SAJ CAPITAL SDN BHD - 2018

MARC has assigned a rating of AA-_IS to SAJ Capital Sdn Bhd’s (SAJ Capital) Sukuk Murabahah of up to RM650 million for up to 12 years. The outlook on the rating is stable. SAJ Capital is wholly owned by Ranhill Capital Sdn Bhd (RCSB), which in turn is a wholly-owned subsidiary of Bursa Malaysia-listed Ranhill Holdings Berhad (Ranhill). RCSB holds an 80% interest in SAJ Ranhill Sdn Bhd (SAJ), the sole provider of treated water services in Johor.

The bulk of the proceeds from the issuance will be advanced to parent RCSB to early redeem the outstanding notes under its existing Sukuk Musharakah of RM540 million in nominal value. The source of funds for principal and profit payments on the sukuk will be from the dividend payouts from SAJ. The rating on SAJ Capital is equated to that of SAJ on the basis that the issuer functions as a single-purpose funding conduit for the sukuk.

The rating incorporates SAJ’s long track record in operating water assets, its position as the sole distributor of treated water in Johor and its strong financial performance that is characterised by stable cash flow generation and a debt-free position. The rating is moderated by irregular profitability margins as well as uncertainties surrounding the timeliness of tariff hikes.

SAJ operates under a three-year operating license under the purview of the National Water Services Commission (SPAN) and has the right of use of water assets for 45 years under a facility agreement with the national water asset owner, Pengurusan Aset Air Berhad (PAAB). SAJ leases from PAAB water assets comprising 44 water treatment plants, 22,004km of water distribution infrastructure and 15 sludge treatment plants in Johor. As at end-June 2017, SAJ has a combined water treatment capacity of 754 million m3, and has been able to reduce the state’s non-revenue water (NRW) from about 40% in 1999 to 24.7% currently. SAJ is currently operating in its fourth three-year operating period spanning between 2018 and 2020. Licensing risk is mitigated by its stable operating track record in meeting key measures, including reducing NRW, as set out by SPAN.

MARC notes that SAJ has no debt as it is prohibited under the Water Services Industry Act 2006 from incurring borrowings not related to its licensed activities. The company has also no material capital expenditure requirement, given that the task of funding new water asset developments falls under PAAB. Furthermore, SAJ’s working capital requirement also remains small given that it has no inventory holding costs. Nonetheless, as there is no fixed schedule for tariff revisions under the current arrangement, the company’s profit margins have been volatile. For its next operating period, SAJ has proposed a tariff review in tandem with the additional capex that PAAB would need to undertake during the period. MARC draws comfort from the fact that under the agreements the company is assured of reasonable returns, ranging between 8% and 13% historically. Notwithstanding the tariff revisions, on average, the water tariff in Johor has been increasing at about 4.4% per year since 2010.

For 2016, SAJ registered stronger revenue growth of 12.2% y-o-y to RM1.1 billion and net profit growth of 82.2% to RM137.8 million, mainly owing to the 2015 tariff hike which raised rates by an average of 16%. The growth also reflects higher water consumption arising from a rapid expansion in customer base, which in turn can be attributed to new housing developments and businesses in the state. Lease payments to PAAB over the past five years accounted for about 40% of cost of sales. Due to SAJ’s limited capex and stable working capital requirements as well as its debt-free position, the company has been paying out an average of above 100% of its annual net profit for the past five years. The dividend payout averaged at about RM121 million per year over the period.

Based on cash flow projections that include tariff revisions for each operating period that are in line with the increase in lease rental payables to PAAB, SAJ Capital is expected to provide an average finance service cover ratio (FSCR) of 3.75 times over the repayment period of the sukuk. MARC notes that the cash flow projections are susceptible to delays in tariff increase, although in the event of such delays, SAJ would propose to defer capex spending and thereby delay any concomitant increase in lease payments.

The stable rating outlook factors in MARC’s expectations that SAJ should not face any significant hitches in its operations that would affect its financial performance over the next 12-18 months. Downward rating pressure will occur if SAJ does not receive timely water tariff increases that should commensurate with any increase in lease payment obligations.

Major Rating Factors

Strengths

• Water treatment operator and sole treated water distributor in Johor;
• Strong operating track record; and
• Stable cash flow generation.

Challenges/Risks

• Uncertainties surrounding timeliness of tariff increases; and
• Licensing risk