Hyflux

[freedom]

Hi freedom,

There is a section on preferred shares in Ben Graham's Security Analysis which I enjoyed reading and helped improve my understanding of the topic. Perhaps you may find it useful too. They are Chapters 14 and 15 of the sixth edition.

Here are some snippets from the opening chapter:
"That the typical preferred stock represents an unattractive form of investment contract is hardly open to question. On the one hand, its principal value and income return are both limited; on the other hand, the owner has no fixed, enforceable claim to payment of either principal or income. It may be said that preferred stocks combine the limitations of creditorship (bonds) with the hazards of partnership (common stocks)"

and

"One of the basic principles of investment is that the safety of a security with limited return must never rest primarily upon the future expansion of profits. If the investor is positive that this expansion will take place, he should obviously buy the common stock and participate in its profits. If, as must usually be the case, he cannot be so certain of future prosperity, then he should not expose his capital to a risk of loss (by buying the preferred stock) without compensating opportunities for enhancement."

----------------------------------------------------------------------

You mentioned that you don't see it as a fixed-income instrument since principal is not guaranteed. Well, I don't see it as an equity investment since my upside is capped! I guess what we have in the end is really what Graham described it to be, a combination of the limitations of both fixed-income and equity.

Taking Hyflux's case, I think that the preferred shares was all in all, as good a financing deal as the company could have gotten, given the issue's low coupon rate (compared to its MTN notes) and perpetual status, and the company's high level of debt. And if this whole raising-external-financing-for-expansion thing works out in the end, the real winners should be the equity holders (but that doesn't mean the share is attractive now at its current price). What the shareholders got was cheap financing and a debt they possibly never have to repay.

In fact, I can think of a few ways in which common shareholders can screw preferred shareholders. One way is to not pay any dividends at all. Most of the earnings should then be reflected in the appreciation of the share price. If it doesn't, and the share price is lower than intrinsic value, the company can still execute buy backs to return value to shareholders, thus skipping dividends totally. (This last buy back part is hypothetical, I'm not sure if skipping preferred dividends and buying back common shares is legal).

Having said that, there can be situations where Hyflux's preferred shares can be attractive. Firstly, I would prefer if there wasn't a debt as large as common shareholders equity in front of me blocking my principal repayment. Secondly, I would want to be confident of the cash flows of the company going forward. I want it to be so huge that they have no good alternatives for capital allocation and cannot justify holding as cash, and would be force to pay it out as dividends. In the meantime, I am not going to risk my money just reaching for that 1% or 2% more yield.

Hi, D123.

In the last paragraph, would it be better to invest in its common stock rather than preferred stock to enjoy the benefit more?

[Musicwhiz]

The idea of the RCPS is to ensure a steady high yield for shareholders which is cumulative in nature, and much higher than their yield on common stock. If the Company had retained its earnings to grow its business without paying dividends to common stock, then the objective of owning common stock must then be for capital appreciation rather than yield.

By implicitly choosing preference shares over common stock, a shareholder is limiting his upside while ensuring he has limited downside unless the company goes completely bust.

Hence, preference shareholders upside is definitely capped but they should go in with their eyes open and not expect the share price of their shares to appreciate as much as the common stock. They are enjoying a higher yield than common stockholders and hence have no reason to complain should there be higher price appreciation for the common stock over the preference shares.

[D123]

would it be better to invest in its common stock rather than preferred stock to enjoy the benefit more?

Yes, I would agree with that. In such a situation, and both common stock and preferred stock are available at book value, it is most likely that the common stock holders would benefit more.

But since common stock and preferred stock are separate securities, their relative attractiveness would depend on their prices. If the conditions are met such that the preferred shares' principal and interest are secure, they could be a better investment prospect at par than the common stock if, for example, the common stock was selling at a P/E of 50. Hmm, or maybe I should say less worse.

I think at the end of the day, one approach is to look at the company's current and historical performance, try and forecast its future performance, and then try to see how we can participate in that through its debt, preferred shares and common stock. It could be that even though the company is an attractive one, its various securities (debt, preferred, common) have varying degrees of attractiveness.

[freedom]

Is it a bit weird to account preferred share as part of common equity to compute NAV? like what Hyflux did in Q2 2011.

as a result of issuance of S$400 million preferred share, NAV of Hyflux went to above $1....

[D123]

Is it a bit weird to account preferred share as part of common equity to compute NAV? like what Hyflux did in Q2 2011.

as a result of issuance of S$400 million preferred share, NAV of Hyflux went to above $1....

Yes, I think it's very easy to separate the accounts for preferred shareholders and common shareholders, and then to calculate book value per share using total common shareholders' equity. Not sure if it's done for SG companies, but I've seen it done in some US companies.

What Hyflux did here seems rather disingenuous. Anyway, my personal perception is that Hyflux's developments over the years have been driven more by MBAs trying to generate accounting growth rather than engineers engineering technological growth. Not sure if this is best for a young company and its shareholders.

[Musicwhiz]

Business Times - 05 Aug 2011

Hyflux net slides 47% in 'transition' quarter

By LYNN KAN

DESALINATION player Hyflux recorded a net profit of $14.5 million for the second quarter ended June 30, down 47 per cent from $27.3 million for the corresponding quarter last year.

Turnover shrank 21 per cent to $111.1 million from $140.4 million, as Hyflux went through a 'transition' quarter, reallocating its attention from the Middle East to Asia - particularly China, Singapore and possible projects on the horizon in India.

'Q2 is a turning point for us as we move between the different regions,' said group chief financial officer Cho Wee Peng.

Upcoming quarters will be brighter as revenue is recognised on its Tuaspring Desalination Plant project.

What gnawed away at earnings were higher staff costs and higher financing costs in the run-up to the Tuaspring Plant and higher amortisation from its intangible assets.

Earnings per share for the second quarter fell to 1.22 cents from 3.22 cents in Q2 FY10. The company also announced an interim dividend of 0.67 cent per share. Hyflux's order book is at a record $2.1 billion.

While Hyflux's Q2 revenue underperformed - DBS Vickers forecast $150 million - its shares were not penalised yesterday, sliding just half a cent to $1.95.

Hyflux said that the fire that occurred at a warehouse on its Algerian project site in Magtaa in late July was still under investigation and its causes are still unknown.

Hyflux would need to reprocure the damaged membranes, pumps and cables. The total damage tally was estimated at US$50 million.

Though the Magtaa plant's commissioning would be delayed nine months to May 2012, the insurance taken out on the project would cover damages as well as the overheads incurred during the nine months.

Revenue growth in H1 for Hyflux was powered by China, which went up to $70.7 million or 36 per cent of total revenue from $45.7 million or 19 per cent of total sales in H1 FY10.

The Chinese government has recently made a commitment to clean water, a boon to desalination players like Hyflux.

And with recent Chinese central bank tightening, companies like Hyflux with access to foreign capital funding have the upper hand, said Mr Cho.

'Domestic Chinese players who don't have access to offshore funding will face funding difficulties. Chinese banks are holding back new loans so they will face difficulties,' he said.

Hyflux is also scouting out a project in the Dahej region in Gujarat, India, in a consortium with Hitachi and Itochu Corporation, but declined to elaborate more on its development.

[Thriftville]

Hyflux share have been plunging recently... which trigger my interest!

Any buddy has knowledge on membrane technology? Would hope to hear your views on how Hyflux is able to maintain their competitive advantage... Thanks in advance!

[Jared Seah]

I would like to share my reflections and learnings on the interesting discussions on Hyflux preference shares issue back in April 2011.

Boy! Was I wrong!

http://singaporemanofleisure.blogspot.co...rence.html

A special word of thanks to RBM. The road less travelled is indeed lonely (but profitable!)

A reminder to myself - don't ever lose track why I am investing in the first place.

Cheers mate!

[hkl]

I would like to share my two cents worth on the water treatment industry as well.

Membrane technology aside, the China story on water treatment has been around for some time. I personally invested in two companies not too long ago, Sinomem and United Envirotech. Sinomem has since been privatised. As for United Envirotech, the investment was done with much less due diligence. The realization that $67mil out of $102mil of service concession receivables in their FY2011 balance sheet were due in more than 5 years prompted me to divest. There's also the story of municipal governments in China pledging land on the outskirts as collateral and channeling loans into SPVs to fund their projects. Land prices go up and they get more loans to fund more projects and so on...

Turnkey operators, especially like UENV which has a Build-Order-Transfer model, require extensive capital to finance their projects upfront. The fact that UENV has been raising cash consistently should have been a big warning sign for me. I realise in retrospect that this is similar to the fanfare that solar energy was greeted with back then. The prospects may sound good but not all companies will prosper in the end.

I'm not saying that UENV is bad, but the investment just could not let me sleep sound at night. Today there are many counters on SGX with a foot or two in water treatment, boustead, hankore, darco, sembcorp etc, not to mention the s-chips.

I might be invested in the water treatment stocks again, but i sure will be doing my homework the next time..

[RBM]

I believe that one of the drivers of Hyflux's Equity Shares poor recent performance is their exposure to MENA countries, and I know some of the key players in institutions aren't too keen on Hyflux's debt level. In today's market environment, I believe it would be wise for them to focus their desalination efforts even more on Singapore, China and OECD countries............ and less on "interesting places".