Decent set of results

Story: Excluding an unrealized forex gain of S$1.76m (owing to the appreciation of RMB against SGD), 3Q08 results were largely in line with our expectations, with distributable cash generation of 1.33 Scents –accounting for 48% of 2H08 projected DPU. Management remains confident of meeting the 4.88 Scents DPU payout target for FY09 (after waiver by sponsor Hyflux).

Point: 3Q08 revenues declined 17% q-o-q to S$13.9m, owing to lower construction revenue of S$10m compared to S$13.3m in 2Q08, as fewer project milestones were reached. The Beichen and Zunhua projects have been delayed and will now be completed in 4Q08 and 1H09, respectively. Tariff receipts grew 23% q-o-q to S$4.7m, though volumes grew by only 1% and utilization rates actually fell to 59% from 63% in 2Q as new plants came into play. Thus, much of the growth in tariff receipts can be attributed to tariff revisions negotiated at existing plants. Operating costs were again well managed, and operating margins held up at 60%, compared to 58% in 1H08 and higher than our initial FY08 projection of 45%. Cash balances at the end of the period stood at S$37.5m, down S$13m over the period owing to payment for construction costs and 1H08 dividend payout of S$4.45m.

Relevance: We revise our DPU forecasts for FY08 and FY09 up by 4.5% and 13%, respectively to account for the better visibility in sustenance of margins. The proposed first phase of asset acquisition from Hyflux will bolster the DPU from FY10 onwards. Maintain BUY, at a revised target price of S$0.62, based on our blended valuation methodology. Key risks include delays in future acquisitions if the credit markets remain tight, and a slower ramp up in utilization rates in industrial areas in the wake of a perceived slowdown in export oriented industries in China.

Acquisition terms inspire confidence

Story: Hyflux Water Trust (“HWT”) has agreed to purchase 5 water/wastewater treatment plants from sponsor Hyflux, for a total consideration of S$88m. The acquisition is expected to be financed by an outstanding revolving loan facility of US$66m.

Point: This is the first phase of acquisitions under the ROFOAR portfolio offered by Hyflux in end-June and will be conducted in two tranches, depending on the expected date of commencement of operations of the individual plants. The 5 plants have a combined capacity of treating 160,000 cu m of water/day and represent a 36% increase over current portfolio capacity of 445,000 cu m/day. The purchase price of S$88m represents a P/BV of roughly 1.4x, as against IPO valuation of 1.3x P/BV. The premium is justifiable given that all the plants will be fully functional at the time of acquisition, compared to the IPO portfolio where only 7 of the 13 plants were operational. HWT will also ink agreements with sponsor Hyflux to eliminate interest rate risk and risk of lower-than-expected utilisation rates, in order to ensure positive DPU accretion. With this acquisition in place, we conservatively enhance our DPU forecasts by 8%, 20% and 30% over the next 3 years, based on assumptions of 50% capacity utilization in the first year – ramping up to 100% by the 4th year – and fixed rate interest payments of 5% per annum.

Relevance: Following our downgrade last month, share price has plunged 32% – underperforming the broad market index, which fell 17% over the same period – and is now trading at 14% FY09 yield. Based on the higher valuation on expanded asset base and a target dividend yield of ~10% for this asset class, we revise our target price upwards to S$0.61. We expect the market to react favourably to HWT’s positive acquisition intent on favourable terms and the relatively secure yield accretive growth story and upgrade the counter to BUY.

Growth story under the scanner

Story: Growth seems to be at a premium now, with access to funds drying up. As credit markets tighten up worldwide, Hyflux Water Trust (“HWT”) may find the going getting tougher to finance its potential acquisitions.

Point: HWT has been negotiating the debt funding required to finance the acquisition of the first tranche of nine assets from sponsor Hyflux but credit conditions have deteriorated since the initial announcement and spreads have widened to a level, which may render the acquisition
of certain assets unviable. As a result, HWT may choose to acquire only a part of the portfolio on offer, if the terms of financing are more favourable in that case. Thus, there is considerable uncertainty in the timing and quantum of the acquisition-driven growth story for HWT.

Relevance: As such, we see possible further downside to the share price, as current spread of HWT’s dividend yield over 3m USD LIBOR at 4.9% is lower than YTD peak of 6.2%. Moreover, compared to other SGX-listed business trusts, including closest peer CitySpring, HWT is trading at a much lower yield. Thus, we reduce our target price for HWT to S$0.53, based on blended valuation methodology – DDM and dividend yield valuation – to better reflect the importance of target yield for investors in this asset class, especially in the absence of a credible growth story amidst current credit market uncertainties. In addition, we cut our FY08 and FY09 DPU estimates by 3% and 13%, respectively, to factor in possible lower utilisation in existing assets and downgrade our recommendation on the counter to HOLD.

Distributions on track

Story: Hyfux Water Trust once again surprised us on the upside, with 2Q08 net earnings of S$2.2m (up 94% q-o-q) adding up to almost 52% of our existing FY08 forecast. Net payout to investors for HY08 stood at 2.17 S cents (after Hyflux waiver) as against projected DPU of 2.09 S cents as per IPO prospectus.

Point: The surprise in earnings was mainly a result of lower-than-expected operating expenses and lower trust expenses. HWT continues to excel as far as cost management is concerned and even bettered its1Q08 operating margins (68% in 2Q vs. 48% in 1Q), with operating expenses of only S$1.2m on tariff receipts of S$3.8m. Tariff receipts were up 19% q-o-q as utilisation rates jumped from 51% in 1Q08 to 63% in 2Q08 and two more plants were completed, bringing the design capacity of completed plants to 325,000 cu m/day. The Trust looks to be on track to meet its DPU guidance of 4.88 S cents (after waiver) for the year – given that the remaining three plants are expected to be completed before the end of the year and utilisation rates should move closer to 70%. Management is further negotiating organic expansion potential for four existing plants of about 155,000 cu m/day, which should see closure in 6-9 months.

Relevance: We have revised up our DPU forecast for FY08 by 7% to account for the better-than-expected margins achieved in 2Q08, while leaving our FY09 forecasts unchanged awaiting further visibility on the sustenance of margins. Our DDM-backed Target Price remains unchanged at S$0.90 and we continue to maintain BUY on the stock, while keeping a close watch on how the acquisition scenario unfolds as HWT deliberates on the first tranche of assets offered by sponsor, Hyflux. Current dividend yield is attractive at 7.5%-8.4% for FY08-09 and represents a good entry point, in our opinion.

Hyflux Trust first-half DPU rises 4%

Interim period saw distributable cash of $4.5m

HYFLUX Water Trust (HWT), the first pure-play global water business trust to be listed in Asia, yesterday reported distributable cash of $4.5 million for the first half of the year.

This translates to distribution per unit (DPU) of 2.17 cents – 4 per cent higher than the forecast 2.09 cents. Based on yesterday’s closing price of 63.5 cents per unit, the DPU works out to an annualised yield of 6.8 per cent.

However, HWT is forecasting full-year DPU of 4.88 cents, reflecting a yield of about 7.7 per cent, and the trust said it expects to meet the forecast.

For the second half of the year, utilisation rate of its water treatment plants is expected to increase, while more plants will be completed, the trust said.

‘We are pleased that HWT has exceeded its forecast for its first distribution,’ said Saud Siddique, chief executive of the trustee-manager. ‘HWT’s performance is underpinned by the positive outlook in the water industry in China, and the strong fundamentals of our projects.’

Mr Siddique said that of the trust’s initial portfolio of 13 water treatment plants in China, 10 are in operation while the rest will be finished by the year-end.

There are no comparison figures for the previous period as the trust’s portfolio was constituted only late last year. The trust distributes cash every six months.

For the quarter ended June 30, HWT reported total revenue of $16.7 million and net profit of $2.2 million.

This was double the Q1 net profit of $1.1 million on lower trust expenses, hedging and forex gains, said Grace Goh, HWT’s chief financial officer and chief investment officer.

Nine plants from sponsor Hyflux Limited with total capacity of 290,000 cubic metres a day are now being considered for injection into the trust and HWT is on target to submit the proposed injection to unitholders for approval by November this year, Mr Siddique said.

‘We are focusing on growing the asset base as fast as possible. As we bulk up we will become more attractive to a wider investor base,’ Mr Siddique added. In all, Mr Siddique said, the trust has a ROFOAR (right of first refusal and right to match) pipeline from sponsor Hyflux of 20 projects totalling 815,000 cubic metres a day, spread over seven provinces in China.

He added that the trust, which now has no gearing, is actively seeking debt financing to expand its portfolio of water treatment plants.

HWT has secured a committed three-year revolving credit facility of US$66 million with an interest margin of Libor/Sibor plus 98 basis points.

The trust is targeting up to 50 per cent gearing, using debt from banks rather than bonds, Mr Siddique said, and it may look to equity financing once that threshold is reached.