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Defensive utility stocks could ride infrastructure boom

Jeffrey Tan
Jeffrey Tan • 8 min read
Defensive utility stocks could ride infrastructure boom
SINGAPORE (Feb 18): Utility companies, which are usually deemed to be boring defensive stocks, could turn out to be sexy growth counters. This is because the growing demand for better infrastructure and amenities on the back of the population growth and r
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SINGAPORE (Feb 18): Utility companies, which are usually deemed to be boring defensive stocks, could turn out to be sexy growth counters. This is because the growing demand for better infrastructure and amenities on the back of the population growth and rising affluence in Asia-Pacific is leading to the implementation of new utility projects in the region.

“Because of their strategic significance, utility services have traditionally been provided by the public sector. However, ballooning population growth and fiscal constraints have resulted in more of the world’s utility services to spring from the private sector, which faces similar macroeconomic headwinds as other key industries,” according to SGX My Gateway, Singapore -Exchange’s investor education portal.

Notably, most of the locally listed utility stocks have seen a resurgence since the start of the year, reversing the decline of previous years. But are these stocks fundamentally sound?

For starters, many of them are still cheap compared with the Straits Times Index’s price-to-earnings multiple of 11.6 times — even after accounting for the run-up in their prices. All recorded positive margins in the last 12 months, with several enjoying double-digit figures. Most of the companies also had a positive return on equity, with many posting double-digit figures.

More utility projects

A utility stock investors might want to take note of is China Jinjiang Environment Holding, the first private waste-to-energy (WTE) operator in China. From Jan 1 to Feb 12, it recorded the highest total returns among its peers, at 30.4%. It also has the highest 12-month trailing earnings margin of 19.7% and highest 12-month trailing dividend yield of 8.5%. In addition, the stock is trading at an undemanding valuation of just 6.6 times earnings and 0.8 times book value.

China Jinjiang plans, builds and operates WTE facilities in China. The company operated 20 WTE facilities and two resource recycling projects in 12 provinces, autonomous regions and centrally administered municipalities there as at Sept 30, 2018. It also has a presence in Singapore, India, Brazil, Indonesia and Germany. In total, the facilities in operation have a waste treatment capacity of 29,240 tonnes a day.

The company is gearing up for a significant increase in capacity, in China as well as other markets. It now has six WTE facilities under construction and 21 in the “preparatory stage”. Upon completion, the total installed waste treatment capacity of all the facilities — including existing ones — will more than double to about 66,210 tonnes a day, says the company.

In Singapore, China Jinjiang is building what it claims is a “first-of-its-kind” mechanical biological waste treatment (MBT) project. Located at Tuas Avenue 2, this facility can treat 500 tonnes of municipal solid waste daily. Its associate company, JE Synergy Engineering, will provide engineering, procurement and construction-related services to the project for $66.6 million.

However, China Jinjiang will not own and operate the MBT facility. This is because the 20-year concession was awarded in 2016 to a consortium comprising Hangzhou Jinjiang Group — the controlling shareholder of China Jinjiang — and a Singapore-incorporated entity called Eastern Green Power. The company says “strict project rules” prevent the transfer of the tender from the consortium to another entity. The MBT facility will be owned and operated by JE Synergy, which is a joint venture established by HJG and EGP.

For 9MFY2017 ended Sept 30, China Jinjiang reported y-o-y revenue growth of 13.6% to RMB2.11 billion ($423.3 million) on the back of improvement across all its business segments. Earnings, however, fell owing to a combination of higher financing costs, administrative expenses and share of loss in a joint venture. During the period, earnings fell 4.5% y-o-y to RMB378.8 million, despite gross profit having increased 17.4% to RMB800.6 million. The company has a net debt position of RMB5.53 billion as at Sept 30.

Water treatment company China Everbright Water is another stock to consider. The company has “good deal flow”, which DBS Group Research reckons has gone unnoticed by the market. Plus, the stock is cheap, adds the brokerage.

Last year, China Everbright bagged multiple sub-projects under the Ji’nan Zhangqiu urban-rural integration water supply project in Shandong Province. These include the Zhangqiu Yellow River Water Transfer and Water Resource Replenishment Project, Zhangqiu Baiyun Water Plant Water Supply Project Phase I, and Zhangqiu Chengdong Industrial Water Supply Project. The projects are worth a total of about RMB1.52 billion.

China Everbright also secured the Ji’nan Sludge Treatment Project in Shandong Province and Jiangyin Waste Water Treatment (Binjiang Plant and Shizhuang Plant) Upgrading Project in Jiangsu Province. These are worth a total of about RMB90.61 million. Additionally, the company won the Dalian Pulandian Waste Water Treatment Project Phase II project in Liaoning Province worth about RMB82 million. It also secured other projects during the year.

“The company is progressing well in securing more projects, riding on the increasingly stringent requirements in water treatment standards by the government. It is getting more project extensions which allow capacity expansion, upgrade of treatment standards and higher tariffs. In addition, it is extending into new business areas such as leachate treatment,” DBS analyst Patricia Yeung writes in a Jan 16 note. “The strong project pipeline will sustain decent earnings and high earnings visibility.”

For 9MFY2018 ended Sept 30, China Everbright reported y-o-y revenue growth of 42% to HK$3.39 billion ($586.74 million). Earnings leapt 36% y-o-y to HK$515 million. The company has a net debt position of HK$5.78 billion.

China Everbright has the second-highest trailing 12-month margin of 14.1%. DBS has a “buy” rating on the stock with a price target of 47.5 cents. This implies an upside potential of 39.7% based on its Feb 12 closing price of 34 cents.

Attractive dividend play

Keppel Infrastructure Trust (KIT), which invests in a diverse portfolio of gas, electricity, water and waste management assets, has an attractive yield of 7.5%. Its distribution per unit (DPU) of 0.93 cent in 4QFY2018 ended Dec 31 was in line with expectations, says DBS.

The steady DPU can be attributed to the trust’s unique top line. DBS notes that most of KIT’s assets derive revenue from availability-based payments, which are independent of actual offtake. “Hence, cash flows are highly predictable and not exposed to economic cycles,” DBS analyst Suvro Sarkar writes in a Jan 23 note.

Now, with the recent shareholder approval obtained by KIT to fully acquire Ixom and fund its acquisition in part via a preferential offering and placement, its prospects could be rosier. Ixom is a leading chemicals manufacturer and distributor in Australia and New Zealand, supplying industrial and specialty chemicals, such as liquefied chlorine, chlorine derivatives and caustic soda. It has an enterprise value of about A$1.1 billion ($1.06 billion), according to KIT.

“We believe the deal is a step in the right direction as it diversifies the asset base, arrests the net asset value decline, lengthens the effective life of the trust and creates organic growth potential, which was largely missing till now,” says Sarkar. “Valuations look reasonable and much lower than what KIT itself is trading at in terms of EV/Ebitda (enterprise value to earnings before interest, taxes, depreciation and amortisation), so [it] doesn’t look like management is overpaying for the asset.”

That aside, there may be risks arising from a legal dispute between KIT’s wholly-owned unit Basslink and the State of Tasmania. The latter alleged that the former had breached the Basslink Operations Agreement, leading to the six-month outage in 2016. Tasmania is claiming losses of A$100 million.

However, DBS reckons that the trust is “sufficiently” protected from such troubles. “Even in the worst-case scenario, KIT will not be liable to pay any damages as any claims against Basslink are ring-fenced at Basslink level. In any case, KIT does not depend on cash flows from Basslink for current distributions, and project loans are also non-recourse to KIT. We ascribe zero value to Basslink in our valuation for KIT, hence any negative newsflow from Basslink is an irritant at best and does not affect fundamentals for KIT,” says Sarkar.

DBS has a “buy” call on the stock with a price target of 58 cents, which is an upside potential of 17.2% based on its Feb 12 closing price of 49.5 cents.

Cheap, but lacking growth

Among the Straits Times Index component stocks, Sembcorp Industries is one of the very few with a significant utilities business. However, SCI’s steady utilities business is weighed down by its 61%-owned Sembcorp Marine, which is still suffering from the oil slump.

As such, UOB KayHian expects Sembcorp’s upcoming results for 4QFY2018 ended Dec 31 to show few surprises on the upside. Instead, the market will likely focus on the company’s strategy and status of its India IPO, says the brokerage. The company will also be scrutinised on how it intends to fund future inorganic growth, given the slow pace of divestments and limited cash balance to support both the utilities and marine businesses. “Funding of large projects may be an issue going into 2019 if divestments do not pick up, and we are somewhat concerned,” UOB KayHian analyst Foo Zhi Wei writes in a note dated Feb 1.

Still, UOB KayHian is keeping its “buy” call on the stock, only because it is cheap. Current share price implies a non-marine one-year forward price-to-earnings multiple of 7.5 times, slightly below its long-term mean of eight times, and dividend yield of 2.4%, it says. UOB KayHian has a price target of $3.20, implying an upside potential of 26% based on its Feb 12 closing price of $2.54.

This story appears in The Edge Singapore (Issue 869, week of Feb 18) which is on sale now. Subscribe here

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