The Straits Times / The Business Times News on Hyflux

Water stocks: upbeat despite profit warnings

Analysts say larger players with more diversified market base unaffected

TWO water-related companies issued profit warnings last week, as reporting season kicked in. But most analysts remain upbeat on the sector.

They say this because the two companies that issued warnings - namely, Eco Water and Pan Asian Water Solutions - are very small players and operate largely in South-east Asia. Larger players like Bio-Treat Technology and Sinomem swim in the booming China pool, and others like Hyflux have a more diversified market base.

Eco Water said it expects first-half losses due to lower gross margins from its municipal wastewater business in Malaysia. It has also been hit by higher fixed general and administrative costs. Meanwhile, Pan Asian - which provides piping equipment for plants in Singapore, Hong Kong and Vietnam - also expects first-half losses, due to fewer projects delivered in the first six months of 2006 and losses from subsidiaries.

'These companies are very small and dependent on fewer projects. One or two delays can affect their bottom line and it is not surprising to see them sink into losses,' said Kerryn Tay of CIMB-GK.

Ms Tay does not expect similar counter-party risk for the better-known firms. 'The bigger players like Hyflux and Bio-Treat have far more, between 50 and 80 projects, and earnings are less volatile,' she said.

She also downplays the importance of profit warnings issued in the middle of the year. 'Warnings are largely due to timing of profit recognition. It may affect earnings for the quarter but the earnings will flow into the next quarter and will still come in for the year. I prefer to look at a company's order book and profit margins,' she said.

In the coming reporting season, Bio-Treat will be announcing its full-year 2006 results. So will Metax Engineering, a smaller company with a focus on India. Most of the other water-related companies listed on SGX - including Hyflux, Sinomem and Asia Water - end their financial year in December.

'We expect Bio-Treat's Q4 '06 results to be significantly stronger on a sequential basis, as witnessed in the past two financial years,' Merrill Lynch wrote in a July 11 report initiating coverage on the stock.

Merrill set a 12-month price target for Bio-Treat of $1.43. It expects 24 per cent growth in Bio-Treat's net profits to 406 million yuan (S$81 million), and growth in basic earnings per share to 9.1 cents in FY06, from 7.7 cents for FY05.

In the longer run, Merrill sees further growth in turnkey projects, as well as in recurring income from BOT/TOT projects. 'Given its strong project pipeline, we forecast an EPS CAGR of 14 per cent over FY06-FY09,' it said.

As for Hyflux, its second-quarter report is 'unlikely to surprise the market', Goldman Sachs said on June 19. 'We expect Q2 2006 results to be in line with our, as well as consensus, expectations. We hope to get an indication of the size of the orderbook.

Goldman set a price target of $2.50 for Hyflux - which closed at $2.09 yesterday - but warned 'the upside is modest relative to the risks involved' as 'the industry is competitive, financing requirements can be substantial, and project risks are high'.

Analysts say governments in China - the main market for many of the SGX-listed water companies - are awarding more build-operate-transfer and transfer-operate-transfer contracts, as opposed to turnkey contracts. 'This is risky as firms then require high capital outlay in the beginning, and recoup costs and make profits only over 20 years,' said Chew Boon Leong, an analyst with Riedel Research Group.