Tanjong ... Jul10

Tanjong plc (RM17.50) is hoping that some of its bids for new power projects will come to fruition over the next few quarters. In the meantime, earnings from its existing power assets are expected to remain relatively resilient — although overseas earnings, denominated mostly in US dollar, are hurt by the stronger ringgit.

Higher dividends?
Steady cash flow from operations will sustain the company’s dividend payments. Tanjong raised the first interim dividend to 20 sen per share, up from 17.5 sen per share in the previous corresponding quarter. This could bode well for total payments for the current financial year ending January 2011.

Gross dividends totalled RM1 per share in FY10 which comprised four quarterly dividends of 17.5 sen, each plus a final dividend of 30 sen per share. Even assuming dividends remain at RM1 per share, shareholders will still earn a fairly decent yield of 5.7% at the prevailing price.

Good chance of securing new power projects
Dividends aside, we believe the stock offers good prospect for capital gains — which will be driven, primarily, by growth for its power business.

The company was successful in its bids for select power assets in 2006 and, again, in 2007. The subsequent global economic downturn resulted in few new projects. But with the recovery, there are now quite a number of greenfield power projects on the block, including those in the UAE, Egypt, Bangladesh, Oman and Saudi Arabia — a region where Tanjong has already an established track record as one of the larger private power generators. Thus, the company is fairly upbeat on its chances to secure at least one or more of these projects.

Indeed, Tanjong aspires to add some 4,000MW to its power-generating portfolio over the next five years. The company has a relatively strong balance sheet to leverage on. Its existing power plants generate a cumulative RM1 billion in cash flow annually while the company has over RM1.5 billion in gross cash, some RM1.3 billion of which lies with the power business.

The successful acquisition of earnings accretive assets will drive valuations lower. Already, Tanjong shares are trading at attractive valuations of about 11.1 times our estimated forward earnings — well below the estimated P/E of about 15-16 times for the broader market.

Contributions from power projects located abroad accounted for roughly 46% of the company’s earnings before interest and taxes (Ebit) in the latest quarter ended April 2010. Including earnings from the three local power generating plants, power made up about 79% of Tanjong’s Ebit — and will continue to be the main driver for growth going forward.

Less rosy for gaming units
On the other hand, outlook for the gaming division — the numbers forecast totalisator (NFO) and racing totalisator (RTO) businesses — is less rosy.

The NFO business fared relatively well in 1QFY11, despite a decline in sales per draw, thanks to a lower-than-average prize payout. The company attributed the drop in sales per draw to the high number of special draws, seven in 1QFY11, which diluted sales for normal draws as well as competition from new games offered by the other players. Its share of the NFO market dipped by about 1.9% to an estimated 20.8%.

With the higher government betting duties of 8% — up from 6% effective June — and a normalisation of the prize payout, we expect earnings will be subdued for the foreseeable future.

The major industry players are currently exploring various measures to mitigate the impact of the higher taxes. These include the possibility of reducing the prize payout, although such a move may play into the hands of the illegal operators, currently estimated to be about the same size as the legal NFO market.

Elsewhere, the RTO business remains deep in the red in 1QFY11. Tanjong is working hard to resolve some of the cost overrun issues at the turf clubs and expects to see improvement towards the end of the financial year. Even so, it will most likely stay in the red going forward, but hopefully at lower levels.

In short, the gaming division is still a reliable cash cow, with steady cash generation and limited capital expenditure requirement. But the highly regulated and mature nature of the industry is unlikely to translate into meaningful earnings growth. Gaming accounted for under 15% of Tanjong’s EBIT in 1QFY11.

Other businesses small relative to power
The property and leisure — Tropical Islands and TGV Cinemas — divisions collectively accounted for the remaining 6% of Tanjong’s Ebit in 1QFY11.
Menara Maxis is fully occupied while TGV is doing relatively well on the back of improved attractions and more screens. Nonetheless, neither business is expected to register growth that is material to Tanjong’s overall earnings.

Tropical Islands should continue to see very gradual improvement in its operations. A turnaround is still very much dependent on the availability of on-site accommodation, which will lengthen visitor stay and widen its catchment area.

Under an agreement with a third party developer, a total of 439 vacation homes are targeted to be completed by end-2012. So far, 23 units have been completed with another 48 or so to be put up over the next few months. However, financing remains a hurdle, especially amid the prevailing tight credit environment.

To speed up the process, Tanjong is exploring potential tie-ups with other third party investors for alternative forms of accommodation, such as hotels, as well as recreational facilities including restaurants and cinemas in the resort.

Note: This report is brought to you by Asia Analytica Sdn Bhd, a licensed investment adviser. Please exercise your own judgment or seek professional advice for your specific investment needs. We are not responsible for your investment decisions. Our shareholders, directors and employees may have positions in any of the stocks mentioned.