Why there're flaws in the most extensive written piece on WCEHB (3565) WCE HOLDINGS BHD
I must say I am impressed with a fellow blogger on the piece about WCE titled "Why Highways are gruesome industry - WCE Holdings Berhad".
This article has been pointed to me, and I feel that since I have been a
promoter of this asset and stock, I do have a duty to write and provide
my opinion.
In his article, he pointed out that WCE is worth 25 sen which is around the pricing it is trading at currently.
Let me go point by point but I try to be brief:
- assumptions and cashflow projections - I would like to thank him for providing a brief on RAM's base numbers for the calculation of the highway's rating and cashflow. It is highlighted as below that the base case scenario for the cashflow provided by RAM is RM461 million on average for the first 5 years of its full operations. That I assume will be for year of 2022/2023 where this project has been delayed to. I have done my own cashflow (extensive) and it is very difficult to share it and I have to say that the numbers which I have is very close.
My basis for the first full year of operation is based on PLUS's numbers as well as the traffic that the west coast is able to generate by itself. Choivo puts it that the first full year of revenue will be RM200 million which I do not think is right. At the moment (prior to the 18% discount), PLUS is doing about RM4 billion a year. About 78% of that comes from North-South Expressway (NSE). Hence, on that basis, we can project some numbers for WCE. NSE has 772km whereas WCE has 233km (actual length is 316km as some portion are free). Lets assume that with the opening of WCE, it will take about 35% of the traffic from PLUS. The numbers will hence be something like this:
The first few years, the growth should be high, hence let's put a 7% onto the growth of the revenue.
So we should be able to get numbers like RM395m, RM422m, RM452m, RM484m, RM517m. So let's say my calculation provides a revenue of RM454 million for the first 5 years on average. This is pretty close to the ones provided by RAM. RAM as in its usual practice will put a sensitised case where it provides RM275 million. That in our language is the worst case scenario. One must note that RAM looks at whether the bond is payable while I look at the investability of the project (which margins of safety) See below.
This beginning number is very important as it is a basis for subsequent
years. In cashflow projections, only few things are important: inflow,
growth, costs. Once we have the first full year inflow right, the next
thing which is important is growth. Highways will have high growth in
first few years and as we know for WCE, many developers are already
preparing themselves for the completion of this highway as the project
act as nucleus for growth from the west coast to southern Selangor.
Remember Abdul Wahid (ex TM, Maybank CEO) was very keen for the growth
of southern Selangor through Klang and Port Klang when he was the EPU
Minister.
- The project is 50 + 10 years. The writer only uses 50 years for his cashflow projection. The PLUS10 is when WCE does not meet the minimum required IRR (which I assume is at around 9%). As we know, there is a huge difference between total 50 years vs if we are able to collect another 10 more years. Remember, the last 10 years are the best 10 years. Obviously, if WCE is able to achieve the minimum IRR, then the toll collection should end at year 50, then we should be not debate about how profitable the highway is.
- The writer mentioned highway is rarely profitable. It is not true, many highways in Malaysia are profitable. Some highly. He puts in the numbers for PLUS. That is not right and misleading. PLUS was built at a costs of RM5 billion. How did it have RM30 billion debt today. This is because the owners were taking money upfront and used the cashflow to sell debt. That I believe had been done various times. Basically, PLUS is about using the cashflow to increase the debt. When the debt is high, obviously the interests is proportionately high as well - hence the losses, which coincidentally reduces the tax rates. So, for the profitable highway guys, it is about increasing the debt with low interests and reducing the taxes. I believe the restructuring for KL-Karak and ECE are pretty much the same. Let me put it this way, why is it that even less than a year ago several parties were keen on PLUS and they were putting a price of up to RM39 billion on PLUS. One must know that some of the bidders have been advised by the same group of people whom are advising for the WCE project.
Although SPRINT is not profitable, this is because it is part of the continuous project from LDP. The strategy is SPRINT feeds the traffic to LDP, where the latter is the most profitable highway in Malaysia. Such is the cleverness of Gamuda. Yes!, The Storm water project is not supposed to make money as Gamuda-MMC already took the money from the difficult construction project. Although some highways are not profitable, they have been poorly studied and are usually built by PNB or some contractors whom did not do enough study. I do not want to name them.
- IJM's track record - The company is second to Gamuda at studying, building and managing highways through its subsidiary Road Builder. Such highways are NPE, Besraya and eventually LEKAS will be profitable as well. IJM will not want to depend on traffic consultant to provide the numbers or projection as their skin is in the game. Why would IJM be negotiating hard on the contract when it knows it would have been losing money on the project.
- WCE is not really northern region - in fact WCE is taking away the more profitable portion of PLUS's NSE - which is why it stops at Banting and Taiping.
- The meat is not for the highway owners but rather the contractors and maintenance companies, as mentioned. NOT TRUE. In the case of PLUS - yes. Why? PLUS is owned partially by us (through EPF) while UEM's subsidiary - Edgenta - maintains the highway. Let me put it this way, if I am owner and contractor, I have liberty of allocating the profits. In the case of WCE, IJM is not making much profits as it is putting attention at keeping the costs within the budget - as it has also been overrun. Talking about PLUS, if the maintenance is given to another company, and WCE is from within, how much savings would WCE be having?
In the case of WCE, the listed company will be the owner (80%) and maintenance company as well.
Generally my mistakes is by putting much early thoughts into a very long term project, as I put myself into a position where if provided an opportunity to buy a highway like this, at what price would I commit. That obviously is not in the mind of many investors as they would rather see the money now - hence the difference between greenfield and brownfield projects.
To me, it is not even meaningful to put WCE at a price of around RM700 million which is the value the market provides for it today. If it is a loss making highway, it would be zero value for the highway (without including the 40% property owned at Rimbayu). Anyway, the highway and property division is clearly demarcated and the liabilities are not intertwined. Why is RM700 million an unimaginable valuation then? There are mainly few probabilities -
1) what is the probability of the project not completed - well it is now about 70% completed.
2) what is the probability of it being loss making which makes the project not meaningful - think of the additional 10 years assuming it does not achieve the targeted IRR.
3) what is the delay on the portion which is free and build by the government
Hence, when looking at it, it is about the probabilities as RM700 million is about 2 of initial years of collection for a project which has 50 or more years to receive its cashflows. The latter years, what the inflow will be I do not even need to share as in highway, it is about continuous growth albeit at lower growth for latter years. Think through this carefully.
In his article, he pointed out that WCE is worth 25 sen which is around the pricing it is trading at currently.
Let me go point by point but I try to be brief:
- assumptions and cashflow projections - I would like to thank him for providing a brief on RAM's base numbers for the calculation of the highway's rating and cashflow. It is highlighted as below that the base case scenario for the cashflow provided by RAM is RM461 million on average for the first 5 years of its full operations. That I assume will be for year of 2022/2023 where this project has been delayed to. I have done my own cashflow (extensive) and it is very difficult to share it and I have to say that the numbers which I have is very close.
My basis for the first full year of operation is based on PLUS's numbers as well as the traffic that the west coast is able to generate by itself. Choivo puts it that the first full year of revenue will be RM200 million which I do not think is right. At the moment (prior to the 18% discount), PLUS is doing about RM4 billion a year. About 78% of that comes from North-South Expressway (NSE). Hence, on that basis, we can project some numbers for WCE. NSE has 772km whereas WCE has 233km (actual length is 316km as some portion are free). Lets assume that with the opening of WCE, it will take about 35% of the traffic from PLUS. The numbers will hence be something like this:
Total PLUS revenue x NSE portion x 35% x total WCE's length compared to PLUS x 233 (i.e. the tolled portion) / 316
= RM4,000 million x 78% x 35% x 316 / 772 x 233 / 316
= RM329 million a year
Besides that I am sure that WCE is generating its own traffic as the
path that it passes through has its own base which is from Klang to
Lumut and right up to Penang port. That to me should be around 20% of
additional traffic. So let's say
RM329 million x extra 20% = RM394.8 million
The first few years, the growth should be high, hence let's put a 7% onto the growth of the revenue.
So we should be able to get numbers like RM395m, RM422m, RM452m, RM484m, RM517m. So let's say my calculation provides a revenue of RM454 million for the first 5 years on average. This is pretty close to the ones provided by RAM. RAM as in its usual practice will put a sensitised case where it provides RM275 million. That in our language is the worst case scenario. One must note that RAM looks at whether the bond is payable while I look at the investability of the project (which margins of safety) See below.
- The project is 50 + 10 years. The writer only uses 50 years for his cashflow projection. The PLUS10 is when WCE does not meet the minimum required IRR (which I assume is at around 9%). As we know, there is a huge difference between total 50 years vs if we are able to collect another 10 more years. Remember, the last 10 years are the best 10 years. Obviously, if WCE is able to achieve the minimum IRR, then the toll collection should end at year 50, then we should be not debate about how profitable the highway is.
- The writer mentioned highway is rarely profitable. It is not true, many highways in Malaysia are profitable. Some highly. He puts in the numbers for PLUS. That is not right and misleading. PLUS was built at a costs of RM5 billion. How did it have RM30 billion debt today. This is because the owners were taking money upfront and used the cashflow to sell debt. That I believe had been done various times. Basically, PLUS is about using the cashflow to increase the debt. When the debt is high, obviously the interests is proportionately high as well - hence the losses, which coincidentally reduces the tax rates. So, for the profitable highway guys, it is about increasing the debt with low interests and reducing the taxes. I believe the restructuring for KL-Karak and ECE are pretty much the same. Let me put it this way, why is it that even less than a year ago several parties were keen on PLUS and they were putting a price of up to RM39 billion on PLUS. One must know that some of the bidders have been advised by the same group of people whom are advising for the WCE project.
Although SPRINT is not profitable, this is because it is part of the continuous project from LDP. The strategy is SPRINT feeds the traffic to LDP, where the latter is the most profitable highway in Malaysia. Such is the cleverness of Gamuda. Yes!, The Storm water project is not supposed to make money as Gamuda-MMC already took the money from the difficult construction project. Although some highways are not profitable, they have been poorly studied and are usually built by PNB or some contractors whom did not do enough study. I do not want to name them.
- IJM's track record - The company is second to Gamuda at studying, building and managing highways through its subsidiary Road Builder. Such highways are NPE, Besraya and eventually LEKAS will be profitable as well. IJM will not want to depend on traffic consultant to provide the numbers or projection as their skin is in the game. Why would IJM be negotiating hard on the contract when it knows it would have been losing money on the project.
- WCE is not really northern region - in fact WCE is taking away the more profitable portion of PLUS's NSE - which is why it stops at Banting and Taiping.
- The meat is not for the highway owners but rather the contractors and maintenance companies, as mentioned. NOT TRUE. In the case of PLUS - yes. Why? PLUS is owned partially by us (through EPF) while UEM's subsidiary - Edgenta - maintains the highway. Let me put it this way, if I am owner and contractor, I have liberty of allocating the profits. In the case of WCE, IJM is not making much profits as it is putting attention at keeping the costs within the budget - as it has also been overrun. Talking about PLUS, if the maintenance is given to another company, and WCE is from within, how much savings would WCE be having?
In the case of WCE, the listed company will be the owner (80%) and maintenance company as well.
Generally my mistakes is by putting much early thoughts into a very long term project, as I put myself into a position where if provided an opportunity to buy a highway like this, at what price would I commit. That obviously is not in the mind of many investors as they would rather see the money now - hence the difference between greenfield and brownfield projects.
To me, it is not even meaningful to put WCE at a price of around RM700 million which is the value the market provides for it today. If it is a loss making highway, it would be zero value for the highway (without including the 40% property owned at Rimbayu). Anyway, the highway and property division is clearly demarcated and the liabilities are not intertwined. Why is RM700 million an unimaginable valuation then? There are mainly few probabilities -
1) what is the probability of the project not completed - well it is now about 70% completed.
2) what is the probability of it being loss making which makes the project not meaningful - think of the additional 10 years assuming it does not achieve the targeted IRR.
3) what is the delay on the portion which is free and build by the government
Hence, when looking at it, it is about the probabilities as RM700 million is about 2 of initial years of collection for a project which has 50 or more years to receive its cashflows. The latter years, what the inflow will be I do not even need to share as in highway, it is about continuous growth albeit at lower growth for latter years. Think through this carefully.
