Stock likely oversold. Since reporting a slightly muted set of 1H11 results in early Aug, Hyflux Ltd's share price has taken quite a tumble, falling some 23% to hit a low of S$1.50 yesterday. As a recap, Hyflux saw its 1H11 revenue fall 18% to S$197.9m, while net profit fell 35% to S$21.9m. While we had expected the negative knee-jerk reaction, we believe that the sell-down over the past few weeks has been slightly overdone. This as the market is currently only ascribing a forward PER of 13.6x to the stock, which is already below one standard deviation (SD) below its mean of 21.0x. Although the stock has previously fallen to as low as 10x forward PER (-2SD from the mean) during the global financial crisis, we note that the situation is slightly different now.
Order book is stronger than before. For one, the company's order book has improved significantly since then. As of end-Jun, its order book stood at S$2.1b - also the highest ever recorded - which it expects to deliver through to end 2012; this versus just S$1.48b at end-Dec 2008. We further note that the bulk of the S$1.16b EPC (Engineering, Procurement and Construction) contracts mainly comes from the S$750m TuasSpring project, which in our view, is also a significant improvement in the project risk. Meanwhile, the remaining S$940m comes from O&M (Operation & Maintenance) contracts, which typically stretch up to 25 years. And management intends to focus on beefing up its O&M segment to provide more recurring income to offset its otherwise lumpy EPC revenue.
Clean water is an essential commodity. While Hyflux is taking it slow in MENA at the moment (mainly due to the uncertain political climate), we continue to recognize the potential in that region as the need for clean, potable water would only escalate in the future. According to the World Bank , per capita water availability in MENA will fall by half by 2050, with serious consequences for the region's already-stressed aquifers and natural hydrological systems. Meanwhile, China is another area that holds good potential for Hyflux, as the government intends to double its budget for environmental protection and water resource development to US$450b for 2011 to 2015.
Maintain BUY. Hence even in a downturn, we believe that the water industry should continue to be quite resilient, given that clean water is an essential commodity. Nevertheless, due to the lower overall market, we still see the need to pare our valuation peg from 22.5x to 18x (-0.5 SD from mean) blended FY11/FY12F EPS, bringing our fair value lower from S$2.26 to S$1.81. Maintain BUY.
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