Turning the tide in water sector

WATER rarely generates the buzz that electricity enjoys in the utilities space. While the latter has benefitted from policy support and investor attention, fuelled by solar schemes and grid upgrades, water has historically lacked a compelling growth narrative.

That may be changing, with some – like Kenanga Research – suggesting that water could be “the next big story” in Malaysia’s infrastructure space, driven by tariff reforms, rising demand from data centres (DCs) and renewed private sector interest.

Kenanga Research notes that sentiment toward water-related stocks has improved noticeably since last year, compared to prior years, supported by ongoing tariff adjustments and steady progress in infrastructure development.

A key turning point came in February 2024, when water tariffs were increased and a standardised tiered structure across states was introduced – marking the first major change in decades.

However, analysts say current tariffs remain insufficient to cover the full cost of water treatment, with most states still relying on subsidies.

This has led to talk of another potential tariff adjustment in the second half of 2025, which could include a new sub-category specifically for DCs, estimated at RM5.50 per cubic metre.

DCs are intensive water users, particularly for cooling systems, and their rapid expansion has pushed regulators to revisit pricing structures.

The concern is made worse by low water reserve margins, which – at around 15% currently – is well below the government’s recommended 25% buffer.

In particular, Kedah, Perlis and Kelantan are operating below the critical 10% margin, according to a recent report by BIMB Securities.

Adding to the pressure is the long-standing issue of non-revenue water (NRW) – treated water lost before reaching consumers due to leaks, theft, or faulty meters.

In states like Perlis and Kelantan, NRW rates reportedly exceed 50%, draining an estimated RM2bil annually from operators, BIMB Securities adds.

The research house notes that each 1% reduction in NRW requires between RM800mil and RM1bil in investment, placing immense strain on already limited state budgets.

In response to these challenges, 10 states have submitted tariff hike applications, which have been reviewed by the National Water Services Commission (Span). At the time of writing, no statement has been issued by the water regulator. Industry players anticipate that the new tariffs may be imposed on user groups with significant water consumption.

If implemented, the adjustments could unlock stronger cash flows for water operators and pave the way for a new wave of infrastructure spending, including the replacement of ageing pipelines.

The immediate beneficiaries of any water tariff revisions would be the two listed water operators: Penang-based PBA Holdings Bhd and Johor’s Ranhill Utilities Bhd, via subsidiary Ranhill SAJ Sdn Bhd, both of which stand to gain from improved cash flow and increased funding capacity. The February 2024 tariff hike provided some reprieve, as reflected in their improved financials.

Further down the value chain, Engtex Group Bhd, a leading pipe supplier, is well-positioned to benefit from pipeline replacement and network upgrade projects, analysts say.

A noteworthy recent development is the return of Gamuda Bhd, a major player in water infrastructure, as a water concessionaire. Through a 50:50 joint venture (JV) with Perak’s state development arm, Perbadanan Kemajuan Negeri Perak, the company is set to develop the RM5bil Northern Perak Water Supply Scheme (NPWSS).

The JV will operate under a privatisation concession of at least 40 years, aimed at addressing water shortages in Perak’s Kerian region.

Recall that Gamuda was previously a key water concessionaire in Selangor before selling its stake to the Finance Ministry-owned Pengurusan Aset Air Bhd (PAAB) during the state’s water restructuring in the 2000s. Under PAAB’s asset-light model, the agency owns and builds water assets, leasing them back to state water operators for up to 45 years.

Could NPWSS pave the way for a similar scheme elsewhere?

A retired official who previously served a government water agency says the NPWSS may serve as a template to tap private capital for water infrastructure, especially in states facing urgent infrastructure bottlenecks.

“The key, however, is to strike a balance between keeping tariffs affordable for consumers and ensuring the concessionaire can recover its investment steadily through the tariffs,” he tells StarBiz 7.

While the 40-year concession period is longer than typical arrangements, he says it is not uncommon for large-scale infrastructure projects.

For Gamuda, it offers both construction upside, with pre-tax margins of 10% to 12%, and long-term recurring income.

Beyond these, there are several other catalysts.

Water operators in Johor and Selangor are aggressively pursuing infrastructure upgrades.

Johor has earmarked RM3bil for future developments to support DC growth, in addition to ongoing projects valued at RM800mil. For instance, Ranhill SAJ estimates that requests for water supplies from DCs in the state could rise to 614 million litres per day by 2035.

Downstream, contractors and pipe suppliers could benefit if Span’s proposal for DCs to tap alternative water sources, such as treated effluent from sewage plants, moves forward. This would involve linking new DCs to nearby waste treatment facilities.

Other sustainable water options being explored include off-river storage, rainwater harvesting, and using reclaimed water for cooling.

Over in Penang, PBA plans to complete three water pipeline projects worth close to RM190mil over the next two years, while two new water treatment plants worth RM1bil are being built by PAAB in Seberang Perai.

Meanwhile, Sarawak has allocated RM1.08bil for water pipe upgrades.

In its July report, Kenanga Research identifies several mega infrastructure projects set to roll out in 2025, including the Langat 2 water treatment plant upgrade and the Sungai Rasau Phase 2 water supply scheme.

Having bagged the main contract to build Phase 1 of the latter, Gamuda is a strong contender for Phase 2, with positive spillovers for other listed water-related players down the value chain, such as water infrastructure contractors Salcon Bhd and Taliworks Corp Bhd.

Apart from Engtex, Hiap Teck Venture Bhd also supplies contractors for water reticulation projects.

ACE Market-listed Cosmos Technology International Bhd, which supplies fluid control systems and metal parts for the water and wastewater sectors, could be a beneficiary of higher NRW spending. In December last year, Cosmos saw the entry of Datuk Foong Wei Kuong – co-founder and managing director of JF Technology Bhd – as its major shareholder.

Not too long ago, conglomerates Berjaya Corp Bhd and YTL Power International Bhd took stakes in Salcon and Ranhill Utilities, showing growing confidence in the sector’s reforms and rising investment in water infrastructure.

Except for Gamuda, most water-related stocks have given up earlier gains amid broader market jitters due to US tariff uncertainty. However, Gamuda’s continued outperformance has been backed by contracts wins across its other segments, both in Malaysia and overseas.