Today I will review Hyflux -- the darling who created Singapore's NEWater. CEO Olivia Lum was a household name when she quitted school to start her company to make this first-of-a-kind Singapore-made water filtration technology because I own 30 units of 6% Cumulative Preference Shares (CPS) which I bought via an IPO in 2011. The structure was such that you get paid $6/year for every $100 unit held for 7 years. Upon maturity, Hyflux either redeems your capital or extends the tenure by a duration to be determined but at a 8% rate. The main reason why I bought it was because it was like a bond, and we have limited bond choices as retail investors.
Last week, this said CPS was trading below par value, or $100. The lowest was $93. Over the past 6 years holding this CPS, the price had been always at least $100. That pompted me to dig little deeper into its financial report.
The company is debt-laden. Debt/Equity (D/E) ratio is 80 as at Jun 2016. The lower the better. There are many other companies who fare much worse, so don't be too alarmed. There are other companies with similar preference shares holding much much much more debt (about 4 times more than Hyflux), for e.g. Oxley holdings (D/E = 348). Aspial's DE = 208. Basically I had divested all my shares in any company whose D/E ratio is above 50 because the economy is undergoing a lot of change and companies with high debt will likely have difficulties changing because they may not have the money to make the moves they want.
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| Top 10 D/E companies extracted from SGX Stockfacts |
Anyway, back to Hyflux. After going through the financial report, the line item that is burning their cash is something I don't really understand, this term called "service concession arrangement". After doing a Google search, I seem to understand it as a maintenance agreement to manage and operate the water/energy plant after Hyflux constructs it. Hyflux owns the rights to manage and operate and these rights can be sold to other operators. However, as the filtration technology is proprietary to Hyflux, I am not sure whether there are patent or rights income because I don't see it anywhere in the financial report.
The other thing I was trying to identify was the profit margin to operate the plants. In 1H2015, profit margin (before tax) was 22%. in 1H2016, profit margin (before tax) was 2%. I seriously hope that I am misinterpreting the report. What happened over 1 year? 2 projects started, so higher revenue had been recorded, however, expenses are also very high as these are construction costs (~S$300M). The 2 projects are: TuasOne waste-to-energy (“WTE”) project (to be completed in 2019, client NEA) and Qurayyat Independent Water Project (“IWP”) in the Sultanate of Oman (to be completed in 2017, client Oman gov). This S$300M is likely the "service concession arrangement" line item on the cash flow sheet. In terms of reporting, I would have preferred the project expenses and loans to be tracked separately to show that their cash flow issues are purely because of the projects.
My conclusion is that Hyflux' negative cash flow issues are due to project construction costs. However, this is not conclusive as the company chooses not to separate the development and maintenance business. I still have faith to hold on to my CPS. If I were the Hyflux CEO, I will probably want to report my revenue, expense, debt, profit by the business nature. In terms of construction projects, I will also require my clients to pay me more upfront to manage my cash flow better. I probably prefer to buy the CPS that guarantees the 6% payout than to buy Hyflux equity ($0.51, 1.2 cents dividend or 2.3% yield) whose dividend is currently heavily penalised because of negative cash flow.
The writer owns Hyflux CPS 6% at the time of writing.
Thank you for sharing your thoughts on Hyflux as an investment.
ReplyDeleteI think your decision to hold Hyflux bonds, instead of their equities is a great one. Since the bonds hold priority over equity when it comes to liquidation, you will get back a larger portion your principle should the company go into liquidation.
However, looking at the financial reports and the fact that Hyflux has been burning cash since 2010. I think its extremely risky to conclude that the negative cash flow issues are due simply to construction costs. The line item "service concession arrangement" would include all existing plants that Hyflux. In my opinion, since the amount of this line item has been increasing over time, it would suggest that Hyflux has an increasing large obligation to existing plants. As you know, water is a basic necessity of all the countries the plants are build, and it is the government's imperative to keep costs low for their own population, Hyflux would have a difficult time renegotiating previous contracts that have been established if the prices has been agreed to.
The upside to Hyflux is that it has the backing of Temasek (i.e. Singapore government) and would likely be provided more avenues of funding for the foreseeable future. Hence, it is my opinion that your investment in the bonds of Hyflux is not likely to be of high risk. However, the equity investment of Hyflux on the other hand would not be the same.
Thanks for sharing. Personally I have doubts as to whether Temasek will save hyflux. They didn't save NOL. They didnt save SMRT. It's still profit-driven.
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