PBA ... Apr11

Mercury Securities Sdn Bhd Research

BACKGROUND
In 1999, Perbadanan Bekalan Air Pulau Pinang SB (PBAPP) (Penang Water Supply Corporation) was corporatised to serve as Penang’s water supply company. In 2001, PBAPP became a wholly-owned subsidiary of PBA Holdings Bhd (PBA). In 2002, PBA was listed on Bursa Malaysia’s Main Board.

“Supply of water to Penang”
PBA’s operations in the state of Penang mainly involve the sourcing, treatment, supply and sale of water to the public. PBAPP is the water supply company that serves the State of Penang in Malaysia. The Chief Minister of Penang, YAB Tuan Lim Guan Eng is now the Chairman of both PBA and PBAPP.

Pinang Water Limited (PWL)
PWL is a joint venture amongst PBA, Ranhill Water Technologies Sdn Bhd and YLI Holdings Bhd. PWL had successfully built the Yuan He Water Treatment Plant in Yichun City in China. Its wholly-owned subsidiary manages the plant.

Island Springwater Sdn Bhd (ISSB)
ISSB, PBA’s wholly-owned drinking water bottling company had commenced its marketing and business operations in September 2009. Its water bottles (Island brand) have been sold to various organizations, such as government departments, hotels and corporate bodies. Besides venturing into the retail market, ISSB is also looking at securing OEM products.

PBA Resources Sdn Bhd (PBAR)
PBAR manages the operations of 2 subsidiaries – the eco-friendly Air Itam Teambuilding Centre (AITC) and the Penang Water Services Academy (PWSA), a water industry training academy set up jointly with the Penang Skills Development Centre (PSDC). In 2010, AITC’s complex had been upgraded to be able to accommodate up to 100 trainees at the same time.

“Training services”
PWSA’s students included PBAPP staffs, SPM school leavers and representatives from other water-service organisations. PWSA is running its Malaysia Skills Certificate (Sijil Kemahiran Malaysia – SKM) courses (that is recognized by the Ministry of Human Resources) for school leaves since the 2nd quarter of 2010. Additionally in January 2010, PWSA formed a strategic partnership with MARA to organize apprenticeship programmes, technical training programmes and plumbing licence courses.

PBA Holding’s management team is led by its CEO Ir. Jaseni bin Maidinsa. Jaseni is also the GM (general manager) of PBAPP. He is has a civil engineering background and has worked for PBAPP and its predecessor for more than 24 years.

NRW (non-revenue water) is a key performance indicator in the water supply industry. NRW refers to water that is “lost”, mainly through leaks in the mains, burst pipes and the flushing of mains and pipes, as well as water theft and fire fighting. It is measured as the difference in percentage between the volume of water produced in a year and the actual recorded consumption.

“State with lowest NRW”
Since 2000, PBAPP has been gradually reducing and controlling the NRW percentage in Penang to 19.1%, which is the lowest NRW percentage in Malaysia. This relatively low percentage reflects high efficiency in water supply management.

The average NRW percentage for all water supply companies in Malaysia in 2007 was 37.5%. PBAPP manages the NRW percentage in Penang by adopting technical strategies and methodologies promoted by the International Water Association (IWA).

In Penang, 1% of NRW is equivalent to 2.72 billion litres of water (as at 2008). Based on the current production costs, the value of 1% of NRW recovered or saved in Penang is about RM1.7 million.
Besides cost savings, the efficient NRW-management in Penang also helped PBAPP to ensure sufficient water supply coverage without the implementation of additional costly multi-million water infrastructure projects that might impact water tariffs.

OUTLOOK/CORP. UPDATES
In tandem with the improving domestic economy (GDP terms), we expect that the group’s water revenues would grow as well. Water is a relatively inexpensive consumer expense, and we foresee that the demand would grow steadily, especially for trade/industry users.

“Economy growing steadily”
The latest available Malaysian economic data (January 2011) revealed reasonably positive growth rates in y-o-y percentage terms, for instance: IPI (+1.0 y-o-y), Manufacturing Sales (+7.7% y-o-y), Exports (+3.0% y-o-y) and Imports (+13.5% y-o-y). Malaysia had also reported a very respectable 4Q/2010 GDP growth of +4.8% (+7.2% for full year 2010 GDP), stable 4Q/2010 unemployment rate of 3.2% and manageable CPI of 2.4% (January 2011). Meanwhile, Bank Negara Malaysia (BNM) had last reaffirmed its accommodative overnight policy rate (OPR) of 2.75% on 11th March 2011.

“New Trade Tariff structure implemented”
PBA had implemented a new water tariff structure on 1st November 2010. It represented a 27% hike in water tariffs for all “trade category” water users. Nevertheless, in PBA’s 4Q/FY10 figures, we did not notice any significant increase in revenue. Prior to this, the last trade tariff review in Penang was in 2001, while water supply costs had risen by 64% during the past 10 years.

VALUATION/CONCLUSION
With regards to the status of the debts (totalling RM9.2 million) due to PBA from related party transactions (which have been outstanding for more than 12 months and which have not been fully settled) as of 31st December 2010, PBA is in the midst of finalizing the terms of settlement proposals with the related party. The settlement proposal is targeted to be finalized by 2011 and the details will be announced upon finalization.
“Share buybacks”

During FY10 ended 31st December 2010, PBA had repurchased 2,000 of its issued shares from the open market at an average price of RM0.85-RM0.89 per share. The shares repurchased are being held as treasury shares.

PBA had declared and paid out a total of 3 sen tax exempt dividend per share (DPS) (or equivalent to 4 sen gross DPS) for its FY10 ended 31st December 2010. In recent years, PBA had consistently implemented dividend payouts of at least 30% of its annual net earnings. We expect that PBA would be maintaining this level of dividend payout for its FY11.

“Reasonable dividends”
With an adjusted beta (correlation factor) of just 0.67 to the KLCI, PBA has slightly outperformed the KLCI this year (by +1.1% vs. -0.55% year-to-date (YTD)). Market conditions have also been volatile lately, impacted by the recent political uprisings in the Middle East/North Africa and major earthquake in Japan. Nevertheless, as PBA is not an especially large market-cap stock, this may put a dampener on its market visibility and trading volume.

“Buy Call”
Based on our forecast of PBA’s FY11 EPS and an estimated P/E of 11 times (within its historical range), we set a FY11-end Target Price (TP) of RM1.12. This TP offers 24.3% upside from its current market price. Our TP for PBA reflects a P/BV of just 0.55 times over its FY11F BV/share. Meanwhile, the local water service sector’s average P/E and P/BV is 14.5 times and 1.0 times, respectively.

“Planning Ahead”
PBA’s management has planned well for the coming years, with the implementation of new trade tariffs and WCS. It has also planned ahead in terms of capital expenditure (capex) and measures needed to lower NRW levels.
We find that PBA’s P/E and P/BV valuations are quite undemanding, while it has reasonable dividend yields and ROEs. Meanwhile, the group’s gearing levels are very minimal, and it may even turn into a net cash position during its FY11.
Nevertheless, PBA’s businesses also face risks such as a possible slower rate of economic growth, weak trade consumer demand, foreign exchange fluctuations and rising costs (e.g. electricity, oil/gas, chemicals for water treatment and plastic for its water bottles).