Hyflux - Backend loaded growth (DBSVickers)

HOLD S$1.95 STI : 3,107.01 (Downgrade from BUY)

Price Target : 12-Month S$ 2.07 (Prev S$ 2.47)

Reason for Report : Earnings/ TP revision

Potential Catalyst: Contract wins and divestment

DBSV vs Consensus: Sales and revenue significantly below consensus

• 2Q misses but expect China, Tuaspring & Tlemcen O&M to drive a stronger 2H

• FY11/12F revised by –24%/+17% to factor in higher costs & Magtaa pushback to FY12

• Downgrade to HOLD, SOTP TP lowered to S$2.07

2Q11 earnings missed due to weaker sales, higher costs. In tandem with weaker than expected sales of S$111m, PATMI of S$14.5m (-47% y-o-y, 97% q-o-q) came in significantly below our S$27m forecast. 1H made up only 38% of our original FY11F compared to 42% in FY10. Excluding S$1.9m of forex losses, core profit would be S$16.5m. Sales fell 21% y-o-y because Magtaa is winding down and MENA’s contribution has shrunk to 48% of sales from 75% a year back. Although cost controls lifted gross margin to 49.8% from 44% in 2Q10, net margin slipped to 13% from 19% due to higher financing, depreciation and higher effective tax rate. Hyflux maintained interim DPS of 0.67 Scts.

S$1.16bn EPC backlog covers 1.3x FY12 sales. Hyflux has secured S$982m contracts YTD. We are not factoring in any more wins this year. However, there could be small wins along the way as Hyflux continues to pursue projects in China, India and SEA. Meanwhile, nine of Hyflux’s China projects are at various stages of development including near completion or operational soon. Hence, there is scope for asset divestment over the next six months, which could further boost earnings.

Earnings pushed back to FY12, SOTP lowered to S$2.07. In addition to higher costs and taxes, the Magtaa fire will delay some EPC recognition. Hence, we have cut FY11F earnings by 24% and push up FY12F by 17%. For 2H, drivers include continued execution of China projects, start of Tuaspring (~ 15% recognition) in 4Q11 and some O&M flow through from Tlemcen. Notwithstanding higher earnings in FY12, our SOTPbased TP is reduced to S$2.07, in line with lowered market valuations and delayed O&M receipts for Magtaa too. Downgrade to HOLD on limited price upside.