs or lags.

Same investment case. The investment case for CitySpring is unchanged – its strong sponsor (Temasek) and its basket of defensive assets. The trust’s assets feature (1) a monopolistic market position or strategic consideration; (2) fairly stable and predictable cash flows that are fairly non-cyclical; (3) CPI-linked revenue escalations that act as a hedge against inflation or regulator-controlled returns; (4) fairly inelastic demand or availability-based revenues; and (5) a long investment horizon. The noncyclical nature of CitySpring’s cash flows is also a major differentiator against other yield plays like shipping trusts and REITs who have run into industry downturns.

Same concerns. Our concerns have been accentuated, rather than assuaged, by the 28% decline in CitySpring’s share price since our last report. Basslink, CitySpring’s S$1.5bn acquisition, is currently 100% debt financed. This approach allowed the trust to bypass shaky equity markets but it is not a sustainable or permanent solution in our view. Additionally, we feel CitySpring’s current portfolio lacks critical mass and should grow through further acquisitions. An equity cash call would be a necessary next step – but it would be highly dilutive at current price levels. We retain our HOLD rating with new fair value of S$0.57 (previously S$0.80). We have also adjusted our earnings estimates to reflect a weaker AUD.

CitySpring seeks assets worth $1b

But infrastructure trust says valuations are still too high

CITYSPRING Infrastructure Trust, sponsored by Singapore investment company Temasek, is seeking buys worth over $1 billion but said asking prices were still too high.

‘We’re on the negotiating table for a number of opportunities but valuations are too high. Holders of good assets are not yet coming down to a value we find reasonable,’ CitySpring chief executive Au Yeung Fai told Reuters in an interview yesterday.

The trust was not in a desperate need to acquire, and would rather walk away from deals rather than overpay, Mr Au Yeung said, adding that some deals were as much as 30 per cent above what he was prepared to fork out.

CitySpring wants to buy assets such toll roads, ports, and power firms in countries including China, India, and in South-east Asia, and with two-thirds of the opportunities reviewed worth under $1 billion and a third worth over $1 billion.

CitySpring shares closed at $0.71 yesterday, down half a cent.

The stock has fallen 23 per cent so far this year, against the benchmark Straits Times Index’s 27 per cent drop.

Mr Au Yeung, a former investment banker with Barclays and then JP Morgan, said most sellers in Asia are still holding on in hopes of riding out the global economic downturn, although he sees the potential for plum deals in Australia.

‘In Australia there are a lot of infrastructure trusts which are financially distressed and are looking to offload their assets. Maybe some of those valuations will come down, but they haven’t come down sufficiently yet,’ said Mr Au Yeung.

Stocks of Australian trusts such as Macquarie Infrastructure, Babcock & Brown Infrastructure and Transurban Group have been battered by poor market conditions this year, putting pressure on them to sell assets.

CitySpring, in which Temasek has a 28-per cent stake, currently owns a town gas producer and water desalination plant in Singapore, and an undersea electricity cable linking two states in Australia.

It is also interested in the third and final power generation firm PowerSeraya, being divested by Temasek , but has not yet decided whether to bid, Mr Au Yeung said.

Backing from deep-pocketed Temasek has made it easier for CitySpring to obtain bank financing, and this relationship has not hindered deal negotiations despite political sensitivities linked to the wealth fund’s overseas investments, Mr Au Yeung said.

‘This has never been an issue for us. Temasek still has a good reputation across the region, and assets we target typically are not government privatisations but in private hands,’ said Mr Au Yeung, a Cambridge University mathematics graduate.

Unlike Singapore-listed real estate investment trusts such as CapitaMall and Ascendas Reit which typically distribute 90-100 per cent of income to shareholders, Mr Au Yeung said CitySpring will stick to a policy of retaining about half of its cashflow.

‘Some of the cash which is left over, we feel it’s prudent to keep in the trust, to cater for business needs and unforeseen events,’ he said.

‘If we cut everything to the wire, there’s no margin for error and in today’s market with so much uncertainties, that’s not a good model.’ – Reuters

Nascent infrastructure play

Singapore-listed infrastructure play. CitySpring Infrastructure Trust (CitySpring) is a Singapore-listed business trust focused on infrastructure assets. It owns City Gas, Singapore’s only producer and retailer of piped town gas. It also owns a 70% stake in SingSpring, Singapore’s only supplier of desalinated water to the Public Utilities Board. After its IPO, CitySpring went on to acquire Basslink, an electricity interconnector in Australia. These assets essentially operate as regulated monopolies with regulated tariffs (City Gas) or under long-term contracts and concessions (SingSpring and Basslink).

Backed by Temasek. CitySpring is sponsored by Temasek Holdings (Temasek), a private investment vehicle wholly owned by the Singapore government. Temasek owns CitySpring’s trustee-manager and is also the trust’s single largest unitholder with a 27.8% stake. Investing and owning infrastructure assets is not an easy task, with risks on political, social, legal, and technical levels. Temasek has a strong balance sheet, is highly experienced in infrastructure investments, and has a strong business network internationally. This is a key differentiator in our opinion.

Stable, non-cyclical cash flows. CitySpring’s assets feature some unique characteristics including: (1) a monopolistic market position or strategic consideration; (2) stable and predictable cash flows that are fairly non-cyclical; (3) CPI-linked revenue escalations that act as a hedge against inflation or regulator-controlled returns; (4) fairly inelastic demand or availability-based revenues; and (5) a long investment horizon. We find the stability of CitySpring’s cash flows attractive, especially in current market conditions. The non-cyclical nature of CitySpring’s cash flows is also a major differentiator against other yield plays like shipping trusts and REITs who may be heading into industry downturns.

Deferred cash call blocking further growth. CitySpring originally intended to fund last year’s S$1.5bn Basslink acquisition on a 3x debt-to-equity basis. CitySpring then decided to wait out difficult market conditions, and has postponed the equity issue indefinitely. Basslink is currently 100% debt financed, which we do not find sustainable. In our view, CitySpring’s current portfolio lacks critical mass and we would like to see it significantly grow its portfolio through further acquisitions. This makes the equity cash call necessary, not just inevitable. This affects our valuation of the trust and we initiate coverage on CitySpring with a HOLD recommendation. Our fair value estimate is 80 S cents, or 15.5x FY09F EV/EBITDA (adjusted for SingSpring’s lease receivable repayment). CitySpring is paying out 7 S cents a year, which translates to a 10% yield.