MAY, 2005. Hyflux announces net profit for the quarter to March is up 219 per cent to $8.98 million. Revenue doubles year-on- year to $24.2 million; 72 per cent of sales come from the Middle East and the company expects hundreds of millions of dollars worth of projects from the region. Share price? Roughly $3.65.

May, 2008. Hyflux announces net profit is up five-fold to $5.7 million. Revenue, at $89.6 million, is five times the restated $17.5 million in the year-ago quarter. North Africa and the Middle East account for 56 per cent of sales and Hyflux has just secured a $630 million desalination contract in Magtaa, Algeria. Share price after the announcement? Roughly $3.65, and going on to hit $3.71 as of yesterday.

But investors probably still remember what happened after 2005. Within ten months, Hyflux was trading down at around $2.70 after it sold its stake in a Middle East joint venture to its Dubai partner, Istithmar, in March 2006. Hyflux said that it made a 20 per cent gain from the whole affair but investors, who had hoped for millions of dollars worth of new Middle East projects, sold the stock down viciously. One analyst said that only a quarter of the anticipated orders materialised.

Will Algeria be Dubai redux? At the current moment, with Hyflux on the rise, once-burnt investors have yet to turn shy again. Perhaps they should. The Magtaa plant has not yet contributed revenue to Hyflux, but there are some troubling omens.

According to Global Water Intelligence, an industry publication, Hyflux's bid for Magtaa included a remarkably low engineering, procurement and construction (EPC) cost - just US$441 million for a 28-month construction period. The closest rival bid was for US$457 million over 36 months.

And the desalinated water price, which provides recurring revenue for the company, was just 55.77 US cents per cubic metre - possibly the lowest tariff in the world, according to GWI.

The low EPC cost should be a worry, going by Hyflux's latest profit statement. According to its Q1 results, construction profit from an earlier 200,000 cubic metre per day desalination plant in Tlemcen, Algeria is coming below expectations.

CIMB's Jessie Lai calculated that Tlemcen contributed $49.8 million in sales but overall, gross margins contracted 26 percentage points year-on-year on higher construction costs.

Ms Lai noted that Hyflux's Q1 core earnings, after stripping out one-off items and a $5 million forex gain, was just $0.9 million, despite the surge in revenue.

In May 2005, DBS Vickers made much the same point about Hyflux - core earnings, after taking out a $5.5 million fair value gain, was just $3.5 million due to lower EPC profits. Nevertheless, some analysts remain bullish on the stock. JPMorgan, for example, is retaining an 'overweight' call, saying that it expects positive news flow from project wins in China and Algeria.

It's likely that Hyflux's pipeline of new deals isn't drying up any time soon. For the past year, it has been announcing 200 to 300 million yuan (S$39-59 million) worth of new orders every few months. That's going to add a lot to headline revenue numbers, even without considering the mammoth Magtaa contract. Hyflux says that it hopes to book EPC revenue from that deal of $600 million from 2009 to 2011.

But high sales don't necessarily translate into good earnings if costs shoot up. The Tlemcen precedent is worrying; CIMB's Ms Lai notes too that higher construction costs were incurred at an unnamed China water project due to changes in design specifications. Higher recurring income should help earnings, but as noted, Hyflux may have had to slice its tariff rates to the bone to secure new contracts.

And margins will also depend on cost of capital. Hyflux said that it secured 75 per cent of the funding for Magtaa at a 'very low' rate of 3.75 per cent. The remainder could be borrowed for Libor + 1.5 per cent, according to management.

Those rates are astonishingly low. Some say that this could be due to Hyflux's good relationship with the Algerian government. An Algerian Energy Company (AEC) source told GWI that 'we had instructions from the government' to award Hyflux the smaller Tlemcen deal (Magtaa was won in an open tender put out also by AEC). And the Algerian banking sector, which is providing the 3.75 per cent loan line, is dominated by state banks.

Investors will remember that Istithmar, Hyflux's old Dubai partner, is an investment holding company owned by the United Arab Emirates government. Algeria, embroiled just ten years ago in a bloody civil war, will hopefully prove to be different.