TRIS Rating has affirmed the company rating of Universal Utilities PLC. (UU) at “A-” with “stable” outlook. The rating reflects the company's low operating risk, the resilient demand for tap water, and the steady cash flows generation backed by long-term offtake agreements with price escalation formulas. The rating is partly enhanced by UU's strategic importance to its parent company, Eastern Water Resources Development and Management PLC (EASTW; rated "A+/Stable"). However, these strengths are partially offset by customer concentration risk and the limited opportunities to expand into new service areas.
The “stable” outlook reflects UU’s low operating risk and reliable streams of cash flow from tap water operations. UU's credit upside scenario could materialized, if the company is able to expand portfolio without weakening its balance sheet. However, a delay in the IPO or any aggressive debt-funded investments which resulted in a sustained high leverage would negatively impact UU's credit quality. 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 as EASTW's arm and was responsible for waterworks services. Currently, UU provides tap water services in 12 service areas with a total production capacity of 361,660 cubic meters (cu.m.) per day and a committed minimum offtake quantity (MOQ) of 190,805 cu.m./day. The services UU provides are under concessions, management contracts, management lease contracts, as well as related business of engineering services. In 2015, UU acquired 90% of Egcom Tara Co., Ltd. (Egcom Tara), a tap water producer served in Ratchaburi and Samut Songkram provinces, at a total cost of Bt1,918 million. Egcom Tara has a production capacity of 48,000 cu.m. per day with a committed MOQ of 35,400 cu.m./day.
UU's above average business profile is supported by the low operating risk nature of the tap water business and steady growth in the demand for tap water which is resilient to external factors. Generally, tap water services do not require complicated technology. However, the industry poses some barriers to entry due to the limited raw water resources, rights of way for pipelines, and permission or a concession from the authorities in order to operate a water treatment plant.
UU carries customer concentration risk. The Provincial Waterworks Authority (PWA) is its major customer, contributing over 70% of UU’s annual revenue during the past five years. However, since the PWA is a state enterprise, its credit profile is acceptable. The prospects for UU to expand 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 contracts directly from municipalities and formulate a service model for unserved areas.
UU's credit profile is enhanced by the support it receives 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 operational and financial support to UU, should the need arise. However, the level of support from EASTW may be limited considering EASTW and UU each has sizable growth plans.
UU's financial profile is supported by its stable and reliable cash flows. In 2015, UU sold a total of 83.7 million cu.m. of tap water, an 11% increase year-on-year (y-o-y). The double-digit growth was partly due to the acquisition of Egcom Tara in August 2015. Excluding the acquisition, the organic sales volume rose by 5% y-o-y to 79.4 million cu.m. Revenue from operations in 2015, excluding Bt96 million of revenue from construction under concession agreements, increased by 15% to Bt1,145 million. For the first quarter of 2016, the volume sold grew by 18% y-o-y to 23.1 million cu.m. Sales revenue jumped by 27% to Bt337 million. The sharp rise was due to the consolidation of Egcom Tara which has a per-unit tariff of Bt25.6/cu.m., compared with UU's average per-unit tariff of Bt12.8/cu.m.
The acquisition of Egcom Tara improved UU's overall profitability. The operating margin from normal operations (operating profit before depreciation and amortization, as a percentage of sales) was 38% in 2015 and 47% for the first quarter of 2016, compared with 22%-31% prior to the Egcom Tara acquisition. The operating margin is expected to stay over 40% during 2016-2018.
UU's balance sheet was negatively affected by the acquisition. Total debt rose from Bt2,158 million in 2014 to Bt4,831 million at the end of March 2016. The ratio of debt to capitalization rose from 38.86% to 62.08% over the same period. However, UU plans to list on the Stock Exchange of Thailand (SET) in the second half of 2016 or the first quarter of 2017. The planned initial public offering (IPO) is expected to raise Bt1,000-Bt1,600 million. The proceeds from the IPO will be used to pay down the acquisition debt. As a result, UU's capital structure is expected to improve should UU success with the IPO. The debt to capitalization ratio is expected to fall and stay below 40%. Liquidity remains acceptable despite the recent rise in debt. For the first quarter of 2016, the ratio of funds from operations (FFO) to total debt was 18.22% (annualized, from the trailing 12 months). The earnings before interest, taxes, depreciation and amortization (EBITDA) interest coverage ratio has stayed high and stood at 11.18 times at the end of March 2016.
Under TRIS Rating's base case scenario, during 2016-2018, UU's revenue is expected to grow organically by at least 3% per annum, supported by the resilient demand for tap water. UU’s funding needs over the next 12 months are debt repayments of Bt1,792 million, including the bridge loan of Bt1,600 million for the Egcom Tara acquisition and planned capital expenditure of Bt250-Bt350 million. The funding sources are estimated FFO of at least Bt480 million per annum, cash and cash equivalents of Bt536 million at the end of March 2016, and from the expected IPO proceeds of Bt1,000-Bt1,600 million.
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