Hyflux – All major projects are sailing along

While both 1Q revenue and profit attributable were below our expectations, the underlying profit for the period was encouraging, with EBIT increasing 23% yoy. The two main deviant items from our expectationswere China municipal revenue and the effective tax rate. However, 1Q has historically been the weakest quarter and not a good reflection of the full year.

We believe the lower than expected China municipal revenue will be rolled forward to the next quarter when a few BOT projects are due to be delivered. Effective tax rate for the quarter was 25.7%, higher than FY08’s 11.6%. However, management expressed that effective rate for the full year is still likely to be within previous guided range of 10-15%.

Cost of goods sold decreased 9% due to lower commodity and material costs. This lifted gross margins from 23% to 33% on a qoq basis and is also higher than FY08’s 30.7%. This positive development alleviates some of our worries that cost overruns could develop at its MENA (Middle East and North Africa) projects due to the competitive bid for the Magtaa project.

All three key desalination projects are running on schedule, with preliminary groundwork on the Magtaa project underway. With the investments into its projects, net gearing has increased from 0.4 to 0.8. This is within our expectations, as highlighted in our 1st april 09 report where we forecasted net gearing to increase to 81.5%.

We maintain our BUY call on Hyflux and lift our SOTP target price from $2.13 to reflect the higher market value of its stake in Hyflux Water Trust. We believe the Group will remain selective on capital-intensive BOT projects due to the tight credit market. However, if credit markets continue to ease, the Group’s appetite for winning new projects may return.

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