Hyflux slow EPC Order Hampers Outlook for FY14

Citi's Take

Hyflux reported FY13 PATMI of S$44m (-28% YoY) which came in within consensus expectations. With the completion of Tuaspring in 3Q13, we also saw corresponding decline in raw material cost (-31% YoY) and staff costs (-13% YoY), alongside a revenue decline of 18% YoY. Higher depreciation and amortization (+78% YoY) and other expenses (+39% YoY) due to increased utilities/ professional fees and S$11m provisions made against receivables (including S$8m receivables provision against trade receivables or approximately 3% of total trade receivables end FY13) were the main drags on PATMI. The company’s net gearing increased to 1.15x in FY13 (vs. FY12’s 0.56x) as borrowings increased to include non-recourse financing to project-finance Tuaspring.

Management guidance – Management guided that the slow momentum may continue into 1H14 as Hyflux continues to work towards the financial close for the Dahej project later in 1H14 (implying project commencement only in 2H14). Nonetheless, Hyflux remains active in tendering for large projects in Singapore, Africa and Middle East. While we had not seen any meaningful asset recycling transactions in FY13, Hyflux maintains that it will continue to
pursue an asset-light strategy and thus will continue to actively seek asset-recycling initiatives.

Implications — Earnings momentum could slow; gearing up – Given the 29% YoY contraction in its EPC orderbook in FY13, earnings momentum will likely be subdued for FY14, similar to the trend we saw in FY11 (earnings -37% YoY) after its EPC orderbook declined 43% YoY in FY10 post the Global Financial Crisis. With fresh order wins in FY14 likely only to contribute meaningfully next year, and its significant O&M book providing a larger steady stream of income for Hyflux from FY15 onwards, we believe the key towards addressing slower earnings in FY14 will lie with asset sales from its portfolio of plants and concessions which total in excess of S$1b.idend of 0.70 cents that was paid out in September 2013.

Valuation
We expect Hyflux's valuation to rerate as its order book momentum recovers. Our target price is pegged at S$1.62, which is derived using a sum-of-the-parts methodology that combines the value of Hyflux as a
1) growth enterprise (S$1.18 per share based upon PER of 20x , which is the long term mean for Hyflux, on the average EPS of 2013E and 2014E) and
2) gains from asset divestments assuming a 20% gain (S$0.44 per share).

Risks
We believe the following risks could prevent the stock from reaching our target price:
1) Problems with execution relating to completion of its current portfolio of projects;
2) Increased competition and failure to win future bids for water projects;
3) Shortage of buyers to off-take its projects available for divestment; and
4) Volatile capital market conditions.