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How To “Hyflux-Proof” Your Portfolio?

Sudhan P.

News emerged on the evening of 22 May 2018 that the Singapore-based water treatment firm, Hyflux Ltd (SGX: 600), has applied to the High Court to commence a court-supervised process to reorganise its liabilities and businesses.

As part of the reorganisation process, the board will only make payments that are critical to the continued operation of Hyflux’s businesses. One of the payments that are affected by the reorganisation is the upcoming distribution on Hyflux’s S$500 million, 6% perpetual capital securities, which is due on May 28 this year – holders of the perpetual securities will not be paid at this point.

As highlighted by my colleague Chong Ser Jing in a May 2016 article of his on Hyflux’s aforementioned perpetual securities, the company had “some areas of concern” in terms of its financial condition. One problematic aspect Ser Jing pointed out was Hyflux’s inability to generate cash.

Hyflux has also voluntarily suspended trading of its shares and securities since 23 May 2018 (before the market opened).

Could Hyflux’s investors have known, before they had invested in it, that such a sorry fate (the need to proceed with a court-supervised reorgnisation of its business) would befall on the company? How can stock market investors prevent a similar case from damaging their portfolio?

Before I answer the questions above, let’s look at some of the key financial figures from Hyflux from 2010 to the first quarter of 2018 that can help to determine how resilient its business is:Source: S&P Global Market Intelligence (note: debt-to-equity ratios are as of the date given while cash flow from operation figures are for the 12 months to the date given)

From the above table, we can see that Hyflux had net-debt-to-equity ratios and total-debt-to-equity ratios that had exceeded 80% in most years for the period under study. This suggests that Hyflux had been operating with a weak balance sheet. The table also shows that Hyflux did not manage to generate any cash flow from operations from 2010 to 2017, as well as the first quarter of this year.

Companies with highly leveraged balance sheets and an inability to produce any cash flow for a long period of time are very likely to run into serious trouble at the very least, or go bankrupt at the very worst. In the business world, the phrase, “Cash is king,” exists for a reason.

Now, back to the questions:

a) Could Hyflux’s investors have known, before they had invested in it, that such a sorry fate (the need to proceed with a court-supervised reorgnisation of its business) would befall on the company?

Answer: The answer is “Yes”. 2017 was the first time Hyflux had suffered a full-year’s worth of losses in its operating history. But, the disaster has been long in the making, and the company’s balance sheets and cash flow statements were the telltale signs. As I had mentioned earlier, Hyflux has had trouble producing cash from its business since 2010. The last time it had positive cash flow from operations was in fact, in 2009.

b) How can stock market investors prevent a similar case from damaging their portfolio?

Answer: Invest only in companies with healthy balance sheets, strong cash flows, and solid long-term growth potential. Such businesses have a very high chance of surviving harsh economic conditions. And the last I heard, no company that has lots of cash and negligible debt ever went bankrupt.

I hope Hyflux can turn around its situation for the sake of its shareholders. As the next line of action, I would strongly encourage everyone to look at the businesses in their stock portfolios and see if the companies they own are producing enough cash flows and have manageable leverage on their balance sheets.

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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 Sudhan P doesn't own shares in any companies mentioned.