No Longer The Hyflux We Used To Know
As the highest yielding retail bond launched since 2015, Hyflux’s recent offering has generated great interests among investors. For starters, the institutional tranche recently closed at SGD165mio, up from initial guidance of SGD50mio. But if the deal sounds too good to be true, it likely is.
The following summarises some of the key considerations, among the many numbers that a prudent credit investor should look at. Credit Deterioration Since the company’s upgrading to mainboard in 2003, the company has embarked on an aggressive debt-fueled expansion. Elevated Debt Level Versus Falling Coverage Ratio
Source: Bloomberg
Leverage climbed as its business model shifted from selling water treatment systems, to a capital-intensive Design-Build-Own-Operate model. Even after a decade, leverage remains elevated. Several monetization of assets have not provided much respite. ( 2014: Sales-leaseback of Hyflux Innovation Centre, 2011: Sale of China assets to a 50:50 JV with Mitsui & Co.).
Likewise, interest coverage ratio, a measure of ability to meet interest obligation, has fallen from the 7.5x during launch of MTN programme, to paltry 2.2x. Both credit and quasi-equity investors ought to be worried about the company’s ability to service its financial obligations in a sustainable manner without additional borrowings or deferring payments to quasi-equity holders.
The fundamentals would further weaken if adjustments were made for the purpose of analysis, as any analyst would, to capture the true state of company’s health. For example, the SGD170mio sales-and-leaseback on its balance sheet that ought to be capitalised as debt, and weighted average of 5.67% interest payment on existing SGD 875mio perpetual classified as “dividend” under accounting rules, just to name a few.
Negative Operating Cashflow For 6 Years
Source: Bloomberg
A closer look at the company’s cashflow statement reveals a significant negative operating cashflow over the last of 6 years. The company’s core business has yet to turn cashflow positive. This, despite the company having shifted to the DBOO model more than 10 years ago, is a serious cause for concern.
Indeed, the operating cashflow is in stark contrasts with the modest annual net income reported, that takes into account non-cash gains.
It is thus not surprising why the company borrows heavily on an unsecured, subordinated basis – to plug the cash gap.
Significant Refinancing Requirement
Source: Bloomberg
In 2016 alone, a total of SGD430mio worth of papers will come due, with SGD330mio becoming callable. Another SGD300mio will become callable in 2017 and SGD400mio in 2018, representing a sizeable refinancing pipeline ahead. If recent retail bond issuance were to be a guide, this translates into potential SGD730mio issuance as it seeks to refinance its liabilities due under one-year. This comes ahead of the recent credit tightening(lenders less willing to lend) as well as potential competition from the MAS bond seasoning framework (read our next article), which will potentially present retail bond investors more choices across the credit curve.
Note: Callable papers are usually called if they make regulatory or economic sense. In this case, certain bonds have a punitive step-up in coupon of 200bp, which makes it economical for the issuer to call back paper and reissue one with extended maturity and/or lower rate.
Seeking Consent
Recall that Hyflux conducted a consent solicitation exercise in Jan 2015 for its existing senior bonds, to loosen certain bond covenants and essentially weakening the safeguards for bond investors. Earlier in 2013, the company did another round of consent solicitation with details undisclosed.
As with most issuers, bond programmes typically include financial covenants to protect bond investors from lack of fiscal prudence by the issuer, notably among high-yield names. The breach of the terms, under certain conditions may trigger an event of default, requiring the issuer to redeem the bonds in full. While covenants protect bondholder in theory, recent slew of consent solicitation exercise (PACRA, MPMSP, EZRASP, NCLSP, etc) has weaken those very safeguards, with some issuers nearing the default triggers.
Bond Pricing
At 6%, this is certainly the highest coupon retail offer this year. However, the pricing looks expensive compared against existing perps. A glance at a similar structured perp issued slightly more than a year ago suggests investors are getting the shorter end of the stick:
Source: Company Announcements Although one may argue that the new perp pays a higher yield, the pick-up in yield is primarily due to interest rate risk (4yr tenor versus 2yr tenor). Not only are investors not compensated for taking greater credit risk by extending tenor (versus the 4.8% paper), pricing does not seem to take into account the deterioration in credit fundamentals.
Summing Up The name familiarity and high yield is likely to provide some support for this issuance (we have the B&D to thank for pacing out retail issuance at increasing coupons). But weakening credit fundamentals and tightening credit environment remains a significant challenge for the company, as access to refinancing becomes restrictive. If anything, the issuer is likely to return to the issuer-friendly retail market in the near-term for its funding needs, but the MAS seasoning framework will keep that window shorter. Investors who missed this issuance may someday give themselves a pat on the back for missing on this issuance.
