RAM Ratings has assigned an AA3 rating (stable outlook) to Edaran SWM Sdn Bhd's ("Edaran" or "the Company") proposed initial issuance of RM750 million ("Proposed Sukuk") under its proposed Islamic Medium-Term Notes ("IMTN") Programme of up to RM1 billion (2012/2032).
Edaran is the main sub-contractor to its sister company, SWM Environment Sdn Bhd ("SWME" or "the Concessionaire") - the concessionaire for collection services and public-cleansing management services ("the Services") in Johor, Negeri Sembilan and Melaka. Collection services refer to the collection of solid waste; public cleansing services refer to the cleaning of public drains, grass cutting, street sweeping and the cleansing of public areas. Proceeds from the Proposed Sukuk will be used to fund the purchase of relevant assets that are required to provide the Services.
The Company has a favourable business profile by virtue of a concession agreement ("CA") that grants SWME exclusive rights to provide the Services in Negeri Sembilan, Melaka and Johor; under a sub-contract agreement, SWME will allocate a significant number of areas to Edaran. In return for carrying out the Services, Edaran will earn fees that are fixed in tandem with SWME's fees under the CA. Demand for the Services is tied to household growth, which has historically been stable.
We derive comfort from the management's experience in providing the Services since 1997. Operational risk is deemed minimal given that the Services are of a straightforward nature. Furthermore, the operating requirements under the sub-contract agreement, which will be structured back-to-back with the CA, are not demanding. Operating requirements are progressively implemented through the first 3 years of the concession, to allow SWME or Edaran sufficient lead time to procure the relevant assets to comply with full-service levels. SWME and Edaran will earn full fees for areas that comply with full-service levels, while areas that have not migrated to full-service levels will be paid interim fees. Notably, Edaran's counterparty risk is deemed low given that the ultimate and sole paymaster is Solid Waste and Public Cleansing Management Corporation, which receives its funding from the Government.
On the flip side, the Company is exposed to tariff-revision risk. Any revision of SWME's fees will cause a corresponding change in Edaran's Fees. We highlight that the Government has exclusive and absolute discretion to decide on the review of SWME's fees, even though the CA specifies the mechanism and a host of considerations for such review. Conservatively, our analysis assumes that the fees remain constant throughout the tenure of the ProposedSukuk while operating costs increase gradually.
Based on RAM Ratings' sensitised cashflow analysis, Edaran's minimum finance service coverage ratio ("FSCR") is expected to come up to a robust 2.33 times (with cash balances, calculated on payment date). From fiscal 2013 to 2014, the Company will need to rely on progressive equity contributions to meet its debt obligations, as capital expenditure and lower interim fees in the first 3 years of the concession will result in negative annual pre-financing cashflow. Notably, the equity contributions are backed by a stand-by letter of credit from Hong Leong Bank Berhad. From fiscal 2015 onwards, Edaran's annual pre-financing cashflow is projected to average at around RM160 million. The Company is not expected to make any distributions to its shareholder throughout the tenure of the Proposed Sukuk due to its stringent financial covenants.
Meanwhile, the financing structure also imposes covenants on the parent and sister companies that are also counterparties. This helps to limit the entire group's risk exposure to that of the concession while intra-group cashflow leakages are minimised. Similar to other concession-based businesses, however, regulatory and force majeure risks are inherent.
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Media contact
Michael Ti
(603) 7628 1015
michael@ram.com.my
Published by RAM Rating Services Berhad
© Copyright 2012 by RAM Ratings
© Press Release 2012
