Syarikat Bekalan Air Selangor Sdn Bhd - 2010 Credit Commentary Report

MARC has revised the issue ratings of the Selangor water sector, including Syarikat Bekalan Air Selangor Sdn Bhd (SYABAS), following a review of the ratings which was initiated in June 2010. The single notch downgrade of SYABAS’ long-term rating to A+ID from AA-ID reflects continued cash flow challenges at the Selangor state’s sole water distributor as reflected by its inability to meet its monthly payment obligations in full to bulk water producers in the state. SYABAS’ historically negative annual cash flow from operations (CFO) and recurring capex have continued to exert pressure on its credit profile with no offsetting positive developments in respect of its deferred January 2009 tariff hike. Furthermore, there has yet to be payments made by the state on compensation claimed by SYABAS due to the tariff hike delay. SYABAS’ payments to bulk water producers have been in excess of its water revenues receipts from consumers. Following the downgrade of SYABAS’ long-term rating, the ratings of MARC-1ID / A+ID on SYABAS’ RM3.0 billion Bai’ Bithaman Ajil Commercial Papers/ Medium-Term Notes Programme have been placed on MARCWatch Negative, premised on SYABAS’ continuing negative working capital position, rising debt leverage and uncertainty over the outcome of industry restructuring talks and the securing of tariff hikes, notwithstanding the absence of any significant near-term debt maturities.

SYABAS is the sole distributor of treated water for the state of Selangor and the Federal Territories of Kuala Lumpur and Putrajaya. Demand risk is regarded as low as demand from its service areas remain robust and its customer base is diversified. SYABAS is 70%-owned by Puncak Niaga Holdings Berhad (PNHB) and 30%-owned by the Selangor state government via Kumpulan Darul Ehsan Berhad (KDEB) (15%) and Kumpulan Perangsang Selangor Berhad (15%). The federal government, through the Minister of Finance Incorporated, holds one golden share in SYABAS which requires the written consent of the federal government to be obtained prior to any asset disposal or merger.

Based on its audited financial statements for the year ended December 31, 2009 (FY2009), SYABAS posted a 34.0% increase in revenue at RM1,869.3 million (FY2008: RM1,394.8 million) and pre-tax profit of RM374.2 million. In FY2009, SYABAS recognised RM434.18 million of compensation for the deferred tariff hike as revenue and as a corresponding trade receivable. Nevertheless, MARC notes that the Selangor State Government (SSG) has not gazetted the revised rates as of September 2010. Excluding this amount, revenue would be flat at RM1.435 billion and, with appropriate adjustment made to its amortised project development expenditure and government grant, SYABAS would have reported a smaller pre-tax profit of RM67.1 million. Reflecting slower payments to water treatment operators (WTOs), trade payables outstanding more than doubled to RM690.4 million as at end-FY2009 (FY2008: RM339.7 million) while average days payables lengthened to 345 days (FY2008: 243 days). On top of an increase in redeemable preference shares (RPS) subscribed by the Ministry of Finance (MOF), SYABAS received an unsecured interest-free loan in December 2009 of RM320.8 million from the federal government which was utilised to meet outstanding payments for water purchased from the WTOs. As at December 31, 2009, SYABAS’s total borrowings stood at RM3,155.8 million (FY2008: RM2,770.6 million). SYABAS’ FY2009 unadjusted debt-to-equity (DE) ratio stood at 2.2x. The DE ratio would be lower at 2.0x in FY2009 excluding the interest-free loan from the government. The DE ratio would be higher at 3.1x in FY2009 inclusive of the interest-free loan and should a reversal of previously recognised revenue occur with respect to the compensation for the deferred tariff hike.

The recent regulatory and operating environment uncertainties have challenged the perception of strong implicit government support and highly predictable cash flow the water sector has historically enjoyed. MARC believes that urgent intervention on the part of the federal and/or state government of Selangor is required to prevent a freefall of the current rating in the following months. A further multiple-notch rating downgrade is likely by end of 2010 in the absence of meaningful progress in industry restructuring negotiations and action on the part of the issuer and/or project sponsors to achieve closure on the above issues.