Hyflux Ltd: Better times ahead?

Hyflux is one of Singapore&rsquo s home-grown brands which has established itself internationally as an innovative environmental solutions provider. However, its near-term business outlook is likely to remain challenging. We take a quick look at the company&rsquo s fundamentals.

The Company

Hyflux&rsquo s core business is to provide fully-integrated municipal water treatment and renewable energy solutions. Listed on the Singapore Stock Exchange (with a market cap of S$439.8 million as of 17 May 2016), Hyflux develops, own and operates numerous public infrastructural assets in Singapore, China, Africa and the Middle East region. Its landmark projects include Singapore&rsquo s first NEWater plant as well as some of the largest desalination plants in Asia.

Hyflux&rsquo s Business Model

Hyflux&rsquo s revenues are mostly derived from the operation and maintemance (O& M) of more than 30 water, wastewater, water recycling and desalination plants around the world through service concession arrangements. A significant part of its earnings come from the recognition of engineering, procurement and construction (EPC) revenues from its pipeline of municipal and industrial projects. This includes the sale of proprietary water filtration membrane technology for industrial use.

The municipal segment (where Hyflux provide water treatment solutions to local governments) comprise 94% of the company&rsquo s revenues of S$ 445 million in FY2015 while the industrial segment (supplying liquid seperation application for manufacturing and petrochemical industry) contributed 5%. (see Chart 1). In terms of geography, Hyflux&rsquo s derived the majority of its revenue in FY2015 from   the Middle East and North Africa region (MENA) in FY2015, having secured new project wins in Oman and Saudi Arabia (Chart 2).

Chart 1: Revenue by Segment

Chart 2: Revenue by Country/Region

Hyflux has also recently ventured into the consumer segment to grow their recurring income with its investment in Indonesia-based PT Oasis, a manufacturer of bottled drinking water. It also invested with Kaqun Europe, a consumer water technology company, to manufacture and distribute highly oxygenated water under a brand name ELO within the Asia-Pacific region. However, these investments are in its early stages and unlikely to provide support to its earnings soon. 

Recent project wins contributes to strong order book

FY2015 and 1Q2016 was a strong period for Hyflux as the company strengthened its order book by a significant 21% to S$ 3.66 billion from S$ 2.93 billion as at end-FY2014. This came from a slew of new project wins which include building a seawater reverse osmosis desalination plant in Oman (Qurayyat IWP), the contract to build the Ain Sokhna Integrated Water and Power Project in Egypt, as well as two projects in Saudi Arabia.

Chart 3: Hyflux&rsquo s Order book

Closer to home, Hyflux entered into a joint venture with Mitsubishi Heavy Industries to develop the TuasOne Waste-to-Energy (WTE) project, which includes a concession to provide waste treatment services over a period of 25 years and contributing S$ 750 million to its order book.

Lacklustre financial performance with a heavy debt load

Hyflux reported a net profit of S$45 million in FY2015, a 22.7% decline over the previous year. This is despite a steep rise in revenue primarily due to the recognition of construction revenues from its Qurayyat IWP project in Oman, as the firm&rsquo s margins contracted due to rising input costs.

The company&rsquo s balance sheet is also relatively levered as it relies largely on debt to finance its operations, sporting a net-debt-to-equity ratio of 160% in FY2015 after adjusting for a significant amount of interest-bearing perpetual securities (principal amount of S$875 million with coupon payments of S$64.6 million in FY2015), which are traditionally treated as a form of equity financing. Its latest (as of end-2015) adjusted interest cover and net-debt to EBITDA stood at 0.97x and 20.1x respectively, suggesting that the company&rsquo s earnings may be insufficient to cover the interest payments on its borrowings.

Table 1: Key Credit Ratios

Table 2: Selected Financials (Income and Cash Flow Statement)

Table 3: Selected Financials (Balance Sheet)

Despite this, Hyflux has not formally breached its financial covenants that it has to meet under its S$1.5 billion Multicurrency Debt Issuance Programme, which requires an interest cover of at least 3 times, a consolidated tangible net worth of not less than S$300 million, and the ratio of consolidated net borrowings to consolidated tangible net worth of not more than 1.5 times.

It is worthwhile to note that in January 2015, Hyflux had successfully carried out a consent solicitation exercise with noteholders to seek covenant relief, broadening the interest coverage ratio covenant to include the unencumbered cash position of the company in addition to consolidated EBITDA, allowing the company more wiggle room to meet its debt obligations.

The debt issuance programme was issued in 2008 with an original limit of S$300 million, which was increased in two separate occasions in order to expand its operations, with the most recent one done in January 2016, raising the maximum aggregate principal amount of securities that may be issued to S$1.5 billion. The programme was also amended to include perpetual securities, apart from fixed rate notes.

Challanging Industry Conditions Going Forward

Against the backdrop of unfavourable cyclical conditions, Hyflux&rsquo s business environment is likely to remain tough for the foreseeable future. This is in addition to persistently subdued oil prices, which will constrain the likelihood of securing more orders from countries in the Middle East as the region reduce investments in infrastructure.

Given this scenario, that the company&rsquo s near-term earnings would be anchored around its committed order book as it recognises revenues from its existing service concession contracts stretching to between 25 and 30 years, and more crucially on its pipeline of construction projects, which will be completed over the next four years. Net profit is estimated to improve as we project margins to increase owing to better management of operating costs. Its business is also expected to generate a modest amount of free cash flows from its revenues even as it maintains its capital expenditure and dividend payments to common shareholders. These projections are made with the bear case scenario of the company failing to secure significant new contracts to grow its order book.

In the worst case scenario where Hyflux&rsquo s cash position deteriorates materially due to delayed payments from its main customers, it may have to reduce its capital expenditures or monetize its assets by going through further strategic divestments of service concession rights as well as sales of its non-core assets. In 2014 for example, the company sold and leased back the Hyflux Innovation Centre for a cash consideration of S$170 million in order to strengthen its balance sheet. It also divested its concession rights for five water and wastewater treatment plants in China in 2015. Further asset sales will be made going forward to free up cash flow. Specifically, as of end-2015, its balance sheet had S$212 million in assets classified as held for sale. The majority comprises of its 50% joint venture stake in Galaxy NewSpring Pte Ltd, in which Hyflux&rsquo s management has guided that it intends to sell this year.

Balance sheet expected to remain weak

While Hyflux remains fundamentally solvent as a business, we think liquidity will likely be an issue for the company given the extent and maturity profile of its borrowings. Its balance sheet is therefore anticipated to remain weak as looming principal debt repayments and interest costs crimp its cash balances. As of end-FY2015, the company had S$1 billion in total bank borrowings which are repayable over a period of 15 years, a proportion of which (S$484 million) consists of unsecured bank loans which will come due over the coming year. It had recently secured refinancing of its revolving credit facility and rolled over its existing five-year US$200 million facility due for repayment in July. Given the relatively low quantum of its remaining short-term loans (S$274 million), it is expected to successfully refinance the rest of its short-term borrowings.

Additionally, Hyflux has four outstanding bonds issued under its debt issuance programme, with maturities extending into 2019. It also has three perpetual securities with embedded call provisions, obliging the company to redeem them upon its first call dates (which falls between 2016 and 2018), or face hefty variable coupon step-up rates. Hence, it is expected to redeem one series of its perpetual bonds (HYFSP 4.800% Perpetual Corp (SGD)) when it reaches its first call date in July as well as HYFSP 3.500% 21Jul2016 Corp (SGD) which will come due in the same month, requiring a total principal repayment of S$275 million in 2016.

Chart 4: Bond Maturity Profile

Table 4: Hyflux&rsquo s Outstanding Bonds (Including perpetual preference shares)

Our projections do not support the view that its earnings will generate sufficient free cash flows to support its debt repayments. In view of this, Hyflux will likely tap the bond markets again soon to extend its debt maturity profile, redeeming the considerable amount of debt securities coming due and preventing an escalation of its borrowing costs due to the onerous coupon step-ups of its perpetual securities.

Our view:

Our examination of Hyflux suggests that barring a large asset sale, the company’ s balance sheet is unlikely to delever significantly over the next few years, which means credit ratios will continue to remain under pressure (we’ re expecting to see interest coverage in the low 1X range over the next three years). Nevertheless, Hyflux is a household brand name in Singapore, and has a strong track record of obtaining access to capital markets at attractive rates – recall that in 2011, total orders for the  HYFSP 6.000% Perpetual Pref (SGD) - Retail  were in the order of S$1.4 billion for an eventual S$400m issue size. For a prospective investor looking at Hyflux&rsquo s bonds, the firm’ s weak credit profile should be weighed against its ability to continually tap capital markets for financing – we would also suggest that investors pay close attention to the pricing for Hyflux&rsquo s bonds, which can be skewed by strong retail investor participation (the  HYFSP 6.000% Perpetual Pref (SGD) - Retail  has generally traded at a steep premium to par, resulting in a yield-to-call significantly below the 6% original coupon rate).

 

This article was provided courtesy of iFAST. iFAST Corporation operates in Singapore, Hong Kong and Malaysia as iFAST Financial Pte Ltd (Singapore), iFAST Financial (Hong Kong) Ltd and iFAST Capital Sdn Bhd (Malaysia) respectively and is licensed by the local financial market regulator in each respective jurisdiction .

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