Sunday, April 17, 2011

Hyflux Preference Shares

Like most yield hungry Sg investors, I have been googling around on Hyflux's preference shares, but sadly, the information online is still somewhat lacking. One of the best analysis out there is done by la papillion:

The blogger has written a blockbuster trilogy as well, do read through his whole analysis, totally worthwhile! Considering that the deadline for subscription is like 3 days from now, I guess this will be the first and last post for me.

For those really dunno what's going on, Hyflux is the leading water company in water deprived Singapore. The mkt cap of the firm exceeds a billion dollars, which means it is not your small fry SGX listed co, this can be the next Keppel Corp one! Recently, the firm announced this plan to raise S$200mn via pref shares with perpetual yield of 6%, with a step up to 8% some years out.

A pref share is similar to a bond in the sense that it gives you an interest income (well in this case a more or less compulsory dividend). The difference being that the dividend is perpetual (at least theoretically). Also pref shareholders are junior vs debt/bonds but senior vs common equity. This means that if the firm goes bust, pref shareholders stand to get something only if all bondholders have taken their share - ie nothing much left lah. However, pref shareholders usually enjoy a higher dividend. In this case, a good 6%!

As for Hyflux, there are various issues involved and I will simply summarize the pros and cons briefly here:

Here's the good part first.

1. The dividends are cumulative - ie if they fail to pay one time, they must make up next round, ie you will more or less get your 6% over time.

2. The dividend must be paid as long as common shareholders are paid, bcos pref shareholders are ranked higher vs common shareholders. Looking at its common dividend, Hyflux's track record is ok, not super stellar but at least got dividend every year since a couple of years ago, albeit the yield is pathetic, like 2% kind.

3. Hyflux enjoys the support of the SG govt, while it is unlikely that the govt will step in to save the stakeholders (ie debt or shareholders) in the event Hyflux goes belly up, it is also unthinkable that Hyflux would actually go bankrupt in the next 3-5 yrs. The govt has in the past been supportive of Hyflux, awarding landmark mega contracts (like the first de-salination plant etc) to the firm every couple of years.

4. It is a well-runned company. Top management knows their stuff and has earned the respect of both investors and competitors. Just that it is in a bad business. More on this below.

Here are the cons:

1. Why is the firm doing such a detrimental financing? They can always borrow from the banks at a lower rate, but they chose pref shares, and have to pay 6%. It might have something to do with their credit rating, if they raise more debt, the rating will fall. It then also says something about their financing options. Last checked, the firm has S$1bn in debt and S$500mn in equity. It's definitely higher than most SG blue chips although not that bad if you compare it with global co.s. Maybe the uprising in Africa is really taking a toll on their businesses. Or maybe Olivia Lum thinks that she should share her success with all Singaporeans. Well that is my wishful thinking :)

2. Hyflux's business model is not robust. It relies on winning projects, which in turn is economic sensitive. Even worse, its growth relies on winning ever bigger projects, most recent ones were like US$1bn or more one. In bad times, like during Lehman, project pipeline dries up and cashflow goes into red.

Also, they have no say over the price, they bid for the projects and can only win with lower bids vs others. Inflation in the last few years is causing their input costs to go up. Now with Libya, I suspect they are not in a good shape although a recent SG project should help. This validates the point made above: the SG govt lends a hand during bad times.

3. The cashflow track record is not exactly great. Over the last few years, they averaged FCF of S$30mn, which means that this pref share dividend alone will eat up S$12mn or 40%. There is one year the FCF went into -40mn, so if that happens again, the shares WILL plummet, both pref and common, like it or not. In short, not too much of a buffer that can guarantee payment until perpetuity.

4. The shares will trade on SGX come end Apr, which means that there might be downside risk if you need the money. It can be trading at $80, then you lose 20%. Of course I suspect it should trade above $100 in the next few weeks bcos Sg investors are suckers for such high yield. Already it's oversubscribed by 8x or so. But we must remember when the going gets vicious, it is likely this thing can go to $70 or even $60. The OCBC pref shares went to $80 during Lehman (now $104). If that happens, you have to ask if you are willing to add more :)

4. Hyflux is likely to buy back the shares asap, 6% of 200mn to pay every yr is no joke (S$12mn as mentioned, or roughly 40% of its FCF), but that's ok even if we just get a couple of yrs of 6% as the shareholders.

5. Finally if you subscribe, you need to do some guesswork, bcos you are not going to get everything. From the 8x oversubscribed no. probably $100k will get like $15k or something. Then again, you must be prepared you might get everything, but this is quite a low probability event now.

Conclusion: Probably an ok deal though not entirely secure like buying the safe and sound blue blue chips. Buyers would be betting on some implicit government support in really, really dire straits, a competent management that knows what they are doing and of course the 6% yield. 2 days left to go to the ATM to subscribe!