More wind in the sails?

Story: We recently visited some of Hyflux Water Trust’s (“HWT”) water and wastewater assets in China, including one of the 9 plants offered by sponsor Hyflux to HWT for acquisition as part of the ROFOAR pipeline.

Point: We came back reassured about the Trust’s ability to manage its assets and the inherent growth potential of its existing portfolio. HWT leverages on the experience and track record of parent Hyflux for all aspects of day-to-day operations and administration. Being located out of large industrial parks still in the early stages of development, HWT has a distinct advantage as it allows them to be a part of the industrial growth story being actively promoted by the local governments. Along with this potential of organic expansion, Hyflux has offered HWT a portfolio of 9 assets with a combined capacity of 290,000 cu m/day (representing about 65% of existing capacity) for potential acquisition, at an offer price of S$180m. HWT currently has zero gearing and debt financing should not be a problem, with an US$60m line already in place. Though the offer price looks to be on the higher side at first glance, at 1.6x P/BV (as against valuation of IPO portfolio at 1.3x P/BV), we believe that the acquisition should be yield-accretive from FY11 onwards. HWT would be taking its decision on the offer by 4Q08.

Relevance: We have revised our assumptions for water tariffs and utilisation rates for some of the plants in the existing portfolio based on information gathered off-theground. Hence, our DPU forecasts for FY08 and FY09 consequently stand reduced by 6% and 3% respectively. However, our DDM-backed target price remains unchanged at S$0.90 and we continue to maintain BUY on the stock. Current dividend yield is attractive at 7.0% for FY08 and 8.3% for FY09. Expect a re-rating if and when HWT decides to acquire the Hyflux assets on offer.

China Water Congress 2008 – key takeaways and implications for Singapore water companies

● We attended the second China Water Congress in Beijing last week (15-16 May). Below are key takeaways and comments from the conference. Overall, we reaffirmed our bullish view of the water demand outlook, driven by government-backed initiatives. We reiterate our OUTPERFORM ratings on HWT, AENV, and EPUR, and our NEUTRAL rating on HYF.

● Presentations by the Chinese ministries reiterated the government’s focus on addressing water difficulties. Whilst there are clear opportunities, it appears to us that the existing framework is still at its infancy whilst reforms are underway.

● While the IRR is in the 8-12% range, key investment criteria in determining risk-reward also include location, size, type, etc. Owing to prior success, PPP is a preferred investment option as evident in the active participation amongst the Sing water plays.

● Whilst considerable improvement in desalination technology and on membrane has been made, China has bigger ambitions to be on par with world’s standards. Also, it targets raising its capacity to 0.8-1 mn tons/day by 2010 from today’s 0.2 mn tons/day.

We re-affirmed our bullish view on China’s water demand
We attended the second China Water Congress in Beijing last week (15-16 May). Below are key takeaways and our comments from the conference. Overall, we re-affirmed our bullish view of the water demand outlook, driven by government-backed initiatives. To re-cap, the Chinese government in the 11th Five-Year Plan (2006-10) has allocated a total of RMB1 tn to address water issues, such as supply, waste-water treatment, water reuse, sewage, and environmental protection. Among the Singapore water companies, most have significant exposure to the China water and waste-water market. We continue to believe companies with good track records in China and differentiated capabilities are well-positioned to capitalise on the strong growth potential. We reiterate our OUTPERFORM ratings on Hyflux Water Trust, Asia Environment, and Epure, and our NEUTRAL rating on Hyflux. We remain OVERWEIGHT the sector.

Water reform developments/updates
The first theme of the conference focused on the severity of water difficulties in China and water industry reforms there. The presentation made by the Ministry of Water Resources reaffirmed our positive view of the robust water outlook in China. Whilst there are clear opportunities for investment in China driven by scarcity, climate change, industrialisation, and reforms, the existing industry framework is still in its infancy, with best practices to be explored further and
leveraged across companies and countries. In addition to the mainstream areas/sectors, there were market-driven proposals on opportunities in smaller cities and in various technologies.

Investing in and financing water projects
The second theme was managing investing and financing risks, from the viewpoint of both water companies and financiers. While the internal rate of return with foreign participation is in the 8-12% range, key investment criteria in determining risk-reward also include asset location, portfolio size and type, and governmental involvement, among others. Owing to the success of public-private partnerships in China’s energy and transport sectors using the greenfield (BOT)model, this model is generally accepted in the water sector as well. This is evident amongst the Singapore water companies, many of which have moved to participate in BOT (and brownfield – TOT) water and waste-water projects.

Forging ahead with desalination
The third theme was seawater desalination (SWD). With the government’s support in developing desalination capacity and technologies, China has made considerable advances, especially in technology, since the late 1950s/early 1960s. Through the years, there seems to be an increasing emphasis on membrane-based SWD (~60% of installed capacity). Whilst playing catch-up, China aims to strengthen its technological competitiveness to be on par with world standards and to raise its installed capacity to 0.8-1 mn tons per day by 2010 from today’s established capacity of about 0.2 mn tons per day. At present, there are approximately 19 desalination plants planned or under construction, including Hyflux’s 100,000 cu m/day desalination plant in Tianjin Dagang (valued at S$154 mn), which is scheduled for completion in 2009.

Hyflux Water Trust posts $1.1m Q1 net

HYFLUX Water Trust (HWT), a pure-play global water business trust listed on the Singapore Exchange (SGX) last December, yesterday reported net earnings of $1.1 million for the first quarter ended March 31.

This came on the back of total revenue of $14.4 million, which represented 28 per cent of the trust’s FY2008 revenue projection. HWT announced a distribution per unit (DPU) of 0.87 cent for Q1. The trust expects to meet the forecast DPU of 2.09 cents for the first half. The forecast DPU for FY2008 is 4.88 cents. Earnings per unit for the quarter stood at 0.37 cent.

Eight plants in HWT’s portfolio of 13 achieved commercial operation during the quarter. Utilisation rates stood at around 51 per cent and the trust expects the rates to increase over time.

HWT has no gearing currently. ‘The global credit crunch, slowdown in the US economy and increasing uncertainties in the financial markets have seen tightening of credit from financial institutions and increasing cost of raising funds,’ said the trust in its financial statements.

Nevertheless, the trust has the ability to draw down on a US$66 million credit facility to fund future acquisitions.

According to Hyflux Water Trust Management CEO Saud Siddique, ‘the fundamentals of the water industry remain very positive, particularly in China’.

Mr Siddique added that the pipeline of projects under the ROFOAR (right of first refusal and right to match) arrangement with Hyflux Ltd positions the trust for further growth.

According to HWT’s website, Hyflux Ltd has granted Hyflux Water Trust Management ROFOAR on all water-related infrastructure assets owned by the group.

The ROFOAR pipeline assets saw a 45 per cent growth from last December to the end of April this year, from 760,000 to 1,105,000 cubic metres per day.

HWT shares ended trading yesterday at 75 cents, one cent down. DBS Vickers had issued a ‘buy’ call on the counter on April 4, with a target price of 78 cents.

Smooth sailing to start off with!

Story: Net operating income for 1Q08 came in at S$1.2m, compared to our projected loss of S$1m, and the difference can be largely attributed to change in accounting estimates for financial income ($0.9m) and lower operating costs (S$1.3m). Net profit for the period at S$1.1m, which includes a tax credit of S$0.3m, was even higher than HWT’s full year projection of S$0.8m as per IPO prospectus.

Point: Although tariff receipts of S$3.2m were somewhat lower than our projected S$4.2m, results surprised on the upside as operating costs were much lower than expected for the quarter. Maintenance expenses were lower because all except one of the eight operating plants are newly constructed. The average utilization rates of these plants have increased steadily to 51% in 1Q and is expected to ramp up over time. Operating and maintenance income of S$1.8m represents about 10% of FY08 forecast of S$18.4m but this is expected to increase more than proportionately through the course of the year with the ramp up in utilization of existing and completing plants. Finance income was much higher than projected at S$1m for the quarter and repayment of financial receivables lower than expected, as HWT changed its INT FRS 112-related accounting estimates. DPU after waiver of distributions in respect of Hyflux units was 0.87 cents and represents 42% of HWT’s 1H08 projected DPU of 1.91cts.

Relevance: Though the operating expenses are expected to normalize over the year, we believe there could be added upside arising from potential cost savings and tariff increases, and raise our FY08 and FY09 DPU forecasts to 4.7 cents and 5.4 cents, respectively. Taking into account the revised accounting estimates, which recognize more interest repayment than capital repayment on the financial assets, we have also revised up our revenue and net profit numbers. Maintain BUY at a revised DDM-backed TP of S$0.90 (Cost of Equity 11.4%).

Ready To Surf Up

Story: Hyflux Water Trust (“HWT”) is the first pure-play water trust to be listed in the region and should benefit from strong market fundamentals in the water infrastructure sector in China.
Point: The initial portfolio consists of water-related assets – water treatment plants, wastewater treatment plants and water recycling plants – capable of supplying a total capacity of 445,000 cu m / day in key industrial belts of high growth provinces in China. Growth potential in the initial years will stem from completing plants and escalating utilization rates of existing plants, which could lead to an 82% increase in annual tariff receipts over 2008-2010. Additionally, Hyflux has granted HWT the rights of first offer and refusal (“ROFOAR”) to a pipeline of assets with total design capacity of 760,000 cu m/ day, all ready to be injected into the trust in tranches every 12-18 months. HWT’s debt free position at IPO also leaves significant headroom for debt-sponsored acquisitions in the future.

Relevance: HWT is a defensive earnings play with predictable cash flows, promising a DPU yield of of 7-9% for FY08 and FY09. At current valuation of 0.88x P/BV, HWT compares favourably with REITS and other infrastructure/ shipping trusts listed in Singapore, but with a much higher debt headroom to fund stronger growth potential. We believe the counter will outperform over time as HWT begins to deliver on it post-IPO acquisition schedule, just as market has favoured developer-backed REITs which have delivered on their acquisition promises. We initiate coverage on HWT with a BUY call at a DDMbacked Target Price of S$0.78 (WACC 10.0%).