Hyflux: Still upbeat about the water sector

Seasonally weaker 1Q09 results. Hyflux Ltd posted its 1Q09 results last night. Revenue fell 1.6% YoY at S$88.2m, mainly due to the continued weakness in industrial sales in China (down 35.1%), hit by the challenging economic conditions. But municipal sales managed to grow 7.3% YoY, driven by its still strong order pipeline in that segment. Gross margin also improved from 23.3% in 1Q08 to 33.2%, largely aided by lower raw material prices as well as subcontractor's costs. Nevertheless, due to the absence of a tax credit in 1Q09 (versus S$1.1m in 1Q08), net profit slipped 11.5% to S$5.1m. On a sequential basis, revenue tumbled 50.8%, while net profit tumbled 62.0%, highlighting the usual seasonality of its revenue stream; the first quarter typically records the lowest revenue due to the long Chinese New Year holiday in China.

Upbeat about Algeria, China prospects. Going forward, management believes that the outlook for the water industry remains upbeat, especially in Middle East & North Africa (MENA). Hyflux is particularly bullish about its growth potential in Algeria, as it has just achieved financial close for the US$443m Magtaa Desalination Plant - touted to be the largest in the world with a capacity of 500k m3/day. Construction of the US$200m Tlemcen Plant is also progressing well and is expected to be operational by end 2009. Meanwhile, management is also equally upbeat about its prospects in China, where the company is building and/or operating as many as 30 water treatment plants. One area that Hyflux sees potential is in the growth of water tariffs in China, which are still extremely low by international standards. Although tariffs have grown some 60% between 2003 and 2007, the average is around US$0.20/m3 versus global average of US$3.00/m3.

Expect seasonal uptick in 2Q09. Although management did not provide an update of its order book - EPC jobs last stood at S$1.14b (end Dec 08), the ongoing projects to be completed should ensure that revenue and earnings see the seasonal uptick in 2Q09 and the rest of the year. As such, we are leaving our FY09 estimates unchanged despite 1Q09 revenueand earnings meeting just 14.4% and 8.3% of our full year estimates. And given the recent re-rating of the equity market, we correspondingly raise our valuation from 16x (trough) to 18x FY09F EPS and our fair value from S$1.87 to S$2.11. Maintain BUY.

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