TRIS Rating has assigned the company rating of Universal Utilities Co., Ltd. (UU) at “A-” with “stable” outlook. The rating reflects the company's low operating risk and the resilient demand of tap water industry. The rating also takes into consideration UU's proven track record and steady cash flow generation backed by long-term offtake agreement with escalated pricing formula. The rating is partly enhanced by UU's strategic importance to its parent company, Eastern Water Resources Development and Management PLC (EASTW; Rating “A+”/Stable outlook). However, these strengths are partially offset by customer concentration risk and the difficulty of business expansion into new services areas.
The “stable” outlook reflects UU’s low operating risk and reliable streams of cash. TRIS Rating expects the company to expand through the conservative use of leverage in order to maintain its credit quality. UU's credit upside is possible, if the company's investment plans and its ability to build up earning assets materialized. However, if UU makes any aggressive debt-funded investments, UU's credit quality could be negatively impacted. A change in EASTW's credit profile will affect UU's credit quality.
UU is a wholly-owned subsidiary of EASTW. The company was established in December 1998 to be EASTW's arms responsible for waterworks services. The services UU provides are under concessions, management contracts or management lease contracts, as well as related business of engineering services. Currently, UU provides tap water services in 10 service areas with a total production capacity of 308,460 cubic meters (cu.m.) per day and a committed minimum offtake quantity (MOQ) of 151,283 cu.m./day. UU also provides chilled water supply system services under 15-year contract at the Yodpiman River Walk mall with a total capacity of 4,167 refrigerant tons per day. UU's water treatment plants in Sattahip, Rayong, Bangpakong, Chachoengsao, and Chonburi are its main revenue contributors, generating over 60% of total sales.
UU's above average business profile is supported by the low operating risk nature of tap water business and a steady growth in the demand for tap water. Generally, tap water services do not require a complicated technology. However, the industry poses some barriers to entry since the treatment plant would require permission or concession from the authorities, raw water sources, and rights of way for pipelines, if needed. The project investment is considered moderate, but could be capital intensive if operator needs to invest in distribution networks or provide seawater desalination service which investment cost is about 10 times more expensive than conventional water treatment. UU carries customer concentration risk, as the PWA is its major customer contributing 70% of UU’s total revenue during the past five years. However, since the PWA is a state enterprise, its credit profile is acceptable. UU's growth prospects in many service areas hinge on the PWA's distribution networks. Extensions of the PWA's networks will raise demand for tap water and support UU's growth.
UU's credit profile is enhanced by the group support from its parent company, EASTW. Currently, four of UU's operating platforms are under concessions which EASTW is the concessionaire. Synergies between UU and EASTW in terms of raw water supply and tap water operation enhances group benefits. TRIS Rating views UU as a strategically important subsidiary of EASTW and believes that EASTW is willing to provide UU the operational and financial support, should the need arise. However, the support from EASTW may be limited considering UU's sizable growth plans.
Because it is a necessity, the demand for tap water is resilient to external factors. UU's sales have grown ever since the company started operations because of two factors: increased demand and capacity in its existing service areas, and the expansion of its service areas. During the past five years, UU's tap water sales volume has grown by an average of 7% per annum while its capacity has increased by 3% annually on average. Although demand for tap water has grown steadily, the prospects for expansion are moderate since the PWA is not inclined to grant any new concessions or outsource its operations. In order to sustain revenue growth, UU has to seek opportunities to get a contact directly from municipalities and attempt to formulate a service model for unserved areas.
Its low operating risk and growing demand for tap water support UU's financial profile. In 2014, the company reported revenue of Bt1,263 million. The revenue figure included Bt269 million from construction under concession agreements, which was also charged as a cost of goods sold. Excluding this item, UU's revenue from normal operations grew by 5% from a year earlier. UU sold a total of 75.6 million cu.m. of tap water in 2014, up by 11% year-on-year (y-o-y). For the first three months of 2015, the volume sold continued to grow, driven by the growing demand for tap water plus the expansion of its pipeline networks to end users. The volume sold in the first three months of 2015 increased by 10% y-o-y to 19.5 million cu.m. Sales revenue increased to Bt266 million, up by 13% y-o-y. The operating margin from normal operations (operating profit before depreciation and amortization, as a percentage of sales), has stayed between 22%-31% during the past five years. UU's profit margin fell in 2013 due partly to an 11% drop in the volume of tap water sold from the Sattahip plant. Pipeline system leaks were responsible for the drop. In addition, the increasing raw water price pressured the margin. After sorting out the pipeline problem and the raw water supply arrangement with EASTW, the operating margin improved. For the first three months of 2015, the operating margin was 34.6%. TRIS Rating expects the margin to stay over 30% during 2015-2017.
UU's liquidity profile has been strong during the past five years. The ratio of funds from operations (FFO) to total debt ranged between 33%-36%, except in 2013 when it experienced operational problems. For the first quarter of 2015, the ratio improved in line with profitability to 38.6% (annualized from the trailing 12 months). The earnings before interest, taxes, depreciation and amortization (EBITDA) interest coverage ratio has stayed high and stood at 8.3 times at the end of March 2015.
UU's capital structure is sound. The ratio of debt to capitalization stayed at 37%-39% during the past five years. Going forward, UU plans to expand both organically and through acquisition. During 2015-2017, the company plans normal capital expenditures of Bt100-Bt250 million per annum, which will be funded primarily from its operating cash flows. UU plans to acquire 90% of total shares in Egcom Tara Co., Ltd. (Egcom Tara), a tap water producer in Ratchaburi and Samut Songkram provinces at a total cost of 1,918 million. The acquisition will be financed initially through a bridge loan. UU aims to list on the Stock Exchange of Thailand (SET) at the beginning of 2016. The planned initial public offering (IPO) is expected to raise Bt1,100-1,200 million. The proceeds from the IPO will be used to pay down the acquisition debt. UU's financial profile is expected to remain fair should UU success in the investment and financing arrangements. The debt to capitalization ratio is expected to stay below 40%. However, if there is a delay in the capital increase plan, the ratio of debt to capitalization will soar up and stay over 60%. UU should have a deleverage plan within a couple of year.
In TRIS Rating's base case scenario, during 2015-2017, UU's revenue is expected to grow organically at least 5% per annum. The growth rate will be higher if incorporating the Egcom Tara's revenue. In terms of liquidity, TRIS Rating believes that UU will not experience any liquidity shortage. UU is expected to generate FFO of at least Bt420 million annually in 2016 and 2017, incorporating cash flows from Egcom Tara. This amount of FFO will give UU's financial flexibility.
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