Hyflux (KE)

Event

We had anticipated earnings risk in our previous update. Hyflux’s 3Q11 results confirmed our fears. Without the one-off PPE sale and forex gain, the third quarter would have been in the red. Profitability this year will likely fall far short of earlier consensus expectations ($80m). We downgrade the stock to SELL.

Our View

3Q11 revenue declined by 36% YoY while net profit fell by 34% YoY to $12.6m. A one-off gain on sale of obsolete equipment ($13.2m) and forex gains ($5.1m) prevented a loss. For 9M11, profit declined by 36% to $34m against a full-year consensus of $80m. This was attributed to lumpy revenue recognition, but we foresee more structural issues here.

Execution on China BOT projects continues to be slow, a worry we have earlier expressed. Despite an estimated orderbook of $330m, only $93m were recognised YTD. This is despite some projects having been won as far back as 2008. We think it is likely that management withheld some of these projects, which might be fundamentally unattractive. With a 25-30 year investment horizon, there is also the issue of whether Hyflux is able to divest these projects.

The cessation of the Middle Eastern projects for now may signal an end to a run of attractive projects for Hyflux. Outside of Singapore, management is focusing on China, India and Australia, though the last two are still potential new markets from which concrete contracts have yet to come.

Action & Recommendation

We cut our earnings forecast to mainly reflect slower execution on the remaining EPC orderbook of about $1.1b. We also lower our core earnings multiple to 12x to reflect higher earnings risk. At its current price, Hyflux is still trading at 2.4x P/B, excluding preference shares. This is a lofty valuation given our estimated decline in ROE to below 15% over the next three years. Downgrade to SELL with the SOTP-based target price cut to $1.15 from $2.16.