Distressed utilities - a continuation

White knights and damsel in distress.

In the depths of the doom and gloom originated by the US and China stock correction, there is a silver lining largely unnoticed by the market. 

A CONSORTIUM comprising two major Indonesian groups - conglomerate Salim Group and energy giant Medco Group - has agreed to give Hyflux a S$400 million equity injection, in exchange for a 60 per cent stake in the water treatment firm once it has settled all its debts.

The consortium, SM Investments, will also grant Hyflux a shareholder's loan of S$130 million and a debtor-in-possession loan of S$30 million to help finance it through the restructuring.

With this offer on the table, it falls to Hyflux to negotiate terms of a debt restructuring with each of its creditor groups, which could include debt-for-equity swaps.

The best case scenario turned out to be the outcome of this case although the White knight I envisioned turned out to be completely different entities! The turnabout play thesis is realized. Although I can be reasonably sure that this company will not go bankrupt, whether this company can succeed in regaining profitability and reduce its CAPEX is still yet to be seen. 

This distressed utility cycle is still early on at its recovery stages and the energy market seemed to be nowhere near consolidation at the moment. It will still be an uphill battle and there might be unexpected shocks and a turbulent ride as the company picks itself up. Buy when the dividend is eliminated. Sell when the dividend is restored. I can only hope everything works out well. 

Distresses utilities cycle 

The first stage is disaster strikes. It is faced with a sudden loss in earnings, either because of some huge cost which it could not pass through to its customers, or because a huge asset (such as a new plant) is “mothballed and removed from the rate base.” Its stock would lose around 40%-80% of its value in one or two year period. As investors experienced the drop in the share price, they would no longer felt the utilities as a safe and stable investment. The price keeps falling, and it might trade as low as 20-30% of the book value

The second stage is “crisis management.” A utility business would respond to its disaster by cutting capital expenditure and adopting austerity budget. Normally in this period, the dividend would be eliminated in order to bring strength back to its financial structure. At this stage, there would be no reflection on its stock price yet. 

After that, the business would come to “financial stabilization.” When it had succeeded in cutting cost, the utility begin to generate enough cash for its own operation. Although it might not earn anything for the shareholders at this stage yet, survival was almost the certainty. The stock price of this period might move up to 60-70% of the book value. 

Last but not least, the stage four is that the recovery is recognized. The utility business is capable of earning something for its shareholders, and Wall Street begins to expect improved earnings and the continuation of its dividend. The price of its stock moves up to its book value. So what would happen afterwards? He noted: “How things progress from here depends on two factors: (1) the reception from the capital markets, because without capital the utility cannot expand its rate base, and (2), the support, or nonsupport, of the regulators, i.e, how many costs they allow the utility to pass along to customers in the form of higher rates.” 

Links
https://www.businesstimes.com.sg/companies-markets/salim-medco-consortium-to-pump-s530m-into-hyflux?Echobox=1539859008&fbclid=IwAR1G4tPgC9lggPma2IORtEq9o2HzSubMYLA2B6u0pHQf8xs5guFps1bfvps#utm_medium=Social&xtor=CS1-3&utm_source=Facebook

https://www.businesstimes.com.sg/companies-markets/indon-white-knights-put-s530m-hyflux-rescue-plan-on-table

https://www.gurufocus.com/news/155687/peter-lynch--a-simple-way-to-benefit-from-utility-investments