Syarikat Bekalan Air Selangor Sdn Bhd - 2008 / 2009

MARC has affirmed Syarikat Bekalan Air Selangor Sdn Bhd’s (SYABAS) RM3.0 billion Bai Bithaman Ajil Commercial Papers/Medium Term Notes Programme ratings of MARC-1ID /AA-ID. Concurrently, MARC has revised the rating outlook to developing from stable to reflect SYABAS’ increased risk of lower-than-expected tariffs and early termination of its water distribution concession agreement (CA). In addition to the uncertainty posed by the deferment of its scheduled tariff adjustment in 2009 and ongoing restructuring of the Selangor water sector, SYABAS could potentially face the risk of unilateral termination of its CA arising from purported breaches of its CA as reported by the media. Queries have been raised over SYABAS’ alleged failure to comply fully with the requirement for contracts to be awarded on an open tender basis, differences in actual vis-à-vis approved expenditure, and discrepancies in certain documentation on contracts awarded. Under the CA, the concessionaire is given a period of three months to remedy a breach of its obligations under the CA upon issue of a default notice by the Selangor State Government (SSG). The issuance of any default notice and subsequent termination of the CA arising from failure by SYABAS to remedy the default will, however, require the consent and agreement of the federal government. SYABAS has confirmed that it has not received any official notification on the alleged breaches and also that all its actions have been in compliance with the provision of the CA. MARC will continue to monitor the foregoing developments and take rating actions if warranted by changes in SYABAS’ financial profile.

The affirmed ratings, meanwhile, reflect SYABAS’ dominant position as the sole distributor of treated water for the state of Selangor and the Federal Territories of Kuala Lumpur and Putrajaya, the low risk nature of the water industry, the increasing water demand in its service areas and the company’s improving credit collection efficiency. The ratings are, however, moderated by the heavy ongoing capital expenditure incurred to enhance operational efficiency and to reduce Non-Revenue Water (NRW) which continues to be reflected in persistent large negative free cash flows. SYABAS is 70% owned by Puncak Niaga Holdings Berhad while the remaining 30% is owned by the SSG wholly-owned subsidiary, Kumpulan Darul Ehsan Berhad. The federal government, through the Minister of Finance, Incorporated holds one golden share in SYABAS.

SYABAS’ CA provides for a revision in water tariffs for end-consumers every three years. However, its tariff review which was due on January 1, 2009 has been deferred to March 31, 2009. The scheduled new tariff rate of RM1.90/m3, is an increase of 37% from the current average tariff rate of RM1.39/m3. As an incentive for SYABAS to achieve operational efficiency, the tariff formula incorporates various performance-linked adjustments including the required NRW level as prescribed in the CA. The NRW measured over a period from July 1, 2008 to October 7, 2008, was 31.18%, against the CA’s target of 28.90%. Despite improving to 30.19% towards end-November 2008, SYABAS’ NRW level remains above the target and could affect SYABAS’ prospects of obtaining its full 37% water tariff hike. Notwithstanding the tariff review process provided by the CA, MARC believes that a tariff hike will run contrary to the SSG’s stated intention to ensure water tariffs remain affordable. Whilst SYABAS is entitled to compensation under the CA, the concessionaire could incur an estimated loss of revenue of RM450.0 million annually from 2009 through 2011 in the event that the tariff hike is not approved and no compensation is received.

For financial year ended December 31, 2007 (FY2007), SYABAS sustained its financial performance on the back of the robust demand for water and reduction in NRW. It recorded a revenue of RM1,333.1 million and pre-tax profit of RM193.8 million in FY2007. SYABAS continue to record negative free cash flow of RM846.7 million in FY2007 (FY2006: negative RM816.3 million) as a result of its heavy capital expenditure programme and rising interest costs stemming from an increase in borrowings. In light of SYABAS’ ongoing heavy capital spending programme in coming years, MARC expects free cash flow to remain negative until 2011.

Despite the strain exerted by its persistent negative free cash flow on its liquidity, SYABAS maintains adequate liquidity to service its next coupon payment of RM5.75 million in February 2009. Principal redemption on the rated debt securities commences in year 2013. SYABAS’ finance service cover ratio (FSCR) as at December 31, 2007 of 6.67 times (x) remains in compliance with its minimum required FSCR covenant of 1.25x.

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