MARC has affirmed its rating of AA-_IS on toll concessionaire Lebuhraya DUKE Fasa 3 Sdn Bhd’s (DUKE 3) RM3.64 billion Sukuk Wakalah with a negative outlook. Wholly owned by Ekovest Berhad, DUKE 3 is undertaking the design, construction, financing, operations and maintenance of Setiawangsa-Pantai Expressway (SPE), a 32-km elevated dual two-lane carriageway. The toll road project is being built under a concession agreement with the Government of Malaysia ending August 5, 2069. 

The negative outlook reflects the rating agency’s concerns over the continued regulatory uncertainties on the direction of the toll industry. In this regard, matured toll concessionaires which are able to generate sufficient cash flows and maintain healthy cash balance levels to meet financial obligations without substantial reliance on government compensation would be in a better position to weather any regulatory adjustments. 

The affirmed rating is underpinned by the sufficient construction progress and adequately structured sukuk repayment profile that accommodates the ramp-up of traffic on the expressway. As at September 30, 2018, SPE’s actual overall progress remains steady, standing at 42.40% against the planned progress of 42.35%, according to the independent consulting engineer (ICE). The rating agency also notes that any cost arising from delays would be passed to the engineering, procurement and construction (EPC) contractor through the back-to-back liquidated ascertained damages (LAD) arrangement of RM10,000 per day of delay under the fixed-sum contract. An irrevocable and unconditional bank guarantee of RM184.5 million (5% of EPC costs) further mitigates the construction cost overruns. 

As at October 31, 2018, DUKE 3 has incurred RM1.46 billion on the project while total designated account balances stood at RM2.74 billion. In respect of land required for construction of the expressway, as at September 30, 2018, DUKE 3 has utilised RM210.6 million for land acquisition purposes. As sizeable government funding of up to RM350 million has been set aside for land purchases, financial risk associated with land acquisition has been minimised. DUKE 3 expects to commence work on the remaining lots once they have taken formal possession by end-2018. MARC understands that DUKE 3 is waiting for the disbursement of the reimbursable interest assistance (RIA) amounting to RM460 million from the government. As at October 2018, DUKE 3 has only received its first payment of RM100 million from the government in July 2017.

Under the latest base case cash projections, DUKE 3’s projected minimum and average pre-distribution finance service cover ratios (FSCR) with cash balance stand at 2.24 times and 2.61 times during the sukuk tenure. The revised projections assume the disbursement of the remaining RIA of RM460 million in 1H2020, GST savings of RM56.2 million from the construction costs and higher interest income of RM88.5 million, among others. The sensitivity analysis indicates that the project cash flow can withstand up to a 13% construction cost overrun or 12 months’ delay in the commencement of tolling operations before breaching the FSCR covenant of 1.50 times in 2023 and 2026. It also reveals that DUKE 3 is vulnerable to a breach in the equity-to-capital ratio of 16% by 2023. 

The projections also show that in the event the initial traffic growth is around 23% during the ramp-up period (2020-2024), the traffic growth rate would subsequently have to register 6.5% per annum against 3.6% of operating expense growth to break even. Correspondingly, if the highway meets its projected initial traffic growth of 26% during the ramp-up period, DUKE 3 would break even with a traffic growth rate of 4.7% during the post ramp-up period (2025-2039).

Major Rating Factors

Strengths

• Well-positioned alignment within mature catchment areas;
  
• Accessibility via a network of major roadways;
  
• Debt amortisation matches project cash flows; and
  
• Long-dated concession tenure.
  

Challenges/Risks

• Moderate debt protection measures for the sukuk;
  
• Construction cost overruns and completion delay; and
  
• Risk of toll hike deferrals and delays in receipt of government compensation.