Hyflux margin drain might soon be plugged

The Singapore-listed water treatment firm has suffered a major drop in gross margins which could recover by this year.

Currently, Hyflux gross margin is down to 38% from 50% on the back of rising staf and material costs. But plans to improve efficiency in its billion-dollar Tuaspring investment coupled with increasing contract values point to more profitable quarters ahead.

Here's more from DBS:

Pedestrian results. Sales gained 60% y-o-y to S$138.9m but net profit grew only 4% to S$7.7m. Gross margin dropped to 38% from 50% due to lower margin profile of Asia projects vs MENA and higher staff/ material costs. 1Q11 was also partly boosted by disposal gains, which was absent this quarter. Management expects margin to improve in the following quarters. Higher EPC for Tuaspring has pushed Singapore to account for 65% of sales from 21% previously while MENA’s contribution has declined to just 9% of turnover. Seasonally slower 1Q profit formed 12% of FY12F, compared to 14% in FY11 and 7% in FY10.

Tuaspring investment raised by 18% to improve efficiency. The project cost will be revised up from S$890m to S$1.05bn due to selection of higher efficiency Siemens turbines that is expected to lower operating costs and provide a better return on investment. The cost revision has been submitted to PUB for approval. Hyflux is confident the higher capex can be funded internally and from potential divestment of its China assets (which has not been factored in our estimates yet). Near term, higher project costs imply higher EPC recognition.

Dahej EPC of US$420m is significantly higher but to contribute only in FY13. As Hitachi is outsourcing the bulk of Dahej’s EPC to Hyflux, the portion of EPC services to Hyflux is c.US$420m, significantly above our forecast of US$60-90m. This contract alone would have hit our FY12F new win assumption of S$500m. However, we believe recognition will start a quarter later in FY13 because it takes a year after financial close (still a few more quarters needed) to hit peak recognition levels. Elsewhere, the bidding pipeline remains robust with activities centred around MENA.