The Straits Times / The Business Times News on Hyflux

Hyflux going with the flow

A BIT of Hyflux's lustre seems to have rubbed off of late. Despite announcing a three-fold rise in its first half earnings recently, Singapore's best known water treatment company has been given a lukewarm appraisal by several analysts who had previously hailed its meteoric rise.

Their worries over Hyflux's slackened core earnings, over-valuation and negative free cash flow are legitimate, and investors who want to hop on this hot stock must watch these developments closely.

Many have highlighted Hyflux's weak core earnings, which were given an $11.6 million boost - $8.5 million from the sale of Hyflux's building and $3.1 million from revaluation of its financial assets.

Stripping that out, the company's second quarter profit after tax would have been flat at $5.5 million compared to the same period last year - way below many brokerages' forecasts.

Hyflux's president and CEO, Olivia Lum, has cautioned that with the company taking on more big-scale municipal projects overseas, shareholders can expect lower margins and lumpiness in performance as revenues are recognised by milestones. But she said these assignments provide longer-term recurring income.

Even so, analysts have expressed reservations over Hyflux's ability to pull off its big-scale ambitions. Elsewhere, Hyflux chalked up its sixth consecutive quarter of negative free cash flow of $25 million, while revenue from its consumer products section dropped to $400,000 in the first half from $5 million before.

There has since been a flurry of 'sell' calls. Phillip Securities on Aug 5 downgraded the stock to a 'sell', with a price target of $2.28, both UOB-Kay Hian and Westcomb Financial Group recommended a 'sell' on Hyflux, with fair value of $1 and target price of $2.82 respectively. Meanwhile, CIMB-GK Research also downgraded the stock, with a target price of $3.38.

Hyflux has been an undisputed stock market favourite this year, hitting as high as $3.98 just last month and gaining almost 70 per cent this year. It last closed 22 cents lower at $3.34 on Monday. Its price-earnings ratio (PER) is a whopping 42 times and estimated PER is within the 30-35 times range. The exuberance is not without grounds of course. Sentiment is riding high for Hyflux because of the company's huge order book and the popular theme of the shortage of clean water in developing countries.

It has been impressive in clinching deals in China and the Middle East and is looking at India as a new growth market. To date, its order book stands at $336 million, with municipal projects making up 81 per cent of total orders.

This does not include potential orders worth US$290 million from the Middle East and the $150 million seawater desalination project in Tianjin. Feasibility studies are also under way for a $700 million Harbin Mopan Mountain water supply project and $160 million Changchun waste-water treatment project. These big figures are certainly overwhelmingly enticing, and credit must be given to Ms Lum and her team for pushing the envelope in bringing the Hyflux name to the region. Remember - the company is after all a relatively young one, having started in 1989.

But a lack of a proven execution track record - among them multiple projects in different areas, project delays and capitalisation concerns - have kept market watchers from giving Hyflux their full endorsement.

So even though Hyflux has finished its Tuas desalination project three months ahead of schedule, delays in its Liaoning and Tianjin desalination plants have led analysts to ask if the company is still looking for a partner to take a majority stake in these projects so as to cut its own capital expenditure.

As Westcomb noted: 'Even though the prospects for the industry are excellent and there are many project opportunities available in the market for Hyflux to capitalise on, we feel that Hyflux may be restricted by the large capital requirements necessary for the BOO and BOT (build-operate-own, and build-operate-transfer) projects.'

Of course, Hyflux has constantly stressed that it wants to keep an asset-light strategy to free up its resources. But it has to be mindful of competitors like General Electric and Keppel Integrated Engineering which probably have deeper pockets and possibly loom large on the horizon.

Granted, Hyflux has pulled off incredible feats so far, but investors have to make sure they do not overlook the tough challenges the company still faces.