Investing Lessons From The Recent Hyflux Ltd Saga

Editor’s note: This article first appeared in the 15 June 2018 edition of Take Stock Singapore

Water treatment facilities owner and operator, Hyflux Ltd (SGX: 600), has been in the news lately for all the wrong reasons. In today’s Take Stock, I want to share the lessons investors can take away from the company’s recent saga.

Hyflux’s Fall

What kickstarted the whole chain of events was Hyflux’s announcement on 22 May 2018 that it would enter a court-supervised process to reorganise its liabilities and businesses. During the reorganisation, the company said that it will only be making payments that are “critical to the continued operation of [its] businesses.”

One of the company’s non-critical payments that was mentioned in the announcement is the distribution on its S$500 million, 6% perpetual securities that was due on 28 May 2018. The S$500 million number refers to the size of the issue, while the 6% figure refers to the yield that holders of Hyflux’s perpetual securities are entitled to on an annual basis.

On 23 May 2018, a day after Hyflux made its liability-reorganisation announcement, it voluntarily suspended the trading of it shares. Then, on Monday (11 June 2018), Hyflux revealed that the trustee for its S$500 million, 6% perpetual securities has served up a notice of default after the company failed to pay the distribution on the securities on 28 May 2018.

Signs Of Turbulence

Back when Hyflux issued its aforementioned perpetual securities in May 2016, investors had a huge appetite for the offering, judging from how the company had to increase the issue size of the securities from S$300 million to S$500 million. Were there already signs back then that Hyflux could plausibly run into trouble in the future? Turns out there were.

In a May 2016 article I wrote and published when Hyflux first announced that it would be issuing the perpetual securities, I mentioned that “Hyflux’s financial condition is perhaps one of the most important things to note as it determines how risky the perpetual securities are. On this front, there are some areas of concern in my view.”

My concerns involved Hyflux’s inability to generate cash flow, and its weak balance sheet. Here’s what I wrote on the matter:

“Hyflux has a chronic inability to generate cash flow. According to data from S&P Global Market Intelligence, Hyflux has been generating negative cash flow from operations in each year from 2010 to 2015. Meanwhile, the company currently has a net-gearing ratio (net debt to equity ratio) of 0.98, which isn’t low. (Note: This 0.98 figure does not account for the change in Hyflux’s cash and debt levels that could occur after it issues the new perpetual securities.)

The payment of the dividends for the perpetual securities works out to S$18 million annually (based on a S$300 million issue size) and that money has to come from somewhere. At the moment, Hyflux’s business is burning cash (even in the first-quarter of 2016, the company’s cash flow from operations is a negative S$33.8 million, down from the negative S$26.3 million seen a year ago). The company could issue more shares, borrow more, or sell assets to raise cash. But, to borrow more would further weaken Hyflux’s already debt-laden balance sheet and thus add even more risk to the equation. Selling assets would not be a very palatable choice either as it could weaken the company’s ability to generate cash in the future.”

The risks I identified came into play, unfortunately. Hyflux chose to reorganise its liabilities because it thought that was the best way to protect its core businesses.

The Lessons Within

A recent article from Channels News Asia on Hyflux pointed out that the company’s perpertual securities were chased by retail investors who were seeking high yields. The recent turn of events is a great lesson on how a stock’s yield should never be our only consideration when investing for income.

When Hyflux issued its perpetual securities, it already had huge trouble generating cash flow from its business, and its balance sheet was laden with debt; these are huge red flags for income investors. In fact, these two traits of Hyflux – a history of generating negative operating cash flow, and a high net-gearing ratio – are danger signs in general when it comes to investing in the stock market. In The Motley Fool Singapore’s premium stock recommendation newsletters, on which I serve as an analyst, we also typically shy away from companies that are highly geared and/or have a chronic inability to produce cash from their businesses.

If you are able to keep the aforementioned Hyflux-related lessons in mind as you invest, the chances of you making mistakes in the market in the future could be dramatically reduced.

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Disclosure: The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Hyflux.