Did Hyflux Make Money for its Ordinary Shareholders?

Hyflux is an interesting case. In FY2016, it reported a net profit attributable to owners of $4.8M but a loss per ordinary share of 7.51 cents. Its net asset value correspondingly dropped from $0.56 in Dec 2015 to $0.45 in Dec 2016. The main reason? There are a few different types of owners of the company. Besides the ordinary shareholders, there are preference shareholders and perpetual capital securities (perps) holders. The net profit attributable to owners of $4.8M has to be shared among these different types of owners. Both preference shareholders and perps holders have prior claims over ordinary shareholders. In total, they were paid $63.8M in preference dividends and distributions in FY2016. Thus, ordinary shareholders ended up with a loss of $59.0M after accounting for the preference dividends and distributions instead of the reported $4.8M. Divided over 785.3M ordinary shares, the loss per ordinary share was 7.51 cents.

In order to make money for its ordinary shareholders, it has to make a net profit attributable to owners that is more than sufficient to cover the preference dividends and distributions payable to preference shareholders and perps holders. In FY2016, this amount was $63.8M. In the last 12 months, Hyflux has begun to redeem some of its perps. In July 2016, Hyflux redeemed $175M perps bearing interest of 4.80%. In Jan 2017, it also redeemed $295M worth of perps bearing interest of 5.75%. The remaining perps left are $500M bearing interest of 6.00%. In addition, there are outstanding preference shares of $400M bearing a dividend rate of 6.00%. These preference shares are callable on 25 Apr 2018, failing which the dividend rate will step up to 8.00%. Thus, Hyflux needs to make a net profit attributable to owners of between $54.0M and $62.0M every year, before ordinary shareholders get to enjoy the profits.

Since Hyflux made less money than is sufficient to cover the preference dividends and distributions of its preference shares and perps in FY2016, the money has to be drawn from its retained earnings. Its retained earnings thus dropped from $284.2M in Dec 2015 to $210.3M in Dec 2016. In 2H2017, the figure dropped further to $146.9M after reporting a loss attributable to owners of $24.3M. Preference shareholders and ordinary shareholders have to watch this figure very carefully. If the retained earnings drop to zero, there will be no more reserves to pay dividends, including the 6% preference share dividend.

Thus, at this point in time, Hyflux is not making any money for its ordinary shareholders.

See related blog posts:

• The Accounting for Hyflux's Water Treatment Plants
• Watch Out for Hyflux's Omission of Ordinary Dividends
• If You Invest In Fixed Income, Read the Fine Print

Buying the Most Expensive Integrated Shield Plan When Young and Downgrading When Old

Integrated Shield Plans (IPs) are hospitalisation insurance plans offered by private insurance companies to cover hospital stays in public and private hospitals. They are integrated with the basic Medishield Life plan run by CPF. There are typically 3 types of IPs, namely those covering Class B1 wards, Class A wards and private hospitals. For ease of reference, they are named as Class B1, A and P plans respectively. Annual premiums increase with age and are most expensive for Class P plans. For this post, I will use the IPs offered by my insurer as the basis for discussion, since I signed up with them and have records dating back to 2006 when as-charged plans were first introduced. I believe the trends discussed below are applicable to all other insurance companies offering IPs.

Private hospitals offer the best care compared to public hospitals. However, Class P plans are the most expensive compared to other plans. One of the strategies used by some people to afford private hospital care is to sign up for Class P plans when they are young and premiums are affordable, and downgrade to Class A/B1 plans when they age and premiums become more expensive. As an example, for the Class P plan offered by my insurer, premiums for a person aged 25 is only $417. However, as he ages, premiums increase rapidly to $2,639 when he reaches 70. At this age, the corresponding premiums for Class A and B1 plans are $1,758 and $1,428 respectively, which are equivalent to 67% and 54% of the Class P plan premiums.

It is a good strategy to use, but do note that annual premiums do not stay static. The figures below show the annual premiums for Class B1/A/P plans since 2006, which have been increasing. To be fair, the increases in premiums are also accompanied by enhancement in insurance coverage.

Fig. 1: Class B Plan Annual Premiums Since 2006

Fig. 2: Class A Plan Annual Premiums Since 2006

Fig. 3: Class P Plan Annual Premiums Since 2006

Thus, when you buy an IP, please take note that annual premiums are not static and are expected to rise over time. And for those who plan to use the above-mentioned strategy of buying the most expensive Class P plan when young and downgrading to Class A/B1 plans when older, be prepared to downgrade earlier than expected.

See related blog posts:

• Unforeseen Risk in My Medical Insurance
• The Cost of Buying Insurance at a Later Age
• The Insurance Cost of Being a Smoker

No Need to Maximise Profits with Cash of Last Resort

CPF funds are my cash of last resort in investing. I have quite a good record of investing my CPF funds. However, that statement would be incomplete, because majority of the time, the funds are parked in bank preference shares and collecting regular dividends that pay higher than CPF Ordinary Account's interest rate of 2.5%. On equity investments, there were only 2 occasions when CPF funds were deployed. The first was during the market doldrums during 2000-2003, when I ran out of cash for investments and had to rely on my CPF funds. The second was to buy more of Global Logistic Properties (GLP) than what was allowed for in my cash portfolio (see What is My Target Price? for more info).

Since CPF funds are my cash of last resort, the overriding principle is safety rather than maximising profits. Hence, majority of the time, they were parked in bank preference shares rather than being invested in equities. Furthermore, on the 2 occasions when they were invested in equities, they were not held until profits were maximised. On the first occasion, CPF funds were invested in STI ETF when the STI was at 1,316 points in Feb 2003 and sold when the STI reached 2,169 points in Mar 2005 for a 66% gain. The STI went on to hit a high of 3,876 points in Oct 2007. The reason for selling STI ETF early was because by early 2004, the stock market had recovered from the doldrums and my cash portfolio had turned a profit. There was no longer any need to use CPF funds for equities investment. Hence, they were returned to CPF.

On the second occasion, I bought GLP at $1.985 in Nov 2016 on rumours that a Chinese consortium was interested to buy GLP. Last month, GLP announced that it had selected the Chinese consortium as the preferred bidder, which offered to privatise it at $3.38. I sold the GLP shares bought with CPF funds at $3.22, even though there is another $0.16 to gain if they were held until completion of the privatisation, which has to be completed by 14 Apr next year (unless extended). The gain is 62%. In my opinion, the job is done. There is no need to further expose the CPF funds to unnecessary risks to get the remaining gains. They can be returned to CPF until the situation calls for them again.

When you have a cash of last resort, the important thing is to keep them safe and have them ready when you need them. There is no need to expose them to unnecessary risks for longer than is required.

See related blog posts:

• Behind Every Successful Bear Market Recovery is A Cash-Like Instrument
• Sneak Attack on My Cash Reservoirs
• What is My Target Price?

What Are Driving Those Numbers!

The quarterly earnings season has started and I have been busy reading the financial results. It is sometimes frustrating that the reports do not reveal much about why the business is doing well or poorly and whether the trend will continue. The reports contain a lot of numbers and some discussions, but most of the time, the discussions just regurgitate what the numbers already show. To illustrate what I mean, I will use M1's financial results as an example, but it is not the only company that has the issue.

The figure below from M1's financial results shows the numbers generated by the various business segments in 2Q2017. For instance, it shows that revenue for the mobile telco services segment dropped by 2.1% Year-on-Year (YOY) in 2Q2017, customer subscriptions rose by 4.5% YOY, etc. These are useful numbers to understand how well the business is doing. But they do not explain why revenue has fallen even though customer subscriptions have increased. By right, if customer subscriptions increase, revenue would also increase correspondingly, isn't it?

Fig. 1: Numbers

Following the numbers in the financial results is a discussion of those numbers. The figure below shows the level of sophistication of the discussion. 

Fig. 2: Discussion

The opening paragraph of the discussion says, "YOY, operating revenue at $251.6M for 2Q2017 and $512.3M for 1H2017 were 4.7% and 2.9% higher respectively due to higher fixed services revenue and handset sales. Compared to 1Q2017, it was 3.5% lower." Haven't all these information been reflected in the numbers already? What extra information do investors get after spending time to read the discussion?

What investors really want from the discussion is to understand the factors driving those numbers. Investors should not be left to guess why those numbers rise or fall and whether the trend would continue. An example of a good discussion is actually given by M1 in the second paragraph of Key Drivers, which explains why churn rate hit a high of 1.7% in 2Q2017 when the average historical churn rate is only 1.0%. It explains that "Churn rate was 1.7% for 2Q2017 and 1.4% for 1H2017 as a result of the migration of customers who were previously on 2G data to the M2M platform following the shutdown of the 2G network in April 2017." This gives investors assurance that customers did not desert M1 in droves in 2Q2017.

The discussion should not just be a repeat of what the numbers already show. If companies are serious about providing a discussion, I hope they would be more forthcoming and provide an intelligent discussion about the challenges the company faces and what plans does it have to overcome those challenges. Investors who are informed of these challenges and plans would be more willing to stick through thick and thin with the company when it is going through a difficult patch.

See related blog posts:

• Impact of SIM-Only Plans on Telcos
• Impact of Data Upsize Plans on Telcos
• Challenging Times Ahead for Starhub's Dividends

Properties and the Arrival of Robots and Automation

Recently, I went to view some houses and realised how expensive houses have become. A 2-bedroom condominium in Jurong could go for $1 million and a 4-room HDB flat in Clementi could sell for $700K to $800K. If you read my past blog posts on Properties, you would know that I am not a fan of properties in the long-term, mainly because of the ageing population in Singapore (see Properties, the Population White Paper and the Land Use Plan for more info). 

In the past 1 year, I have also begun to worry about robots and automation taking away jobs (see Early Retirement Maybe A Luxury That I Cannot Afford for more info). I believe that everyone would need to keep on learning and re-learning, and be prepared to change careers at least 1-2 times in their economic lifespans in order to adapt to changes brought on by technology. And in the worst case scenario, a lot of human jobs would be displaced by robots and automation.

For most people, housing is an expensive item and it can take 20 to 30 years to fully repay a housing loan. When you superimpose the trend of robots and automation displacing human jobs with the 20 to 30 years of steady employment required to service housing loans, it raises the question of whether most people can fully pay down their housing loans. And if they could not, what would happen to the housing market in, say, 20 years' time when the full effects of robots and automation happen?

Having said the above, at this point in time, it is not clear whether robots and automation would really displace human jobs on a wide scale as some writers fear, or whether they would allow governments to provide a basic income to every citizen so that everyone need not work and could pursue his/her own dreams. 

Personally, until the effects of robots and automation and governments' responses to them become clear, I would prefer to be more prudent in my housing decisions, i.e. to buy a HDB flat instead of a private condominium if possible, and/or to take a shorter loan tenure such that by the time I am displaced by technology, I would also have paid down the loan fully.

For investors buying properties with the hope of renting them out to foreign talents, robots and automation also raises another issue. If robots and automation really were to displace human jobs, the no. of foreign talents will also decline. Will properties still provide good rental yields in the future? I do not know.

I have raised more questions than answers in this blog post. This is because I also do not have the answers. We can only monitor and act accordingly.

See related blog posts:

• A Prediction About Properties 13 Years Ago
• Properties, the Population White Paper and the Land Use Plan
• Early Retirement Maybe A Luxury That I Cannot Afford

Oil & Gas, Show Me the Orders!

When I sold out of Keppel Corp in Jan at $6.16, my colleague laughed that I had sold too early. Nevertheless, I was pleased to get out of Keppel Corp before it announced results for 4Q2016. I was concerned that orders were not coming in fast enough to replace those orders that had been completed and that Keppel Offshore & Marine (O&M) would show a loss for 4Q2016. True enough, Keppel O&M reported a net loss of $138M for 4Q2016 after asset impairment. I was concerned that Keppel O&M would continue to report losses from that point onwards.

Nowadays, when I consider buying or selling Oil & Gas (O&G) stocks, I look at 2 key information. The first is where is the company positioned along the industry value chain (see My Upstream Oil & Gas Rescue Operations and My Downstream Oil & Gas Recovery Operations for more information). I do not mind the Exploration & Production companies that are at the start of the value chain and the Engineering, Procurement and Construction companies that are at the downstream side of the value chain, but not those in the middle, i.e. Offshore Support Vessel, oil services and ship/ rig building companies.

The other metric that I look at is orders-to-revenue ratio. This is similar to the book-to-bill ratio for the semiconductor industry. If the book-to-bill ratio is higher than 1, it means that the industry is expanding. Conversely, if the book-to-bill ratio is lower than 1, it means that the industry is contracting. Likewise, the orders-to-revenue ratio is able to show whether the companies are getting enough orders to sustain the business through the long and harsh O&G winter. The other way of looking at this metric is that orders will eventually translate to revenue down the road. If the order is $1, you cannot report a revenue of $2 later (nevertheless, you can do 2 years' worth of work in 1 year and report revenue of $2, but the maths dictate that total revenue cannot exceed total orders over time). Thus, the orders-to-revenue ratio is an useful metric in analysing O&G companies.

Based on the above explanation, you will now understand why I sold Keppel Corp in Jan. In FY2016, Keppel O&M's revenue was $2,854M. Its new orders secured over the same period was only about $500M. The orders-to-revenue ratio was only 0.18. A couple of years down the road, would Keppel O&M still be able to report profits based on annual revenue of $500M (or $1,000M if you combine 2 years' worth of work into 1 year)? I thought it was unlikely. Thus, I was pleased to exit Keppel Corp at a price higher than my average cost of $6.08.

Nevertheless, I have to admit that Keppel O&M has continued to surprise me. For 1H2017, it still managed to report a net profit of $1M when I was expecting it to report a loss. And my assessment of Keppel Corp's ability to navigate the rough waters remains unchanged (see Keppel Corp – A Good Captain Sailing Through Rough Waters).

This year, I have considered buying/ bought 3 O&G stocks. In all 3 cases, orders-to-revenue played a key role. The first was Dyna-Mac. Compared to the other O&G stocks, its level of debts is low and therefore has a higher chance of surviving the O&G winter. However, its orders-to-revenue ratio as at end Dec 2016 was only 0.06 (net book order of $12.8M versus FY2016 revenue of $204.0M). In other words, it only had enough work for 1 month and would be idling for 11 months if new orders could not be found quickly. I gave up the idea of buying it.

The second was Triyards. In FY2016, it obtained new orders of US$273.9M, versus revenue of US$324.9M, translating to an orders-to-revenue ratio of 0.84. Compared to Keppel O&M's ratio of 0.18, this is considered very good. The other reason why I bought Triyards even though it is in the shipbuilding sector is because it is a distressed asset play. It is 60.9% owned by Ezra, which went into Chapter 11 bankruptcy protection in Mar. The shares had been pledged to the banks as collaterals for a secured loan. If the banks were to sell the shares, it would trigger a general offer for the remaining shares. As at end Feb 2017, Triyards' net asset value was US$0.673. Unfortunately, in the latest results for 3Q2017, it reported a loss per share of US$0.208 due to asset impairment and cost overruns and the net asset value dropped to US$0.478.

The third stock was Rotary. My average cost was $0.62 and I wanted to average down for a long time. Last year, there was an opportunity to buy at $0.29, but I decided to give it a pass. In May this year, I bought at $0.37. The reason? Again, it is because of orders-to-revenue ratio. When it was trading at $0.29 last year, it only had outstanding orders of about $150M, versus FY2016 revenue of $233.9M. When it reported 1Q2017 results in May this year, the outstanding orders had increased to $435.9M. To me, it was not safe enough to buy at $0.29 last year, but safe enough to buy at $0.37 this year because of the increase in orders. 

As things turned out, I sold Keppel Corp and it went higher. I bought Triyards and it went lower. Nevertheless, the orders-to-revenue metric is sound and I will continue to use it to guide my investments in O&G stocks.


See related blog posts:

• My Upstream Oil & Gas Rescue Operations
• My Downstream Oil & Gas Recovery Operations
• Know Your Customers Well!

Interest Rate Hedging Smoke Screen

After US Federal Reserve increased interest rates in Dec, Mar and Jun, and after Yellen's congressional speech last Wed, interest rates are confirmed on the way up. This will impact companies with large debts, especially REITs, as higher interest expense would mean lower distribution for shareholders. The usual response that companies give to questions of rising interest rates is that they have hedged the majority of their loans by swapping floating loan rates for fixed loan rates. However, are such measures adequate to mitigate the impact of rising interest rates?

If you ask any person who took up a fixed-rate mortgage loan to finance his housing purchase, he will tell you that even though it is a fixed-rate loan, the interest rate is only fixed for 2-3 years. After that, the interest rate will revert to a floating rate. Although he can refinance to a new fixed-rate loan after 2-3 years, the new fixed interest rate will be based on the prevailing interest rates then, not the interest rates now. Currently, a 2-year fixed-rate loan is available at 1.6%. But if interest rates were to rise to say, 2.6%, 2 years later, the new fixed-rate loan after refinancing would be at 2.6%. So, fixing the loan interest rate does not eliminate the effect of rising interest rates. It only postpones the impact to 2-3 years later when the loan or interest rate swap expires.

Moreover, unlike mortgage loans in which you pay down the loan principal over time, company loans are usually bullet loans, in which repayment of the loan principal is only required when the loan matures. Furthermore, these bullet loans are usually refinanced and rolled over to a new bullet loan. In other words, the loan principal is not paid down over time. When you fix the interest rate and pay down the loan over the period of the fixed interest rate, you reduce the increase in interest expense when the rate is reset after refinancing. But when companies do not pay down the loan when the interest rate is fixed, the increase in interest expense 2-3 years down the road is the same as if the interest rate fix does not exist! The only benefit is that companies save some interest expense during the 2-3 years when interest rate is fixed. But it does not eliminate the impact of rising interest rates altogether.

So, when companies say they hedge interest rates, please be aware that it only postpones the impact to 2-3 years down the road.

See related blog posts:

• Why Singapore Interest Rates Might Rise Faster than Expected
• Behind Fixed Deposit Home Loan Rates
• Getting Ready for US Interest Rate Rises