Konsortium Lebuhraya Utara-Timur (KL) Sdn Bhd - 2013

MARC has assigned ratings of AA-IS  and A- to Konsortium Lebuhraya Utara-Timur (KL) Sdn Bhd's (Kesturi) issuances of up to RM2,300 million in nominal value Islamic medium term notes programme (Sukuk Musharakah or Senior Sukuk) and RM180 million redeemable secured junior bonds (Junior Bonds) due 2034, respectively. The rating outlook is stable.

Kesturi is the concession holder of the Duta-Ulu Kelang Expressway (DUKE or project). Kesturi operates the DUKE, which currently comprises 18 kilometres (km) of dual four- and three-lane carriageways linking east and west Kuala Lumpur, under a concession agreement (CA) with the Government of Malaysia. In December 2012, the concession term was extended by 20 years, to 2059, as part of the agreement with the government to extend the expressway by constructing two additional links ie Sri Damansara Link and Tun Razak Link.
 
Net cash proceeds from the issuances will be used mainly to fund the early redemption of its RM820 million Sukuk Musharakah and part-finance the construction of 16km of greenfield dual three-lane extensions to DUKE (DUKE Phase-2) costing RM1.18 billion. Kesturi will also redeem and replace its existing RM50 million Junior Bonds due 2030 with Junior Bonds due 2034 of the same aggregate amount.

The ratings reflect: i) DUKE's continued importance as an integral link in Kuala Lumpur's road network, as evidenced by strong traffic volume and revenue growth since tolling commenced in May 2009 (2012: 11.5% and 11.7% year-on-year respectively); ii)  the long remaining life of the extended concession which provides a 25-year debt-free tail before concession maturity; iii) a manageable debt maturity profile as its Senior Sukuk amortisation schedule is spread between 2019 and 2033, commencing almost three years after the expected completion of DUKE Phase-2 in September 2016; iv) base case forward-looking finance service cover ratios (FSCR) which are projected not to fall below 2.84 times (x) for the Senior Sukuk and 2.43x on a combined basis incorporating the Junior Bonds; and v) Senior Sukuk 1.75x minimum FSCR and 2.25x post-distribution FSCR maintenance covenants which will help ensure strong cash flow coverage of debt service during the term of the Senior Sukuk.

The above positives are moderated by: i) the incremental financial leverage undertaken to fund the construction of DUKE Phase-2; (ii) the risk of underperformance of traffic forecasts, updated in June 2013, including slower-than-expected traffic ramp-up on the new links; (iii) toll hike deferral risk; and (iv) moderate completion risk in respect of the construction of the Sri Damansara Link and Tun Razak Link, the two additional links which form DUKE Phase-2.

The three-notch rating difference between the Senior Sukuk and Junior Bonds principally reflects the subordinate position of the Junior Bonds, coupon deferral risk, and the fact that they do not amortise before their maturity in 2034.

The construction of DUKE Phase-2 is expected to commence in December 2013 and take 34 months, under a fixed-price contract with Kesturi’s 70% shareholder Ekovest Berhad which will subcontract the construction works to its 100%-owned subsidiary Ekovest Construction Sdn Bhd (ECSB). MARC notes the experience of ECSB from its earlier involvement as main contractor of the existing DUKE, the contractual terms protecting Kesturi in the case of cost or time overruns, as well as the project sponsors' undertaking to provide contingency funds of up to RM60 million, approximately 5% of the contracted sum of RM1.18 billion.

The DUKE provides connectivity to important arterial roads in the Klang Valley. The expressway's traffic base is commuter-oriented and it serves catchment areas with high population and vehicle density, and resilient economic activity. MARC has reviewed the updated traffic study by Perunding Trafik Klasik Sdn Bhd (PTK), which provides the basis for Kesturi's toll revenue projections. Between 2013-2016, average daily traffic (ADT) is forecast to grow at a fairly robust three-year compound annual growth rate (CAGR) of 6.2% before rising to 6.8% for 2017-2020 with the benefit of additional traffic volume on DUKE Phase-2. However, MARC notes that the traffic forecasts do not incorporate the impact of the planned public transit improvements. Also, capacity limitations at peak times may not be fully reflected in the traffic forecasts, particularly with respect to the ability of the existing DUKE to accommodate incremental traffic from the Tun Razak Link.

Kesturi's first amortisation payment starts in 2019; the amortisation schedule of the Senior Sukuk matches debt service with the anticipated ramp-up in cash flows of the concession. Kesturi's debt service ramps up significantly in 2022 and 2025, which suggest that project cash flows will be sensitive to extended delays in implementing scheduled toll adjustments in 2019 and 2024 unless adequate cash compensation is received from the government. Assuming toll increases are implemented according to schedule, MARC's cash flow sensitivity analysis of Kesturi's financial projections show that it can still sustain debt service of the Senior Sukuk under a stress scenario which combines a 10% traffic shortfall on the existing DUKE with a 50% traffic shortfall on DUKE Phase-2 against PTK's traffic projections. However, this will materially dilute projected coverage ratios. As with most highway financings, the major risks to the financial projections are traffic volume and tariff adjustments falling below forecasts.

The project is highly geared; it has been developed with modest use of ordinary equity to date. The post-financial close project funding structure comprises RM2.12 billion of senior debt, RM180 million of hybrid debt, RM195 million of Series A redeemable preference shares (RPS), RM45 million of RPS and RM5 million of ordinary equity. Kesturi will be undertaking a proposed capital structure reorganisation exercise involving the redemption of its RM195 million Series A RPS and subsequent capitalisation of the outstanding amount (together with accrued dividends) into new ordinary shares in Kesturi. The proposed exercise which is targeted to be completed by end-2013, will help reverse the trend of recurring losses by reducing Series A RPS-related financing costs taken through Kesturi's profit and loss account. Kesturi expects to turn its accumulated losses of RM186.6 million on its balance sheet into positive retained earnings by 2015.

The stable outlook reflects MARC's anticipation that construction of DUKE Phase-2 will proceed on schedule and within budget. It also reflects the rating agency's expectation of continued resilience in demand as DUKE implements the first of seven scheduled toll increases under the CA on January 1, 2014. In the near to intermediate term, the absence of any debt amortisation payments also provides downside protection from traffic under-performance risk.

Major Rating Factors

Strengths

• Resilient commuter-based traffic since opening;
• Accessibility to a network of major roadways;
• Long remaining life of extended concession; and
• Amortisation schedule matches debt service to anticipated ramp-up in 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
• Risk of toll hike deferrals.