How to Avoid a Stock like Hyflux – 98%↓ in Share Price

Hyflux News

Hyflux is a specialist in water treatment and they provide desalination plant solutions to its customers across the Asia Pacific and others. Its founder is Olivia Lum. For a long time, her story was cited very often in the media as a success story.

Starting last year, Hyflux ran into short-term liquidity constraints and they could not pay coupon payments to the owners of its perpetual securities and preference shares.

As I was scrolling through Facebook this morning, I chanced upon this article called “Retail investor offers counter-proposal” by The Straits Times. In the article, Madam Loo Leong Hun mentioned an elderly investor who is living alone in a one-room flat relies on the Hyflux dividends to pay off her daily expenses. With the possible liquidation of Hyflux’s securities/shares, that particular elderly investor would have no more earning power.

While we hear about the amount being lost in this whole saga, it may mean nothing. But hearing personal stories on how their lives would be changed adversely highlights the importance of proper financial education. The ability to make good calls can alter one’s generational wealth and puts one in a better state.

I would like to share two simple indicators of whether a company is able to sustain paying dividends to its senior debt holders. But I am not here to say bad things about Hyflux, it is not my interests to do it, I just hope the investors are able to get as much money as possible.

If you wish to learn how to avoid such scenarios in easy steps, read this article in full. 

Do Not Rely on Accounting Profits, Rely on Cash Flow

If you’re buying perpetual security or preference shares, in order to collect your yearly dividends, you need to check the cash flow from operations. The cash flow represents the actual cash that a business receives, not the net income. Nothing is guaranteed, don’t assume a company is well-known hence it will do well forever. There are many companies with high income but no cash flow, it is extremely dangerous. 

(source: Morningstar)

By observing the cash flow of Hyflux, despite positive net income, it has been reporting negative cash flow since FY2010. There is no way Hyflux could pay the dividends without utilising existing cash balances or borrowing money from banks. The signs were already on the walls.

Check on the Financial Leverage

Hyflux is a business that is dependent on order books to some degree. The business earnings may dry up if the order book is not being replenished. The deathly combination of negative operating cash flow and rising debt level creates immense pressure on the balance sheet.

We’re going to look at the cash and debt level of the business.

(source: SGX announcements)

You can see the debt level has been increasing since FY2012.

As of FY2017, Hyflux’s shareholder equity was 982mil. Taking $1,252mil divided by $982mil, the net debt to equity position was 127.5%. Hyflux is a capital intensive business and having so much debt makes the entire situation looks like thin ice ready to crack. My preference is for net debt to equity ratio to be below 40-50%. 

Conclusion

All of the information that I highlighted is not tough work. Use Morningstar to guide your decisions and you will avoid investing in companies that may be ticking bombs. Safeguard your wealth and grow it well by investing in high-quality growth companies.

Here is a video format of my article. It is on my Facebook page. Do share it with your friends! Stay tuned for next week’s article.