The Motley Fool

Will Yongnam’s Convertible Bonds be the Next Hyflux?

Yongnam Holdings Limited (SGX: AXB), or Yongnam for short, has announced that it plans to issue S$15 million worth of non-listed convertible bonds. Conversion of these bonds would lead to an issue of a maximum of 83.8 million new shares, which represent about 13.8% of the enlarged issued share capital of the company. The bonds’ maturity is two years from the date of issue of the bonds, and they carry a coupon rate of 7% per annum, payable every six months. The conversion price of the bonds was set at S$0.179, which is a slight premium to the last traded price of S$0.17 for the shares.

You may recall that Hyflux Limited (SGX: 600), or Hyflux for short, issued S$500 million, 6% perpetual securities on 27 May 2016. This was sold to the general public by financial institutions back then and was eagerly taken up due to its attractive coupon rate. However, Hyflux filed for bankruptcy in May 2018, affecting around 34,000 holders of both its preference shares and its perpetual securities.

Though Yongnam’s convertible bonds are targeted at higher net worth individuals, with a minimum investment amount of S$250,000, it still begs the question of whether this might be a repeat of the Hyflux debacle. Let’s take a closer look at the parallels.

Heavy working capital requirements and poor gross margins

Yongnam operates in the construction industry and is a steel fabrication company. The group has two production facilities in Singapore and Johor, Malaysia with an annual total production capacity of 84,000 tons of steel fabrication.

The group tenders for civil engineering and structural steelwork contracts for infrastructure developments as well as buildings such as factories and airports. These are multi-million dollar contracts that sound impressive, until you realise that margins are razor-thin and they all involve heavy working capital requirements.

The evidence is in Yongnam’s recently released first-quarter 2019 (Q1 2019) earnings. For Q1 2019, the group reported a gross loss of S$1.4 million, while in Q1 2018, the gross profit was a tiny S$479,000, for a gross profit margin of just 0.9%.

History of poor free cash flow generation

Yongnam also has a history of poor free cash flow generation, as compiled below:-

The average 5-year free cash flow was negative, and in the most recent fiscal year, the group reported their largest negative free cash flow amount of S$54.8 million. My colleague Ser Jing had written about how Hyflux also had a chronic inability to generate consistent free cash flow. Without free cash flow, Yongnam would essentially be relying on external financing and borrowings to fund its operations, and this increases the risk to the group should these lenders decide to pull the plug (for whatever reasons).

Shaky balance sheet

Finally, Yongnam has a very weak balance sheet. Cash balance as at the end of Q1 2019 was just S$9.8 million, while gross debt stood at S$123.2 million. Most of the group’s assets are parked in inventories (S$42.4 million) and fixed assets (S$311.4 million), which are not liquid in the event they need to raise cash quickly.

Investors should be wary

Though Yongnam may have a long history as a specialist in steel fabrication, the numbers and facts do not paint a rosy picture of where the company is heading. Investors who are interested to purchase these convertible bonds need to be cognisant of the risks, and also be mindful of the parallels between Yongnam and Hyflux.

Click here now for your FREE subscription to Take Stock Singapore, The Motley Fool’s free investing newsletter. Written by David Kuo, Take Stock Singapore tells you exactly what’s happening in today’s markets, and shows how you can GROW your wealth in the years ahead.  

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Royston Yang does not own shares in any of the companies mentioned.