Mudajaya .. Oct10

CIMB Research

Investment highlights
• End to SC query; maintain BUY. Mudajaya has received a letter from the SC stating that it had reviewed the final auditor’s report on the Indian IPP. This is positive as it should put a close to the “poison letter” episode. We are also positive on the MOU inked for the Laos hydropower though we do not expect it to contribute to earnings for at least a few years. These announcements should extend the rerating of the stock, which has bounced back 69 sen or 18% from its low in early Aug 10 and is 22% off the RM5.94 high achieved in Jul 10. We make no changes to our earnings forecasts, BUY call or RM7.94 target price, which we continue to base on a 20% discount to RNAV. Other potential re-rating catalysts include contract wins and positive earnings surprises.

• Auditors report reviewed. In its letter, the SC said that it had reviewed the transaction relating to Mudajaya's investment in the Indian IPP via the auditors report which was finalised and submitted on 9 Sep 2010. It also highlighted that clarification/disclosures made by Mudajaya previously were inadequate and reminded management to comply with good corporate government standards.

• Positive on Laos Hydropower but still too early. The group also announced that it has inked an MOU to take up a 75% stake in a proposed 60MW hydropower plant in Laos. The civil and engineering works is estimated at RM400m and the concession will stretch for 30 years. This is good news for the group’s regional initiatives. However, it is too early to factor this project into our forecasts as it will take 21 months to wrap up the feasibility study, after which it will proceed with the signing of the concession agreement (CA) and negotiations on the power purchase agreement (PPA).

Recent developments
Mudajaya announced that it has received a letter from the Securities Commision (SC).

Key points are:
• The SC has reviewed the transaction relating to Mudajaya's investment in the Indian IPP via the auditors report which was finalised and submitted on 9 Sep 2010.

• Despite having reviewed all disclosures made by Mudajaya, the SC highlighted that clarification/disclosures made by Mudajaya previously were inadequate. This resulted in a more detailed announcement/disclosures on "specific areas" of the Indian IPP venture on 30 Aug 10.

• As a word of caution/reminder from the SC, Mudajaya needs to ensure continuous compliance with Bursa’s disclosure requirements and obligations. The SC expects companies to observe high standards of corporate governance in discharging their duties and responsibilities.

• The SC will not hesitate to take appropriate action against Mudajaya if it is found to have breached any provisions of the securities laws or Bursa’s disclosure requirements in future.

A separate statement that the SC posted on its website indicated that the auditors’ report also revealed that the movement of funds between Mudajaya and related entities is characteristic of the practice known of as “round tripping”. According to the SC, the practice of “round tripping” has been raised as a concern in several jurisdictions. The SC will conduct a separate exercise on the use and disclosures associated with it. According to Business Times, an SC spokesperson has clarified that it is studying the practice of round tripping in general, not specifically for Mudajaya.

Mudajaya also announced that it has inked an MOU with the Laos government for a proposed 60MW hydropower plant. A feasibility study will be conducted by Mudajaya within 21 months. If the feasibility study goes through, the deal will proceed to forming a project development agreement (PDA) followed by the signing of the 30-year concession agreement (CA). Mudajaya will hold a 75% stake while the balance to be held by the Laos government.

Putting a close to the episode. This is a positive development as the contents of the letter suggest conclusion of the SC query given that the SC has fully reviewed the auditors' report. We interpret this as the long-awaited final statement/indication from the SC, and therefore, an end to this episode. The announcement should extend the re-rating of the stock. Based on yesterday's pre-suspension price of RM4.61, the stock has bounced back 69 sen or 18% from its low in early Aug 10 and is 22% off the high of RM5.94 achieved in Jul 10 before the leak of the poison letter.

“Round tripping” as we know it. Based on our understanding, round-tripping implies a scenario where an entity has ownership of a concession and, at the same time, recognises profits from the construction/development of the concession asset. This structure is commonly practised by infrastructure specialists for various concession assets including toll highways, power plants, railways, and water. Although the SC is looking into round tripping, we note that this will be on a general level and does not necessarily have negative implications for Mudajaya’s IPP structure.

In our 9 Aug 10 note, we highlighted that in Mudajaya's case, the total development cost/per MW of US$0.9m for the 1,440MW power plant is 16% below the standard/benchmark for existing IPPs in India of about US$1m-1.2m/MW. Given that the group's Indian IPP is one of the cheapest ones around, there is arguably very little basis for inflated round-tripping profits to begin with.

Positive on Laos hydropower but still too early. We are positive on the MOU for the Laos hydropower venture. The announcement is not entirely unexpected as it is in line with management’s guidance of a possible positive development in that region by end-10. Working on a 10-15% pretax margin on the guided RM400m contract value and a 5-year development period, this project would increase FY10-12 net profit by 3-7%. But it is too early to factor this project into our forecasts as it will take at least 18-21 months to wrap up the feasibility study, after which it will proceed with the negotiations on the power purchase agreement (PPA). Assuming an 80:20 debt equity structure, the group’s share of equity would bet RM60m, which it can finance through internal funds.

Earnings outlook
Shipment of major power plant equipment has started. We retain our earnings forecasts which impute RM3.4bn worth of EP works for the Indian IPP. Profits from the EP works should come in strongly from 3Q10 onwards as the delivery of major equipment such boilers, turbines and generators (BTG) for Unit 1 has commenced. Delivery for units 2, 3 & 4 will come through progressively until 2012. We continue to assume a conservative pretax margin of 20-25% for the EP works, which make up 40-60% of our FY10-12 net profit forecasts. The 360MW Unit 1 is on track for commissioning by mid-2011. The group has so far recognised ~10% of the RM3.4bn EP works. Profits from the EP works should peak at end-2011 or early 2012.

Valuation and recommendation
BUY recommendation and RM7.94 target price reaffirmed. We view positively the letter from the SC. Although we are slightly disappointed that the announcement did not clearly indicate the status of the SC query, we interpret it as the long-awaited final statement/indication from the SC and, therefore an end to this episode. The signing of the MOU for the Laos hydropower is another positive regional development though it will be some time before it contributes to earnings. These announcements should extend the re-rating of the stock which has bounced back 69 sen or 18% from its low in early Aug 10. We make no changes to our earnings forecasts, BUY call or RM7.94 target price, which we continue to base on a 20% discount to RNAV. Other potential re-rating catalysts include contract wins and positive earnings surprises. Trading of the stock will resume today.