MARC has affirmed Syarikat Bekalan Air Selangor Sdn Bhd’s (SYABAS) RM3.0 billion Bai Bithaman Ajil Commercial Papers/Medium Term Notes Programme (BBA CP/MTN) ratings of MARC-1ID /AA-ID. The developing outlook on the rating has been maintained to reflect the unresolved situation around the restructuring of the Selangor water sector and SYABAS’ deferred water tariff hike. SYABAS has yet to receive its scheduled January 2009 tariff adjustment and is unlikely to receive any compensation from the Selangor state government in the coming months. The foregoing has resulted in a notable decline in SYABAS’ credit protection measures as well as lawsuits recently filed against Syabas by two water treatment plant (WTP) operators for alleged outstanding amounts due and owing for the purchase of bulk water, among other things. Mitigating the increased event risk faced by noteholders and pressure on SYABAS’ credit profile in the near-term is a 20-year back-loaded interest free unsecured RM320.8 million loan which SYABAS expects to receive from the federal government by the end of the year. The proceeds of the interest-free loan will be used to partially defray the past due amounts to the WTP operators.

The affirmed ratings, meanwhile, reflect SYABAS’s dominant position as the sole distributor of treated water for the state of Selangor and the Federal Territories of Kuala Lumpur and Putrajaya, its sound operational record and the low demand risk from its diversified base of water customers. Key credit concerns include its politically sensitive tariff regime, which has resulted in difficulties in securing sufficient and timely tariff rate increases, a demanding capital expenditure programme aimed towards reducing non-revenue water (NRW) and its high levels of debt.

SYABAS is 70%-owned by Puncak Niaga Holdings Berhad (PNHB) and 30% owned by the Selangor state government’s wholly-owned subsidiaries, 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.

SYABAS’s scheduled January 2009 tariff hike has been deferred while the Selangor water industry restructuring has been delayed from its revised target completion date in July 2009. To date, no compensation has been paid by the Selangor state government for the delay in the water tariff hike although it is noted that the compensation for tariff deferment in 2006 was paid by the federal government. The delay in the water tariff hike has exerted further pressure on SYABAS’ financial profile which has already been burdened by heavy capital spending requirements. SYABAS has been registering negative cash flow from operation (CFO) for the last three years which has been covered by the drawdown of BBA CP/MTN. To conserve its cashflow, SYABAS has been delaying payment to water treatment plant (WTP) operators since January 2009 and has only been making payment for approximately 60% of its monthly billings from WTP operators. MARC believes that a continued inability to secure the tariff hike or compensation on SYABAS’ part will affect its capacity to remain in compliance with its minimum covenanted debt service cover ratio (DSCR) of 1.50 times (x). SYABAS would only be able to meet its financial covenant with the support of the WTP operators by continuing to partially settle its billings which MARC believes to be unlikely in light of the recent lawsuits brought against SYABAS by two WTP operators, Konsortium Abass Sdn Bhd (ABASS) and Syarikat Pengeluar Air Sungai Selangor Sdn Bhd (SPLASH). SYABAS is defending itself against the claims on the grounds that its action of making partial payment to the WTPs is consistent with its novation agreements with the Selangor state government and WTPs which provides for partial payment to be made proportionately to all WTP operators if SYABAS is unable to discharge its payment obligation in full.

MARC draws comfort from a 20-year interest-free unsecured loan of RM320.8 million which the federal government will be making available to SYABAS to support its obligations in  relation to past due amounts to WTP operators. MARC was informed by SYABAS that it has reached the final stages of concluding the loan agreement and drawdown is expected by end-December 2009. MARC is of the view that SYABAS’ ability to service its obligations on the rated facilities would not be negatively affected by the back-loaded structure of the loan which only amortizes beginning in 2014 and requires modest annual principal repayments of below RM5 million therefrom until 2025. The bulk of repayments will only start from 2026 onwards after full redemption of BBA CP/MTN. However, given that SYABAS is not allowed to incur additional unsecured debt in excess of RM100 million under the trust deed and the likelihood that SYABAS’s debt-to-equity (D/E) ratio will potentially  exceed the covenanted D/E ratio of 70:30, SYABAS will require waivers of non-compliance with covenants from noteholders to draw down the loan. MARC notes that SYABAS will be seeking noteholders’ approval for a one time waiver of the covenant breaches at an Extraordinary General Meeting to be held on December 21, 2009.

For financial year ended December 31, 2008 (FY2008), revenue increased by 4.7% to RM1.39 billion, attributed to the increased consumption from completed residential projects. Pre-tax profit declined by 28.3% to RM138.0 million due to higher finance cost associated with new debt drawdown and higher amortisation of project development expenditure. SYABAS continued to record negative cash flow from operation of RM320.2 million in FY2008 (FY2007: negative RM303.58 million) due to significant NRW. Higher capital expenditure during the financial year caused widening negative free cash flow to RM1.1 billion (FY2007: negative RM846.7 million). The capital expenditure was financed by proceeds from borrowings which caused SYABAS’ gearing level to increase to 2.93x (FY2007: 2.88x). During the first half of financial year ended June 2009 (1HFY2009), SYABAS issued redeemable preference shares (RPS) of RM213.8 million which reduced its gearing to 2.13x as at June 2009. The RPS provides some gearing covenant headroom for SYABAS which is required to maintain a covenanted D/E ratio of 70:30 (or 2.33x) from FY2009 onwards. Prior to FY2009, SYABAS’ D/E covenant was 75:25 (or 3.00x). For 1HFY2009, SYABAS registered a revenue and pre-tax profit of RM922.8 million and RM207.9 million respectively.

While the slow progress made in the restructuring of the Selangor water sector remains a primary credit concern, MARC generally believes that a favourable resolution of the current issues faced by SYABAS is ultimately possible. Given the evolving situation, MARC will closely monitor developments and will take appropriate rating action as warranted.

Contacts:
Sandeep Bhattacharya 03-2090 2247/ sandeep@marc.com.my;
Khairul Emran Mahmud 03-2090 2278/ emran@marc.com.my