KONSORTIUM LEBUHRAYA UTARA-TIMUR (KL) SDN BHD - 2016

MARC has affirmed its AA-_IS and A- ratings on Konsortium Lebuhraya Utara-Timur (KL) Sdn Bhd’s (Kesturi) RM2.3 billion Sukuk Musharakah (Senior Sukuk) and RM180 million Redeemable Secured Junior Bonds (Junior Bonds) respectively. The outlook on both ratings is stable. The three-notch rating differential between the Senior Sukuk and Junior Bonds reflects the potential coupon deferral risk as well as the Junior Bonds subordination to the Senior Sukuk in respect of security ranking and payment priority.

Kesturi, which is wholly-owned by Ekovest Berhad (Ekovest), is the toll concessionaire for the 18-kilometer (km) Duta-Ulu Kelang Expressway (DUKE) which links matured catchment areas in the east and west parts of Klang Valley and the 16km DUKE Phase-2 which is under construction under a build-operate-transfer model. The concession period is until August 2059 with an option to extend for 10 years. DUKE Phase-2 is expected to improve DUKE’s connectivity to the northwest areas of Kuala Lumpur and the city centre via two key links at Jalan Tun Razak and Sri Damansara. As at September 30, 2016, the overall construction progress of DUKE Phase-2 was 90.1% against the scheduled progress of 96.6%.

The rating affirmation incorporates the satisfactory traffic performance of DUKE and the near-completion status of DUKE Phase-2 that mitigates construction and completion risks. The ratings also consider the sufficient liquidity buffer in the project accounts and manageable debt amortisation profile to withstand any cash flow mismatch arising from the shift in the completion date from December 14, 2016 to February 12, 2017, for which Kesturi has received the government’s approval. MARC views that the risk of a prolonged construction delay of more than six months from the new completion date of DUKE-2 is low as the engineering, procurement and construction (EPC) contractor Ekovest Construction Sdn Bhd (ECSB) has taken additional measures to prevent further progress delay, including mobilising manpower, machineries and material. In addition, issues related to project site and traffic management in certain areas that had led to the delay have now been resolved.

The risk relating to construction cost overruns is moderated by the RM1.18 billion fixed price arrangement with ECSB and the 5% cost overrun undertaking provided by project sponsor Ekovest. Furthermore, any liquidated and ascertained damages (LAD) payable by the concessionaire to the government arising from the delay is mitigated by the back-to-back LAD arrangement under the construction contract. In the latest quarterly monitoring report, the appointed independent consulting engineer ZKR Perunding Sdn Bhd (ZKR Perunding) had not identified any possible cost overruns, with the EPC contract sum remaining at RM1.18 billion.

For the financial year ended June 30, 2016 (FY2016), traffic volume on DUKE registered a slower growth of 1.2% to 130,587 vehicles, with actual average daily traffic (ADT) falling short of projections by 3.4%. This may be attributable to the increased toll rates since October 15, 2015. Over the near term, MARC expects performance variance on DUKE to widen further in light of the slower-than-expected traffic volume recovery post-toll hike and the anticipated delay in traffic contribution from DUKE Phase-2. Nonetheless, DUKE Phase-2, which comprises the two dual-carriageway three-lane Sri Damansara and Tun Razak links, is expected to provide a catalyst to traffic growth on the matured DUKE. The near-term traffic risk is also cushioned by the non-demanding sukuk repayment between 2019 and 2021, providing some headroom for traffic ramp-up in both DUKE and DUKE Phase-2.

For FY2016, Kesturi’s cash flow from operations (CFO) increased by 22.7% y-o-y to RM96.8 million on account of the higher toll rates and cash compensation receipt from the government. CFO interest coverage of 0.88 times in FY2016 remains weak, although it should not pose much concern given that near-term finance service costs have been partly pre-funded by the sukuk proceeds. Kesturi’s cash balance of RM157 million assuming full settlement of the outstanding contract sum for DUKE Phase-2 is sufficient to cover the next two semi-annual coupon payments on the rated sukuk. Based on key assumptions that DUKE Phase-2 commences tolling operations on July 1, 2017 and no dividend is paid throughout the tenure of the sukuk, Kesturi’s revised cash flow projections have minimum and average combined finance service cover ratios (FSCR) of 2.74 times and 6.12 times respectively.

In MARC’s sensitivity analysis, Kesturi’s cash flow coverage would remain fairly resilient under its stress scenarios that include a 2% reduction in DUKE’s traffic growth rates and a 30% decrease in toll revenues from DUKE Phase-2. Its cash flow coverage would also remain strong even if the remaining compensation receivables of RM18.6 million were not forthcoming and the toll schedule is deferred by 1.5 years without any compensation. MARC also views the potential dilution in the shareholding of Ekovest in Kesturi to an indirect 60% following its proposal to sell a 40% stake to Employees Provident Fund would have minimal impact on the toll concessionaire’s operational performance or on Ekovest’s technical support for the project.

The stable outlook on the ratings assumes traffic performance on DUKE would largely be in line with projections and DUKE Phase-2 would not experience prolonged delay from the new completion date. The ratings may face downward pressure if Kesturi’s credit metrics deteriorate due to an adverse development on the DUKE Phase-2 project and prolonged traffic underperformance.

Major Rating Factors

Strengths

• Easy accessibility to a wide network of major roadways;
• Long remaining life of extended concession; and
• Amortisation schedule matches debt service to project cash flows.

Challenges/ Risks

• Highly leveraged capital structure;
• Risk of cost overruns and completion delays in relation to the construction of DUKE Phase-2;
• Peak hour traffic bottlenecks on existing DUKE could limit future traffic growth; and
• Toll hike deferrals could weigh on project cash flows at later stage.