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Should Investors Include Water-Treatment Companies in Their Portfolios?

The water-treatment industry has been in the spotlight ever since news broke last year about the shock collapse of Hyflux Ltd (SGX: 600) under a mountain of debt. Investors who had sunk money into the company by purchasing its ordinary shares, preference shares, and perpetual securities are all stuck in limbo now as Hyflux desperately looks for a white knight to rescue it and inject some capital.

This brings us to the question of whether water-treatment companies qualify as good investments. I took a look at three other listed water-treatment companies on the SGX and compared various financial metrics (in the table below) in order to deduce if the numbers looked good or not. Two of them — China Everbright Water Ltd (SGX: U9E) and SIIC Environment Holdings Ltd (SGX: BHK) — operate in the water-treatment industry within China, while the third, Moya Holdings Asia Ltd (SGX: 5WE), operates in Indonesia.

Capital-intensive business

The water and wastewater-treatment industry is extremely capital intensive, and this is evidenced by all three companies’ debt levels, which are significantly higher than their cash balances. Total debt to equity hovers around 100% on average for the three companies, which implies that companies within this sector rely heavily on bank borrowings to fund their projects.

Investors need to be aware that companies within the industry will generally have to borrow a lot and thus are at the mercy of the banks that finance their projects.

Decent gross and net margins

A check on the companies’ gross and net margins shows healthy levels of each, and this shows that water-treatment companies are able to command good pricing for their services, even though water is a heavily regulated commodity in most countries. Though the upside may be capped as governments only allow companies to charge a regulated tariff, companies in the industry that have been pre-approved by the government as water vendors are still able to command respectable margins.

A good industry to consider

All in all, the water-treatment industry is a good one to consider, as water is a precious commodity. However, investors need to scrutinise every company to ensure their contracts have favourable terms — and that the company is not over-extending itself, like what happened with Hyflux. The lack of free cash flow for two of the three companies is also a cause for concern, but as long as the business is managed prudently, I would definitely recommend the industry as a great one to consider.

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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.