MARC ASSIGNS AA-IS RATING TO LEBUHRAYA DUKE FASA 3 SDN BHD’S RM3.64 BILLION SUKUK WAKALAH; OUTLOOK STABLE

MARC has assigned a rating of AA-_IS to toll concessionaire Lebuhraya DUKE Fasa 3 Sdn Bhd’s (DUKE 3) proposed RM3.64 billion Sukuk Wakalah with a stable outlook. DUKE 3 was incorporated by Ekovest Berhad (Ekovest) to undertake the design, construction, financing, operations and maintenance of DUKE Phase 3 expressway under a concession agreement with the Malaysian government in January, 2016. The concession is for a period of 53 years and six months. The 32.1km expressway will be elevated and link the Middle Ring Road 2 (MRR2) at Wangsa Maju to the Kerinchi Link on the Federal Highway in Kuala Lumpur.

The proceeds from the sukuk will part fund the estimated RM5.05 billion project cost; the remaining funding will come from a RM560 million interest-free government reimbursable interest assistance (RIA) and RM850 million equity. The proposed debt and equity mix of 83:17 for the Duke Phase 3 project is in line with similar MARC-rated project financing structures. The rating on the proposed Sukuk Wakalah incorporates the adequate cash flow coverage, the strong track record of the project sponsor, Ekovest, and the importance of the expressway in the transportation development plan for Kuala Lumpur. The rating is weighed down by the moderate likelihood of lower-than-projected traffic growth arising mainly from competitive alternative mode of transportation. In addition, toll pricing and possible future toll hike deferments as well as the potential impact from the incremental financial obligations on the RIA may pose some risks to the project cash flow.

MARC views the construction risk on the DUKE Phase 3 project to be largely mitigated by the track record of project sponsor Ekovest, which had completed the DUKE Phase 1 project and is currently undertaking the DUKE Phase 2 project that is scheduled for completion by end-2016. A fixed sum turnkey engineering, procurement and construction (EPC) contract amounting to RM3.96 billion has been awarded to Ekovest. Given that DUKE Phase 3’s elevated alignment will pass through the densely populated areas of Chan Sow Lin, Pandan Indah and Wangsa Maju, the construction could be challenging relative to Ekovest’s other projects. Nonetheless, the construction period of 42 months is considered reasonable, while comfort is also drawn from the liquidated ascertained damages provisions under the EPC contract and the progressive build-up of 5% of the total construction cost (or RM184.5 million) over the first 18 months of the construction period to mitigate the risk of construction cost overruns. The build-up funds will be progressively carved-out from the EPC’s gross contract billings as security for the sukukholders during construction phase.

MARC notes that as 96.5% of the 553.3 acres of land needed for the expressway are either on existing road reserves or have been acquired, land acquisition risk is considered low. The balance of the 19.6 acres is privately held, of which 6.9 acres (13 lots) in the Chan Sow Lin area are in the early stages of negotiation while the rest are at fairly advanced stages. The sizeable government funding set aside for the purchase of land parcels in the Chan Sow Lin area and the limited number of parcels involved minimise the risk relating to the land acquisition in this area.

The rating agency views that the traffic flow on DUKE Phase 3, upon its expected completion in 2020, could be affected by the availability of alternative routes and Mass Rapid Transit (MRT) system. This notwithstanding, the elevated expressway’s direct connectivity between the heavily congested MRR2 and Federal Highway as well as to other important major toll roads in the Klang Valley mitigates the risk of underutilisation. Based on the traffic study by Perunding Trafik Klasik Sdn Bhd, DUKE Phase 3 is expected to achieve a cumulative average daily traffic of 99,840 vehicles from its four toll plazas when tolling operations begin on January 1, 2020. MARC notes that DUKE Phase 3’s relatively steep traffic growth rates in the first five years are supported by low opening traffic volume and the prevailing heavy congestion along competing routes. Excluding the traffic flow during the ramp-up period (2020-2024), traffic volume is expected to grow by a moderate CAGR of 3.2% p.a.

DUKE 3 is projected to achieve minimum and average pre-distribution finance service cover ratio (FSCR) with cash balances of 2.13 times and 2.29 times respectively during the sukuk tenure. The rating agency notes that the thin project coverage levels are mainly due to the RIA loan repayment that limits DUKE 3 from building up its liquidity reserves at higher levels. The fixed repayment on the RIA will commence in 2023 together with the amortisation of the sukuk, subject to a distribution FSCR of 2.00 times. Nonetheless, the RIA repayments can be deferred (subject to an interest of 8% per annum) and has lower security ranking compared to the sukukholders.

MARC’s sensitivity analysis reveals that the project cash flow can withstand moderate stresses arising from construction cost overruns and traffic underperformance. The project cash flow is vulnerable to a breach in the minimum FSCR covenant of 1.50 times in 2022 should the construction cost overrun exceed 10%. DUKE 3’s finance service ability would also come under pressure in the event of a 20% reduction in the overall projected traffic volume. Under these stressed scenarios, DUKE 3 is expected to defer most of its debt obligations on the RIA to protect sukukholders from a further weakening of the cash flow coverage. Sukukholders are protected from prolonged construction delay of up to 18 months as the prefunded finance service reserve is sufficient to cover the first three semi-annual profit payments.

The stable outlook incorporates MARC’s expectation that the project sponsor will adhere to the predetermined capital commitment under the financing structure and the construction of DUKE Phase 3 will progress on schedule and within budget.

Contacts: Ng Chun Kean, +603-2082 2230/ chunkean@marc.com.my; David Lee, +603-2082 2255/ david@marc.com.my.

June 1, 2016