Who is Hyflux?
Hyflux is a Singapore-based municipal water treatment specialist founded by its current CEO, Ms. Olivia Lum , in 1989. The company was listed on the Singapore Stock Exchange in January 2001 and has been a role model for entrepreneurial success in the city state. The company currently has a market cap of S$441 million (US$324 million); at its peak, its market cap was over US$1 billion.
In 2007, Hyflux listed Hyflux Water Trust (HWT) on the Singapore Stock Exchange, marking the first listing of a pure-play global water trust in Asia, at S$0.78 per unit. HWT contained a series of water infrastructure assets in China and other parts of the world, and was expected to change Hyflux's business model to an asset-light model.
However, three years later, company, together with Mitsui & Co, took HWT private at S$0.78 per unit, a premium to the market price at that time as the units have fallen below IPO price. The transaction valued HWT at S$235 million. The joint-venture company that took HWT private is Galaxy NewSpring Pte. Ltd. Yunan Water recently announced that it is buying the Mitsui half of Galaxy New Spring for US$100 million.
Negative Cash Flow from Operations
We looked at Hyflux's financial performance from 2010 to the first half of 2016. In each of the reporting periods, Hyflux has recorded profitable operations (net profit from S$89 million to S$41 million).
However, if we examine the company's cash flow statement, Hyflux has never recorded a single period of positive cash flow from operations (total cash used in operations of S$1.17 billion in 6.5 years, for an average of S$180 million per year). Hyflux's business model is based on service concessions. As of 30 June 2016, the company has S$1.11 billion of intangible assets arising from service concession arrangements and $923 million financial receivables, i.e., payments for its work in constructing the assets that have yet to be collected. Again, over the past 6.5 years, the company did not record any single year of positive cash flows from service concessions.
Weak Financial Position
As of 30 June 2016, Hyflux had S$1.34 billion of loans and borrowings and S$494 million of cash on its balance sheet. Since 2010, the company has issued S$1.36 billion of "perceptual securities", a 6% cumulative perpetual preference shares ("CPS"), which is trading at $0.9595 on the dollar, and a 6% perpetual capital securities ("Perp"), which is trading at $0.958 on the dollar.
The non-voting CPS, which carries a dividend rate of 6% p.a. of their liquidation preference, payable when, as and if declared by the board. The company has the right, but not obligation, to redeem the CSP on or after 25 April 2018 (7 years). The dividend rate increases to 8% if not redeemed by 25 April 2018.
The Perp takes it a step further - there is no maturity date for redemption. The company issued S$300 million at a rate of 5.75% in January 2014, S$175 million at a rate of 4.80% in July 2014 and S$500 million at a rate of 6% in May 2016.
We call the CPS and Perp collectively as ToxSec. We note that Hyflux is not rated by any rating agencies, and the bulk of these ToxSec is, unfortunately, sold to yield chasing retail investors in Singapore (www.straitstimes.com/business/hyflux-see...). We suspect these factors, together with the lax securities regulations in Singapore, enabled Hyflux to issue these ToxSec to retail investors, and at relatively low yields of 4.8-6%.
If we treat the ToxSec as debt (i.e., obligations that the company actually has to pay back to the security holders), the company would have S$2.71 billion of debt and S$359 million of equity (including non-controlling interests), i.e., a gearing ratio of over 750%.
One key measure that banks like to look at is current ratio, which is the ratio of current asset to current liabilities. As of 30 June 2016, Hyflux's current ratio is a healthy 1.62. However, if we take a closer look, we find that o the SS$1.16 billion of current assets, S$495 million is proceeds from its latest Perp issuance and S$212 million is in the form of assets held for sale, including Hyflux's half of Galaxy NewSpring. Looking further back as of 31 December 2015, Hyflux's current ratio (before the issuance of the latest tranche of Perp) was only 1.05, including S$212 million of current assets held for sale. Without reclassifying these assets from non-current to current, Hyflux's current ratio would have been 0.84. Is this creative accounting or financial engineering? Going back to 30 June 2016, if we take out the proceeds from the latest Perps and the assets held for sale, the company's current ratio would have deteriorated to 0.65, which will raise a red flag amongst its lenders and creditors.
In all honesty, we don't believe that Hyflux is a fraudulent company, nor there are any fraudulent activities within the company. We just think that the company does not possess the right economic model to be a viable continuing business.
Given the lack of cash flow from operations, and a deteriorating balance sheet that is only propped up by the issuance of a very company-friendly ToxSec and reclassification of non-current assets as current assets, we believe that Hyflux is approaching distressed levels. The ability to monetize its water assets would be key to its survival. However, investors have voted with their feed, pushing the prices of its ToxSec below par value. That being said, we don't think that these ToxSec presents investors with an attractive risk-reward proposition, even at their current prices.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: We did tried to short the stock, but couldn't find shares to borrow ...