Ezra – FY 2007 Financial Results Analysis (Part 2)

To continue the financial results review for Ezra, I will continue with the review of the Cash Flow Statement and also the future prospects and strategies for the Group. Unfortunately, there were no presentation slides released by Ezra relating to their results announcement, which is rather uncharacteristic of the company because they are traditionally known to be very shareholder-centric and they have a habit of keeping shareholders updated on the status and progress of the company. Thus, the future prospects of Ezra are compiled from data and information obtained from sources such as the Business Times, Channel Newsasia, The Straits Times as well as The Edge Singapore Magazine.

Cash Flow Statement Review

Ezra reported net cash inflows from operating activities of S$33.5 million for FY 2007, which is a strong indication of recurring cash flows from their core business. This was a 67.5% increase from the cash inflows generated for FY 2006 of S$20.0 million. Starting from a higher net profit before tax base of S$115.1 million, non-cash items such as the gain in dilution of interest in subsidiary and profit from disposal of AFS (available-for-sale) investments had to be removed from the cash flow statement. Depreciation on fixed assets almost doubled from S$4.6 million to S$9.2 million and had to be added back as it was a non-cash expense. Operating profit before working capital changes actually amounted to S$58.7 million for FY 2007 as compared to S$27.8 million for FY 2006; registering a gain of 111.1%. The main culprits for the cash outflow were the huge increase in trade receivables (from S$1.4 million to S$48.0 million) as a result of the scaling up of their business from their enlarged vessel fleet. This was partially offset by the decrease in other receivables but the net effect is still a S$28 million outflow resulting from changes in receivables. This prompts the question of whether the company can maintain a good cash collection cycle as it seems that much of their receivables may yet be uncollectible as at year-end. Fortunately, this factor was mitigated by the cash inflows from the increase in trade and other payables of about S$30.7 million which enabled the company to maintain a healthy overall net cash inflow. Interest and taxes paid also increased as compared to prior year as a result of higher interest on more loans taken up to finance the purchase of new vessels; as well as higher taxes from the overseas taxation of a subsidiary company (which I suspect is HCMC Logistics in Vietnam).

Cash flows from investing activities showed a huge net outflow of S$314.6 million, mainly due to the purchase of fixed assets which came up to a whopping S$300 million. This was more than double of FY 2006’s purchase amount of S$117.5 million and clearly shows Ezra’s commitment to building up its fleet rapidly to take advantage of the buoyant oil and gas industry. Assets purchased and held for sale also increased from S$55.6 million in FY 2006 to S$92.3 million in FY 2007, while the S$22.1 million worth of cash outflow from the purchase of AFS investments would include the 21.83% stake in Ezion Holdings Limited. Although the impact on cash is worrying if one looks at the net cash outflow for FY 2007, note that most of Ezra’s fund raising comes through in the “financing activities” section, which will be explored below. Also, do note that Ezra’s stake in Ezion Holdings has appreciated more than 450% from their purchase price of 33.1 cents per share to S$1.49 as at October 19, 2007. This means that their stake in Ezion is now worth S$74.5 million which is realizable in cash should they wish to sell their stake for cash.

The cash flows from financing activities is where all the “action” is. Ezra has been busy during FY 2007, as they have obtained more banks loans of S$223 million, procured cash of S$62.2 million from the sale of 12% of their subsidiary EOC Limited and also placed out 15 million shares at S$5.18 per share to raise S$76.6 million (net of placement fees). These activities have no doubt managed to generated sufficient amounts of cash for operating purpose and also for fleet expansion, but there is of course a price to pay. Taking up additional bank loans means increasing their gearing and debt-equity ratio; and it also increases interest expenses. Diluting their interest in a subsidiary would mean the recognition of lower profits from as part of the profits belong now to minority interests; while the issue of new placement shares to strategic investors dilutes existing shareholders and lowers EPS. All these moves were undertaken with the implicit assumption that fleet expansion would lead to higher revenues and hence profits, in order to offset the dilution from sale of subsidiary and issue of new shares. An expanded fleet should also generate increased recurring cash flows which would be used to service the higher interest expenses and to eventually pay off the principle amount of the additional loans.

As can be seen from the above analysis, there are inherent risks moving forward into FY 2008 about Ezra’s cash flows, as most of the current inflows are generated from financing activities, and not operating activities. Thus, if their expansion should stall in any way or if charter rates go on a downtrend, the Group could possibly be “squeezed” in the middle as they will end up having lower revenues but higher loans to service. This is the risk of rapid expansion which all shareholders have to bear; and if the company is on track to take advantage of buoyant conditions, then the cash flows would be sustainable in the long run. Do note that subsequent to the financial year-end, Ezra had sold off another 39.1% of EOC Limited to generate gross proceeds of USD 177 million (about S$259 million at today’s exchange rate). This is in part to finance the purchase of deepwater vessels which Ezra has placed orders for; but the company will have to think of other ways of raising more cash if it intends to scale up its fleet, as I perceive that this amount will be insufficient moving forward (see future prospects and strategies for my ideas on how Ezra will make up this shortfall in cash).

Future Prospects and Strategies for FY 2008

In writing about the future prospects and strategies to be used by the Group, do note that some of my opinions may contain forward-looking statements which may or may not represent fully the direction to be taken by the company. Thus, my disclaimer is that I am neither recommending nor discouraging anyone from buying or selling their stake in Ezra.

1) Fleet Expansion and Fund Raising - Ezra plans to continue to expand its fleet to take advantage of buoyant conditions within the oil and gas sector. They have already ordered two 30,000 bhp AHTS for deepwater exploration, a second pipe-lay barge and a multi-functional support vessel (MFSV). It was mentioned that the Group has the option to purchase 7 more MFSV and that this option will be exercised before the end of 2007. Since one MFSV costs S$162.4 million, this would imply that 7 more would cost close to S$1.14 billion ! Mr. Lionel Lee (MD of Ezra Group) had mentioned that the Group will be spending close to US$1 billion from now till FY 2010 to expand its fleet, but he did not give details on how this was to be funded. One option I can think of offhand is for EOC Limited to do fund-raising exercise through the issue of new shares of EOC Limited, thereby diluting Ezra further but in the process raising enough capital to take over the new assets. Similarly, Ezra itself could also draw down more debt or issue new shares in order to raise funds from the capital markets here in Singapore. Another attractive option would be to engage in yet another round of sale-and-leaseback transactions for the newbuild vessels, which was the asset-light method employed by Ezra that enabled it to grow its fleet from FY 2003 till now.

2) Fabrication work to be undertaken by Saigon Shipyard – Ezra is now expanding its scope of business by venturing into the platform fabrication business spearheaded by its 100% owned HCMC Logistics Pte Ltd, which owns Saigon Shipyard in Ho Chi Minh City, Vietnam. On October 16, 2007, the Group announced that the shipyard had won US$130.2 million worth of contracts. Mr. Lionel Lee expects that this area of business could potentially generate “S$150 to S$200 million worth of revenues” by FY 2009, but conceded that margins were lower as compared to their more lucrative vessel chartering business. With the recent contract win, HCMC Logistics seems poised to capture more contracts in future and generate higher value for the Group. Separately, it was also revealed that another shipyard was being built and readied at Vung Tau (a 2-hour drive from HCMC) to handle the additional capacity as the Saigon yard would be running at full capacity by FY 2009. There is much optimism from myself that this area of business could potentially contribute more recurring cash flows for the Group to fund their working capital requirements.

3) Clinching of more FPSO deals – EOC Limited’s other growth driver will be the clinching of its second FPSO deal, after the Group became the first Singaporean company to manage an FPSO. The company is looking to add one new FPSO to its fleet per year and according to The Edge Singapore, they are currently bidding for such contracts worth S$1.18 billion. If they manage to clinch one in FY 2008, delivery will most likely be in late FY 2009 or early FY 2010 (recall that they announced their first FPSO in late CY 2006 and it will only be delivered in 2H FY 2008). Though financing it will be an issue, albeit not a very worrisome one as EOC can raise its own capital in Norwegian markets, the earnings accretion for the Group should still be significant even if it only owns 48.9% of EOC Limited.

4) Charter Rates for Deep-water vessels – Charter rates are projected by Mr. Lee to be on an uptrend for deepwater vessels as there is currently a shortage and the first few such vessels will only be delivered in FY 2009. He predicts that demand will outstrip supply and therefore gross margins should be very good when these vessels are delivered to Ezra.

5) Role of Ezion Holdings – Up till now, the exact role of Ezion Holdings in Ezra’s game plan is still unclear. The question is how is this little-known company going to create synergies for Ezra’s core business; or will it be used to undertake other forms of work which EOC or Ezra will contract to it ? Hopefully, more will be revealed soon.

The next update from Ezra should come when there is more news of the bonus issue and/or dividend payment dates. Also, the Annual Report can be expected some time in December 2007 as well as the AGM.