IPO Note Muscat City Desalination Company (SAOG)

Transcription

1 (Under transformation) 6 December 2017 Al Maha Financial Services LLC

2 Offer Summary Muscat City Desalination Company S.A.O.G. (under transformation) Offer price RO per share (comprising a nominal value of Bzs 100, a premium of Bzs 14 and offer expenses of Bzs 2 per Share) Face value RO Offer size RO 6.3 million Shares offered 54,442,640 Shares (35 per cent of the Paid-Up Share Capital) Authorized share capital RO 25 million Paid-up share capital RO 15.5 million Minimum limit for the subscription Category I Investors : 1000 Shares and in multiples of 100 shares thereafter by each applicant Category II Investors: 500,100 Shares and in multiples of 100 shares thereafter Maximum limit for the subscription Category I Investors: 500,000 Shares by each applicant Category II Investors: 5,444,200 Shares, representing apx.10 percent of the total offer In case of over-subscription of the Offer, the allotment of the offer will be made as follows: Allotment Categories Category I : 65 percent of the Offer i.e.35,387,716 Shares, on a pro-rata basis. Category II : 35 percent of the Offer i.e. 19,054,924 Shares, on a pro-rata basis. Offer period 19 November 2017 to 18 December 2017 Approval of the CMA with regard to the proposed allotment December 31, 2017 Completion of the allotment and commencement of refund January 1, 2018 Listing of the Offer Shares with MSM January 2, 2018 Fair Price RO Upside Potential 35% Recommendation Subscribe Al Maha Financial Services LLC Page 2 of 17

3 Investment Rationale Growing Potable water demand in the Sultanate, favorable for MCDC The Muscat City Desalination Company s (MCDC) core business activity is to develop, own and operate the Al Ghubrah Independent Water Plant. The desalination plant, located in the Interconnected Zone has a contracted capacity of 191,000 m3/d and it supplies approximately 60% of Muscat s water capacity. Of the five water systems in the Sultanate, the Interconnected Zone is the largest, catering more than 80% of the country s potable water requirement. As per projections by the Oman Power and Water Procurement Company SAOC (OPWP), water demand of the Interconnected Zone is expected to grow from 746,000 m3/d in 2016 to over 1 million m3/d in 2023, increasing at the rate of 5% to 7% per year. The Companies in the water desalination space including MCDC are expected to benefit from the favorable demand side. Stable business model supported by a long-term contractual framework The water desalination and power generation companies in Oman have a defensive and stable business model based on long-term agreements with government entities such as Oman Power & Water Procurement Company (OPWP) which is the single buyer of power and water which are distributed by the Public Authority for Electricity and Water (PAEW). The MCDC has contracted revenues with the OPWP for a period of 20 years until 2034 based on availability of the plant irrespective of water demand as per the Water Purchase Agreement (WPA). Thus its revenues are secured comprising of a water capacity charge and water output operation and maintenance charge which are designed to cover the investment by the Company such as debt service, return on capital, tax payments, fixed costs to operate and maintain the plant as well as variable operation and maintenance costs to produce the water output delivered. Power supply required by the plant is ensured by long term electricity transmission and electricity supply agreement with the Muscat Electricity Distribution Company (MEDC) and the Oman Electricity Transmission Company (OETC) that is back-to-back with the OPWP off-take agreement. Operation and maintenance costs are contracted and fixed over the life of the WPA as well as long term financing agreements with hedging strategy are in place to mitigate interest rate risk. Thus the stable business model which is not susceptible to business cycles is expected to help the Company to generate steady revenue and profitability until the expiration of the 20 year WPA with the government. Al Maha Financial Services LLC Page 3 of 17

4 RO Millions Al Maha Research Predictable cash flows and steady profitability The defensive nature of the business model allows MCDC to maintain its steady profitability along with consistent and healthy operating cash flows. Operating profit of the Company is expected to be stable and resilient to change in electricity charges and market dynamics. The Company projects an average EBITDA margin of 45% for the five years from 2017 to 2022 and expects to maintain an average net profit margin at 10% and Return on adjusted Equity 1 of 10% on an average during the same period EBITDA, Finance costs and Profit Before Tax Source: Company Projections E 2018E 2019E 2020E 2021E 2022E EBITDA Finance cost Profit before tax 60% 50% 40% 30% 20% 10% 0% Profitability Margins 48% 47% 44% 43% 43% 43% 7% 10% 10% 11% 9% 2017E 2018E 2019E 2020E 2021E 2022E EBITDA Margin Net Margin Owing to the changes in the income tax law in the beginning of the year, MCDC provides for deferred tax relating to origination and reversal of temporary differences, leading to a one-off taxation charge of RO 0.9 million relating to the prior year in 2017 and additional charges of RO 0.8 million on an average for 2017 and 2018 accounted for in the respective years and the Company s management does not foresee any further one-off charges or expenses related to the same during the forecast period. 1 Equity has been adjusted to exclude fair value changes of derivative instruments Al Maha Financial Services LLC Page 4 of 17

5 Cash flows to show substantial growth, post the WPA Period Project finance and shareholders loans of MCDC which amounts to RO 79 million as of July 2017, are co-terminus with the WPA agreement and as the debt levels and finance costs reduce steadily over the term, profitability is expected to grow consistently. Useful plant life of the Company is up to 40 years and cash flows are expected to increase substantially post the WPA period as the entire debt will be repaid by Attractive Dividend yield, dividend payments to remain consistent MCDC offers an attractive yield of 8% for the year 2018 at the offer price and going forward the Company projects attractive dividend payout of above 75% translating to average dividend yield of 8.2% based on the projected dividends for the next five years Earnings per share (RO) Dividend per Share (RO) Dividend Pay Out 122% 86% 84% 75% 90% Div Yield at Offer Price 8.0% 8.1% 8.1% 8.3% 8.3% No mandatory cash sweep mechanism, limiting dividends: Unlike many of the listed power and water companies in Oman, the financing arrangements of MCDC do not impose any mandatory cash sweep mechanism in respect of the Company s accounts. Hence Company s ability to pay dividends is not expected to be constrained as if a cash sweep was imposed. Also the company has no litigations or arbitrations pending at present, which could impact the future dividend payments. Though the payout is expected to be lower beyond 2022 as per the Company, the dividend yield of 6.6% at the offer price based on the projected dividends during the same period still stays above that of the peer companies in the Power and Water space. Al Maha Financial Services LLC Page 5 of 17

6 Convincing track record of compelling listing gains and capital appreciation for Power and Water Companies Power and Water companies in the local market are known for offering attractive listing gains in their Initial Public Offerings (IPO). Apart from the listing gains, these companies have also demonstrate a proven track record of value creation, offering returns in the form of capital appreciation to investors over a period of time. Initial Public Offerings of power and Water companies in MSM: since 2011: Company Listing Year Issue size (RO Mn) Over subscription (times) Issue price (RO) Listing price (RO) Listing Gains Highest price since listing (RO) Capital appreciation at highest price Current price (RO) Capital appreciation based on current price SMN Power % % % Sharqiyah Desalination % % % Sembcorp Salalah* % % % Al Suwadi Power % % % Al Batinah Power % % % Phoenix Power % % % Note: Prices of SMN Power and Semcorp Salalah are adjusted for share split Face value of Sharqiyah Desalination is RO 1 per share. It is pertinent to note that Power and Water Companies, unlike most of the companies of other sectors which came out with IPO during the same period, offered substantial upside at the current prices levels from their issue prices apart from the listing gains, irrespective of volatility in the broader market moves. Track record of successful listing of the Power and Water Companies is likely to draw and encourage investor participation in the upcoming IPO for listing gains as well as for long term returns. Al Maha Financial Services LLC Page 6 of 17

7 Key Concerns Uncertainty relating to material adverse changes Under the WPA, in the case of a buyer risk event due to change in the law, the material adverse changes owing to an increase in the Company s costs and expenses in excess of RO 250,000 are to be compensated to the company by OPWP through a mutually agreeable mechanism, resulting in a pass through effect for MCDC. Due to changes in the tax law in 2017, which include introduction of withholding tax for foreign nationals, the Company finds a cumulative material adverse change in excess of RO 250,000 and it has notified the same to OPWP for a mutually agreeable position. In case, the Company and OPWP are unable to agree upon the occurrence of the material adverse change, within the timeline provided in of the WPA, then either party shall be entitled to refer the matters in dispute to an expert for determination as provided under the terms of the WPA. Also there remains uncertainty on whether payment obligations under hedging agreements, entered into by companies in Oman, will fall under the category of payments of interest or as payment for services within the meaning of Article 52 of the Tax Law. If payment obligations under hedging agreements entered into by the Company are considered to be subject to withholding tax under Article 52 of the Tax Law by the local tax authorities, then this may result in an increase in the tax related costs for the Company. Any negative outcome of buyer risk event due to change in Tax Law for the Company could have a material adverse effect on its financial condition including the capacity of the Company to pay dividends. High leverage and debt covenants for dividend payments The business being highly capital intensive in nature, MCDC has a high leverage and the Company s total borrowings constitute 83% of its total capital as of July Although the leverage is expected to gradually decline going forward and the debt is expected to be repaid entirely by the end of WPA period, the Company is bound to maintain a Debt Service Coverage Ratio (DSCR) covenant of 1.10 and above for paying dividends, provided that the projected DSCR is forecasted to be above 1.20 for each of the next four quarters. Due to the debt prepayment of OMR 6.5 million made in July 2017 the Coverage Ratio has moved beyond the threshold level for distribution of dividends. However, the Company has received waivers from its lenders with regards to DSCR covenant technical breaches in the past and does not anticipate any further breaches going forward due to the prepayment made in July 2017, based on which the forecasted DSCR is 1.2 and above. Al Maha Financial Services LLC Page 7 of 17

8 Valuation Our hybrid valuation matrix includes the Dividend Discount Model, Comparable Dividend yield Model and Relative Valuation using Price to Book Value and Price to Earnings multiples to arrive at the fair value for the stock offering of Muscat City Desalination Company. Dividend Discount Model (DDM) We find dividend policy of MCDC attractive owing to its regular dividend payments supported by stable cash flows; the payout of the Company during the forecasted period too remains higher as compared to the peers in the local market. In addition to the financial projections by the Company, we have used the following base data and assumptions for our DDM valuation. Base Data and Assumptions Beta 0.51 Risk Free Rate 5.50% Risk Premium 5.00% Cost of Equity 8.03% Terminal Growth 2.0% Dividend Discount Model (DDM) (Figures in RO) 31-Dec Dec Dec Dec Dec-22 Dividend Discount Factor Discounted Cash Flows Primary Value Terminal Value Discounted Terminal Value Equity Value per Share Al Maha Financial Services LLC Page 8 of 17

9 Comparable Dividend yield Model To arrive at the fair value of MCDC using the Comparable Dividend yield Model, we have considered a benchmark dividend yield of 6%, which is in line with the cash dividend yields offered by the latest listed companies in the Power and Water space which are liquid in the market, and the average annual dividend projected by the Company for the next three years. Expected Dividends Dividend month Dividend per share (Bz) Feb Nov May Nov May Nov May Nov May Nov Source: Company IPO Prospectus (Figures in RO) Comparable Dividend yield Model Average Annual Dividend of next 3 years Benchmark Dividend Yield 6% Fair value Al Maha Financial Services LLC Page 9 of 17

10 Relative Valuation The power and water companies listed on Muscat Securities Market are considered as comparable companies for relative valuation as they operate in a similar business environment with long term exclusive contractual framework and have steady financial performance. Comparable Financials (Figures in RO '000s except per share data) Peer Companies P(W)PA Expiry Share Price Market Cap. Div. Yield* PE* PBV ACWA Power , % Kamil Power , % Sohar Power , % Sembcorp Salalah , % Sharqiyah Desalination , % NM 2.17 SMN Power 2022 / , % Suwadi Power , % Batinah Power , % Phoenix Power , % Muscat City Desalination* , % Peer Average *PE and Dividend Yield based on Trailing Twelve Months, Equity has been adjusted to exclude fair value changes of derivative instruments for uniformity NM- Not meaningful Al Maha Financial Services LLC Page 10 of 17

11 Comparable Valuation (Figures in RO) Price to Book Value Comparable Price to Book Value 1.53 Book Value per Share (2019E ) Equity Value Per share Price to Earnings Ratio Comparable Price to Earnings Ratio Earnings per Share (2019E ) Equity Value Per share Weighted Average Valuation Matrix Valuation Metric Weights Fair Value (RO) Dividend Discount Model 25% Average Dividend Yield 25% Price to Book Value 25% Price to Earnings Ratio 25% Weighted Average Fair Value 50% Offer Price Up side 35% Based on our weighted average valuation matrix, we have arrived at a fair value of RO for the stock, which is being offered at an attractive discount at the issue price of RO per share. Al Maha Financial Services LLC Page 11 of 17

12 Outlook and Recommendation We hold a positive view on the equity offer of Muscat City Desalination Company and find an upside potential of 35% for the stock from the offer price of RO Hence, we recommend investors to Subscribe to the issue, in view of the stable and defensive business model of the Company, consistent profitability, attractive dividend yield as well as the capital appreciation potential of the stock on listing and going forward. Al Maha Financial Services LLC Page 12 of 17

13 Key Financials Income Statement (Figures in RO '000s) 2017E 2018E 2019E 2020E 2021E 2022E Revenue 16,256 17,143 17,428 17,771 18,024 18,335 Operating cost -7,598-8,277-8,876-9,233-9,331-9,610 Gross profit 8,658 8,866 8,552 8,538 8,693 8,725 Administrative expenses Depreciation -2,549-2,549-2,549-2,556-2,549-2,549 Finance cost -3,486-3,262-3,151-3,059-2,910-2,754 EBITDA 7,832 8,037 7,705 7,667 7,799 7,819 Other income Profit before tax 1,797 2,226 2,005 2,052 2,340 2,516 Taxation -2,150-1, Net profit / (loss) for the year ,195 1,704 1,744 1,989 1,663 Source: Company IPO Prospectus Al Maha Financial Services LLC Page 13 of 17

14 Balance Sheet Assets (Figures in RO '000s) E 2018E 2019E 2020E 2021E 2022E Non-current assets Plant and equipment 97,106 94,564 92,015 89,466 86,910 84,361 81,812 Deferred tax 1, Total non-current assets 98,526 95,143 92,575 89,985 87,409 84,841 82,272 Current assets Trade and other receivables 1,442 1,284 1,297 1,310 1,323 1,336 1,350 Cash and cash equivalents 10,467 1,777 1,946 1,951 1,918 1,953 1,305 Total current assets 11,908 3,061 3,243 3,261 3,241 3,289 2,655 Total assets 110,434 98,204 95,818 93,246 90,650 88,130 84,927 Equity and Liabilities Share capital 15,555 15,555 15,555 15,555 15,555 15,555 15,555 Total equity 15,257 15,315 15,166 15,656 16,056 16,654 16,932 Non-current liabilities Non-current portion of term loans 71,969 62,536 59,430 56,243 52,928 49,465 45,835 Non-current portion of fair value of derivative instruments 3,028 2,669 2,548 2,281 2,161 2,036 1,906 Total non-current liabilities 83,079 78,046 75,850 72,697 69,569 66,332 62,696 Current liabilities Current portion of term loans 3,423 3,024 3,106 3,188 3,314 3,462 3,630 Current portion of fair value of derivative instruments Accruals and other payables 2,739 1,699 1,582 1,603 1,614 1,591 1,583 Total current liabilities 12,099 4,843 4,802 4,893 5,025 5,144 5,299 Total liabilities 95,177 82,889 80,652 77,590 74,594 71,476 67,995 Total equity and liabilities 110,434 98,204 95,818 93,246 90,650 88,130 84,927 Per Share data in RO Al Maha Financial Services LLC Page 14 of 17

15 Key Ratios 2017E 2018E 2019E 2020E 2021E 2022E Operating Margin 32.5% 32.0% 29.6% 28.8% 29.1% 28.7% EBITDA Margin 48.2% 46.9% 44.2% 43.1% 43.3% 42.6% Net Margin -2.2% 7.0% 9.8% 9.8% 11.0% 9.1% Earnings per share Book Value Per Share Dividend per Share Dividend Pay Out 0 121% 86% 84% 75% 90% Dividend Yield 0.0% 8.0% 8.1% 8.1% 8.3% 8.3% Return on Equity -2.3% 7.9% 10.9% 10.9% 11.9% 9.8% Return on Assets -0.4% 1.2% 1.8% 1.9% 2.3% 2.0% Debt to Equity Current Ratio Interest Coverage Source: Company IPO Prospectus, Al Maha Research Al Maha Financial Services LLC Page 15 of 17

16 Al Maha Financial Services LLC PO Box 1065 PC 117, Al Wade Al Kabir, Sultanate of Oman Tel: , Fax: Contacts Telephone Customer service & Operations: Zakia Al Ghammari Muna Al Hashmi Research: Suresh Kumar Khushboo Badlani Asset Management: Syed Zahiruddin Shailendra Kumar Singh Brokerage: Mahmoud Al Hamsaidi Halima Al Mahrooqi Nasser Al Banna Al Maha Financial Services LLC Page 16 of 17

17 DISCLAIMER: The research report has been prepared by Al Maha Financial Services LLC for private circulation amongst selected clientele for information purposes only and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe any investment. This Report is not directed to, or intended to be used by, any person or entity who (or which) is a citizen of (or domiciled) in any jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject the company to any registration or licensing requirements within such jurisdiction. Al Maha Financial Services LLC will not be liable for any direct or indirect losses arising from the use thereof, and the investors are expected to use the information contained herein at their own risk. Al Maha Financial Services LLC and its affiliates including analyst who has issued this report, may, on the date of this report, and from time to time, have long or short positions in, and buy or sell the securities of the companies mentioned herein or engage in any other transaction involving such securities and earn brokerage or compensation or act as advisor or have other potential conflict of interest with respect to companies mentioned herein or inconsistent with any recommendation and related information and opinions. Al Maha Financial Services LLC and its affiliates may seek to provide or have engaged in providing corporate finance, investment banking or other advisory services in a merger or specific transaction to the companies referred to in this report, as on the date of this report or in the past. The information contained in this report has been obtained from the sources believed to be reliable and in good faith, but which may not be verified independently. While utmost care has been taken in preparing the above report, Al Maha Financial Services LLC makes no guarantee, representation or warranty, whether expressed or implied, and accepts no responsibility or liability to its accuracy and completeness of the data, being provided. Opinion expressed is our current opinion as of the date appearing on this material only. We do not undertake to advise you as to any change of our views expressed in this document. The investments discussed in this report may not be suitable for all the investors. Investors must take their own decision based on their specific investment objectives and financial position, and using such independent advisors, as they believe necessary. Income from investments may fluctuate. The price or value of the investments, to which this report relates, either directly or indirectly, may fall against the interest of investors. This document is strictly for the use of recipients only. None of the material provided herein may be reproduced, rewritten, rehashed, published, resold or distributed in any manner whatsoever without the prior and explicit written permission of Al Maha Financial Services LLC. Al Maha Financial Services LLC Page 17 of 17