Hyflux

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Teh Hooi Ling sounds rather downbeat in her assessment of Hyflux's CPS.

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Business Times - 22 Apr 2011

Hyflux preference shares: a good idea?

By TEH HOOI LING

ON THE back of strong institutional demand, it was reported, Hyflux appeared very likely to double the amount it planned to raise from its cumulative preference shares from $200 million to $400 million.

The preference shares promises 6 per cent return a year - a princely sum for investors in today's low-interest-rate environment. The first question that comes to mind is: Why such a generous pricing given that its latest borrowing cost is only about 3.85 per cent?

So what will the preference shares mean for Hyflux's finances? Well, 6 per cent on $400 million is $24 million. In the last three years, the water treatment company's free cash flow (that is, excess cash generated by the business after allocating sums for capital expenditure) was $81 million in 2010, $47.5 million in 2009 and $6.2 million in 2008. Adding an outflow of $24 million annually would no doubt be a strain.

Furthermore, Hyflux already has quite a bit of debt on its balance sheet. Total debt amounted to some $600 million. And net debt to equity is at 73 per cent now, before this preference issue.

Then there is the currency issue. In its prospectus, Hyflux said that the funds raised from the preference shares would be used to fund the group's water and infrastructure projects and for general working capital.

For the financial year just past, Hyflux's revenues totalled $569.7 million. Out of that, Singapore projects accounted for only 13.2 per cent. The bulk of the projects - 60.3 per cent - are from Middle East and North Africa (MENA). China accounted for the remaining 26.5 per cent.

For projects outside Singapore, the bulk of the contracts are denominated in US dollars. According to Hyflux's latest annual report, as at Dec 31, 2010, the group had trades and other receivables amounting to US$362.8 million, and cash in US dollars amounting to US$82.1 million. Meanwhile, it had loans and borrowings which totalled US$243.4 million, and trades and other payables of US$132.8 million.

So its net US dollar exposure is just $68.7 million.

However, with the issue of the preference shares that are denominated in Singapore dollars - 400 million of it if the issue comes to pass - Hyflux will have a significantly higher obligation in Sing dollars, while continuing to earn the bulk of its revenues in US dollars.

The Sing dollar, as we know, has been on this inexorable climb against almost all other currencies in the world. In the past 10 years, it has gained 3.3 per cent a year against the US dollar.

It just doesn't seem like a good idea to earn from a depreciating currency in order to meet obligations in an appreciating currency.

It might, however, make more sense if the funds were to be used for the $890 million seawater desalination plant project which Hyflux recently won from PUB. That's the group's largest contract to date.

Even then, 6 per cent seems a tad aggressive given that Hyflux is also looking for other water and infrastructure projects in China, India and potentially in South-east Asia and Australia too.

In the final analysis, the preference shares may be good for the preference shareholders, but not that great for the ordinary shareholders. For one thing, it will drain cash available for dividends - not that Hyflux is known for being a high-yielding stock.

Since 2009, Hyflux has underperformed the general market by some 10 per cent. (Since 2010, it's been about 20 per cent.) Given its still relatively high estimated PE ratio of 20 times, and the numerous risks - be it currency, liquidity or geopolitical risks associated with MENA - the odds appear to continue to be stacked against any outperformance.

hooiling@sph.com.sg