K‐GREEN TRUST SEEKS WIDER INVESTMENT MANDATE

Keppel Infrastructure Fund Management Pte Ltd (KIFM), as trusteemanagerof K‐Green Trust (KGT), has proposed an expansion of its investment mandate to cover a wider range of infrastructure assets. It is also proposing a change in sponsor to Keppel Infrastructure (KI) following a group reorganisation last year.

Currently, KGT owns Senoko Waste‐to‐Energy Plant, Keppel Seghers Tuas Waste‐to‐Energy Plant and Keppel Seghers Ulu Pandan NEWater Plant.

Yesterday, KIFM explained that when the trust was listed in 2010, it had focused on “green” infrastructure assets, which reflected the business focus of its sponsor, Keppel Integrated Engineering (KIE), at the time of listing.

However, in May 2013, KIE was reorganised under KI. KI has three core business platforms in Gas‐to‐Power, Waste‐to‐Energy and X‐to‐Energy, the la

Revenue dragged down by absence of construction revenue. KGT’s FY13 revenue was 12% lower YoY, which was largely the result of the exclusion of construction revenue arising from the flue gas treatment upgrade. Revenue from operation and maintenance (O&M) was S$50mil for FY13, which was S$0.3mil lower than FY12, due to lower output from the waste-to-energy plants and NEWater plant. This was partially offset by annual adjustment of O&M and power tariffs.

7.4% yield masks a partial return of capital. KGT’s DPU of 7.82c per unit translates into a yield of 7.4%. We continue to urge investors to look beyond the advertised yield as it masks a partial return of capital from the gradual decline in service concession receivables. KGT’s service concession receivables represent the right to receive fixed and determinable payments from the NEA and PUB.

NAV declining. To put things into perspective, KGT’s NAV continues to be on the decline and currently stands at S$1 per unit. As at Dec 12, KGT’s NAV stands at S$1.05.

Current level of distributions not sustainable. KGT’s concession agreements on its Senoko Plant, Ulu Pandan Plant and Tuas DBOO Plant end in 2024, 2027 and 2034 respectively. As these concession agreements expire, KGT will witness a step-down in its overall distributions. We project KGT’s DPU to decline to 2.25c in FY25 following its first concession expiry.

Maintain SELL. With a true free cash flow yield of merely 2.4%, KGT certainly does not warrant as a compelling yield investment, in our view. The trust’s declining NAV, short remaining concession lives of its assets as well as its low true free cash flow yield are our key concerns. We maintain our SELL recommendation on KGT with a target price of S$0.72.

An insipid growth story. Q313 remains an unexciting quarter for KGreen Trust (KGT). The only catalyst for growth, that is acquisitions, remains nowhere in sight as we continue to witness KGT’s sliding net asset value (NAV).

Results stable, yet uninspiring. KGT delivered revenue of S$17.1mil and net profit of S$3.8mil in Q313, which are ‐1.7% and ‐4.2% lower than our projections respectively. Operation and maintenance (O&M) income continued to form the bulk of overall revenue at 74.9%, with future increases remaining dependent on annual adjustments of O&M and power tariffs to account for changes in consumer price index and fuel price.

Inching towards its first concession expiry. KGT is now another step closer to facing its first concession expiry on its Senoko Plant in 2024. Remaining concession agreements for the Ulu Pandan Plant and Tuas DBOO Plant are due for expiry in 2027 and 2034 respectively. We understand that these concession agreements are unlikely to be renewed.

Zero NAV the end‐game. We reiterate the declining NAV story of KGT. KGT’s assets are recognized as service concession receivables, that represents the right to receive fixed and determinable amounts of payments from its customers NEA and PUB over the concession period. Naturally, these service concession receivables will gradually decline over time as KGT receives its payments. KGT’s NAV of 99c per

share represents an all‐time low as at 30 Sep 2013.

Reiterate SELL. Since our initiation on 15 Apr 2013, KGT is down 9% and is currently trading at S$1.02. At current levels, we believe investors have yet to fully price in the investment negatives of KGT. With an unchanged fair value of S$0.78, we reiterate our SELL call on KGT.

Uninspiring prospects

We initiate coverage on K‐Green Trust (KGT) with a SELL call and a fair value of S$0.80.

KGT is a business trust listed on the Singapore Exchange, with a focus on ‘green’ infrastructure assets. KGT’s portfolio contains three assets, namely Senoko Waste‐to‐Energy (WTE) Plant, Keppel Seghers Tuas WTE Plant and Keppel Seghers Ulu Pandan NEWater Plant. Out of the three assets, we estimate that Senoko WTE plant accounts for approx. 70% of KGT’s overall cash flows. KGT’s assets are held on long‐term concession agreements with statutory bodies such as NEA and PUB, which have a remaining concession term of between 11 and 21 years.

Look before you leap. On the surface, KGT’s 7% yield may seem enticing compared to the average 5.8% yield across S‐REITs and business trusts at present. However, we note that KGT’s 7% yield comprises both a partial return of capital and free cash flow yield. We estimate that KGT’s partial return of capital makes up approx. 68% of its overall distributions, implying that its true free cash flow yield is merely a low 2.2%.

Self‐liquidating. We believe a 7% yield is insufficient to compensate for the cost of its lease runoff and declining NAV. With the concession agreement for the Senoko Plant expiring in 11 years’ time, we expect its overall distributions to be more than halved post 2024. Subsequent to the expiry of Senoko’s concession agreement, the concession for the Ulu Pandan Plant would cease in 2027, resulting in another step‐down in distributions. Moreover, the acquisition cost of KGT’s assets is recognized as service concession receivables, which will decline gradually as KGT receives its fixed capital cost payments from the NEA and PUB over time.

Limited scope for organic growth. According to KGT, its WTE plants namely Tuas DBOO Plant and Senoko Plant are already operating at near full capacity and therefore have limited room to take advantage of higher energy demand. While there is scope for capacity expansions at the Ulu Pandan Plant, there are currently no plans to commit capex to increase capacity at the plant.

Any upside will have to come from acquisitions. Although KGT’s zero gearing level is a plus, its inability to act on any acquisitions since its IPO listing probably brings into question its ability and willingness to leverage on its clean balance sheet and build on its existing cash flow stream. Given the management’s conservative approach towards acquisitions, we are currently not factoring in any acquisitions in our model.

Delivering a predictable stream of cash flows

K‐Green Trust (KGT) is structured as a business trust with three assets, specifically waste‐to‐energy incineration plants Senoko plant and Tuas DBOO plant as well as Ulu Pandan plant, which is a NEWater plant. These assets are operated under concession agreements with the NEA and PUB, of which KGT will build and operate the plant for a concession period between 15 and 25 years and subsequently transfer the plant to the governing agencies at the end of the concession period. Such concession arrangements are accounted for as service concession receivables.

A predictable stream of cash flows: As 80% of KGT’s revenue is derived from fixed capacity payments from the NEA and PUB under long‐term concession agreements, it offers a sustainable stream of cash flows that will continue to support its dividend yield. KGT offers a dividend yield of 7.2%, one of the highest among S‐REITs and business trusts currently. However, there will be no further distributions from the assets upon the expiry of the concession period. Upon the concession expiry of the Senoko plant in 2024, which contributes approx. 50% of the trust’s overall revenue, KGT will witness a significant step‐down in its overall distributions to Unitholders.

Scope to carry out yield‐accretive acquisitions: Due to its net cash position with zero debt, KGT has the financial clout to take on yield‐accretive acquisitions without raising equity finance.

Should KGT engage in acquisitions, this should help to mitigate the loss of income from the expiry of its existing concession agreements.

Declining NAV: The nature of KGT’s service concession agreements means that KGT is subject to declining service concession receivables as it approaches the expirations of its respective concession agreements. This will translate into declining book value over the coming years.