Changing risks profile for YTL Power

Recent investment moves by YTL Power International (RM2.27) appear to underscore the company’s gradual diversification from the power generation and water utility business.

The company launched its high-speed WiMAX broadband services nationwide in November 2010 with some fanfare. This was followed by a joint-venture announcement for an oil shale-cum-power generation project in Jordan, in which it will take a 30% stake.

Whilst the latest ventures may yet offer exciting growth prospects over the longer-term, they also alter the company’s risk profile. Specifically, YTL Power was widely viewed as a defensive investment. This may no longer be the case.
Although the company’s oil trading arm — housed under Singapore-based Power Seraya — has contributed to some earnings gyrations over the past few quarters, earnings from its power generating and water utility businesses were, by and large, fairly predictable.

Steady cash flow from these investments, in turn, support a relatively generous dividend policy, giving investors higher-than-market average yields. But the high upfront investments required for the new ventures may dent the company’s dividend payout going forward.
YTL Power announced a lower second interim dividend of 1.875 sen per share in conjunction with its 2QFY11 earnings results, half of the 3.75 sen per share paid in the previous corresponding quarter.

YTL Power's mobile broadband service under Yes are expected to be loss-making for a number of years.

Despite the cutback, we still assume the company to maintain its total dividends of 13.125 sen per share for the full-year — on the basis of its strong balance sheet. YTL Power has gross cash totalling almost RM8.1 billion at end-December 2010, although net debt stands at about RM13.6 billion. Nevertheless, we do not discount the possibility of reduced dividends, as the new ventures will be a drain on resources, at least in the initial stages.

Perhaps more significantly, they also inject a higher degree to risks and volatility to the company’s earnings profile. With sketchy details on the new ventures unveiled to the investing community, thus far, earnings visibility has become more opaque.

Yes will be loss-making for several years

For starters, it is a given that the mobile broadband services — under the Yes brand name — will be loss-making for a number of years. Losses in 1QFY11 totalled RM7.9 million, rising to RM19.8 million in 2QFY11 following its nationwide launch in November.

We expect losses for the broadband arm to trim YTL Power’s overall earnings for the current financial year. Net profit is estimated at RM1.13 billion, down from RM1.21 billion in FY10. Based on our FY11 earnings forecast, YTL Power shares are currently trading at fully diluted P/E of roughly 15.1 times, which is more or less in line with the broader market’s average valuations.

Continued losses from its broadband unit will also cap earnings growth, at least for the next two to three years. Thus, upside gains for the stock may be limited for some time, although its dividends — net yield estimated at 5.8% — should still appeal to yield-seeking investors.

Intense competition in mobile broadband

YTL has reportedly spent some RM1.5 billion in rolling out its broadband services to-date, out of the estimated RM2.5 billion planned for the network coverage to reach 85% of the population.

Yes offers a novel “pay as you use” tariff structure, subject to a minimum RM30 per month for both voice and data, which favours customers with low usage. Based on the average mobile broadband user’s data consumption of between 1.5-3GB, its rates are fairly comparable to those currently offered by the cellular operators.

Nevertheless we are somewhat ambivalent on the company’s subscriber acquisition success in the intensely competitive mobile broadband market, currently dominated by Celcom, Maxis and DiGi — despite initial, positive anecdotal review on its services.

The cellular operators have the advantage in being able to bundle mobile broadband packages with the voice services of existing customers. Maxis, for instance, offers its subscribers promotional rates for add-on broadband services. Although Yes also offers voice services, the lack of WiMAX-enabled handsets is a major handicap. At the moment, the company has available only one Samsung handset model for subscribers.

As part of its strategy, YTL is planning to offer free broadband services to more than 400,000 students in 20 public universities and select private institutions in the country by end-2011. Earlier this year, the company successfully activated its network in the main campus of University Sains Malaysia in Penang. We expect the company will leverage on this customer base to upsell its services in the future.

Still substantial capex to be spent

Looking further ahead, we believe YTL’s competitiveness will improve when all the operators migrate to the next generation platform, called the LTE.
Supported by the expected robust ecosystem, Yes should better appeal to potential customers, particularly with its plans for quad play — to offer ubiquitous broadband, video and voice services. (Spectrum for rollout of 4G LTE services will be available for use in 2013).

The company inked a license and service agreement with US-based Sezmi Corporation to deploy hybrid TV — comprising of traditional, live over-the-air broadcast as well as over-the-top on-demand online content — in Malaysia and Asia Pacific late-last year. It plans to launch the service in the domestic market by end-2011, at a suggested investment cost of between RM1 billion to RM2 billion.

Success remains to be seen

For the moment though, it is far too soon to tell how YTL will fare in its broadband venture. Similarly, the oil shale project in Jordan is expected to be a long-term investment.

The project is led by Eestia Energia, the national energy company of Estonia, through its 65% stake in the joint-venture. EE was awarded an oil shale concession by the Jordanian government in May 2010. Construction of the oil plant, with output of some 38,000 barrels per day, will commence after the environmental studies are completed.

The venture company will also construct and operate a 900MW oil shale-fired power plant. The energy generated will be sold to the national utility company, Nepco under a long-term power purchase agreement. The oil and power plants — estimated to cost some US$5 billion (RM15.3 billion) — are likely to commence operation post-2015.

A quick recap

YTL Power owns and operates the country’s first independent power generating plants, which were commissioned back in 1994. In 2002, the company extended its reach beyond local shores by acquiring Wessex Water — a UK-based sewerage and water operator supplying 1.2 million customers.

Two years later, it bought a 35% stake in Jawa Power, an independent power producer with a 1,220 MW coal-fired plant in East Java, Indonesia. And in 2009, YTL Power acquired Power Seraya, a Singapore-based power generator and wholesale-retail utility company.