Thursday, March 06, 2008

Swiber - FY 2007 Financial Results Review and Analysis (Part 1)

Ok, I've been procrastinating on doing my analysis for Swiber due to personal commitments, but it was on the back of my mind all this time and I was interested to dig into their numbers and facts. Apparently, some reports have been written by various broking houses which made mention of certain facts and assumptions about the company which I felt was not entirely accurate, and this post will seek to address those issues and clarify them. This is of course, notwithstanding the fact that these same brokerage houses give extremely ridiculous target prices for the company (one stated it at S$5.05 if I remember correctly). My advice for readers and interested investors would be to ignore such "noise" and evaluate the company on your own based on their press releases, numbers and industry profile.

This review will be unusually long and I should inform the reader that it will come in three separate parts which may not all be posted consecutively. Part 1 discusses the Income Statement and Balance Sheet and various aspects to look out for, including margins, debt levels, current ratios and earnings. Part 2 will touch on Cash Flow issues and also touch on various segmental reporting data which the company has so kindly provided. Part 3 will go in depth about the company's prospects and plans for FY 2008 and beyond, and also elaborate on their new business unit Kreuz Shipbuilding. It will also include a summary of their order book and other information gleaned from their presentation slides for FY 2007. So, readers, be patient and I will plough through the information to make sense of this company's prospects, which should promise to be an exciting time for shareholders, as I see FY 2007 and even FY 2008 as "foundation-laying" years for the company.

Income Statement Review

For 4Q 2007, Swiber chalked up US$61.1 million worth of sales, up 159.1% from 4Q 2006's US$23.6 million. Gross margins for 4Q came in at 23.9% for 2007 versus 19.9% for 2006, which the Management attributed to the increased use of their in-house vessel fleet. However, do note that finance costs have also ballooned by 817% quarter-on-quarter as a result of their increase in current and long-term liabilities such as bank loans and bonds (medium-term notes). This will be discussed further under the Balance Sheet review. Administrative expenses incfreased by 155% but is not a serious cause for concern as revenues had increased by roughly the same amount. Stripping away the exceptional gain from the disposal of vessels held for sale (in the sale and leaseback) of US$13.2 million, we get a net profit of US$6.98 milion for 4Q 2007, which is a respectable 78.1% increase over 4Q 2006's net profit of US$3.9 million. Net margins stand at 11.4% for 4Q 2007 and 16.6% for 4Q 2006, so it can be seen that Swiber's net margins were actually negative impacted in the 4Q due to the large increase in finance costs. Moving forward, Swiber has to increase its revenue stream and margins in order to offset the interest effects of the debt it took up; but realistically speaking, this may take some time.

For FY 2007, revenues have increased by 126.4% fom US$66.8 million to US$151.1 million, largely due to a higher order book as a result of more contract wins and also contribution from their largest contract to date - the US$146.6 million project for Brunei Shell. I will touch on why I feel that this contract's value was not fully recognized in Part 2 of my review. Gross margins rose from 22.9% to 28.3% due to the same reasons given in the 4Q analysis. I would expect further gross margin improvement in time to come as Swiber moves into subsea and deepwater services as they are currently chartering a subsea vessel for use in one of their projects. Once their subsea vessels are ready by FY 2009, this would be another boost to gross margins.

Overall, for FY 2007, admin expenses jumped 251% due to higher costs. I would attribute this to the hiring of staff as operations expanded, training of these staff and also increased costs as a result of acquiring their new wholly-owned subsidiary, Kreuz Shipbuilding. As mentioned earlier, finance costs also shot up as a result of more debt which the company took up, thus the rise in finance costs came up to 579% year-on-year. Net profits for FY 2007 (excluding exceptional gain of US$21.7 million) came up to US$28 million, which is an increase of 130.8% over FY 2006's net profit of US$12.1 million. Adjusted net margin for FY 2007 was 18.5% against FY 2006's 18.2%, as the higher finance costs and higher operating expenses took a toll. Thus, even though gross margins improved by 5.4 percentage points, higher expenses eroded most of that improvement and this resulted in only a marginal 0.3 percentage point rise in net margins. Once costs stabilize and contract flows continue, the Group should be able to improve their overall net margins. I estimate that it will probably take the company 1 to 2 years to do this.

Balance Sheet Review

A quick glance at the Balance Sheet reveals that Swiber's net current asset position has strengthened considerably over the past financial year. They have bolstered their Balance Sheet with more fixed and current assets but have also balanced this with higher loans and mid-term debt. Cash balances increased to US$97.7 million as at Dec 31, 2007 and will be touched on in Part 2 during the Cash Flow Statement review. What's interesting are the significant increases in trade and other receivables forming about US$126.7 million worth of current assets. Because of this "spike" in receivables, it has caused the cash flow statement to report a net negative operating cash flow (i.e. operating cash outflow). While increased business activity may account for part of the increase, I would suspect that it cannot explain the entire large increase, which makes up a 288% increase in trade and other receivables over FY 2006. One plausible reason I can think of is that this balance consists of monies which are due to Swiber from their sale and leaseback; thus it may be a timing issue as they may not have received the monies as at year-end but have to account for it as the receivable has already crystallized. I will need to clarify this further with Management during the upcoming AGM. (Note that there is a further US$11.6 million of "Other Receivables" classified as non-current assets, and this could possibly be proceeds from the sale and leaseback of vessels to be delivered in FY 2009, which explains why the cash comes in at a much later stage).

Of note to mention is an amount of US$1.8 million being derivative financial instruments. I linked this number to the statement of changes in equity where there is a similar balance booked under "Hedging Reserve". The description is "gain on cashflow hedges" which means this should form the hedging "gain" which the company has capitalized as a non-current asset in the Balance Sheet. It will be interesting to ask the Management regarding the hedging strategies they use, particularly after the amazing losses sustained by SembCorp Marine and Labroy Marine as a result of these "harmless" derivatives. I will make a note to ask during the AGM as well.

Moving on to liabilities, both trade and other payables have increased as a result of increased business activities. What's important to note is that bank loans have increased significantly from US$10.8 million (current + long-term portion) to US$24.6 million, which represents an almost 250% increase. These borrowings are intended to fund purchases of fixed assets to increase Swiber's vessel fleet. There is also an amount of US$71.1 million being medium-term notes issued during FY 2007 as part of their multi-currency medium-term note programme. The increase in gearing is an opportunity taken by Management to use leverage to grow their business. While Buffett speaks of "great" businesses which can use internally generated cash flows purely for growth, most "good" businesses have to rely on external financing in the form of debt or equity in order to grow. Swiber is such a business - good but not great ! Of course, the risk inherent in such borrowings is that if the company fails to achieve growth which exceeds the cost of borrowing, then leverage acts as a double-edged sword to "slice" the company apart and bleed it dry; not a pretty sight at all. So the key here is to have faith that Management can deliver the results in order for them to increase their gearing from 0.22 to 0.54.

Part 2 of my review will touch on the Cash Flow Statement and discuss how prudently the company is using and generating its cash, and I will also comment on the segmental reporting and tie it back to the regions which Swiber is targeting for growth through strategic alliances/joint ventures.


Anonymous said...

Hi mw,

Many thanks for a detailed analysis of Swiber's FY07 results so far.

Like yourself, I have been tracking Swiber since its early post-IPO days (when it was trading between $0.90-$1.00), although I must admit that unlike yourself, I have gotten in and out a few times, each time locking in some profits.

Would like to take this opportunity to thank you for sharing the responses from management with regards to the many conspicuous points u brought up in your analysis. They certainly help people like myself who just can't find the time to attend AGMs/EGMs to have a more clearer picture of the company.

Keep up the excellent work!


musicwhiz said...

Hello Ziwen1,

You are welcome and I am glad you appreciate the analysis. I will try to make Parts 2 and 3 just as comprehensive though I need more time to read and digest before I can make any meaningful conclusion(s). Good to know too that you made a few rounds, but is your current buy price giving you sufficient margin of safety ?

I will do my best to update readers, shareholders and interested investors on Management's responses. I will continue to do so after attending the upcoming AGM too, assuming I can remember all that's said as there is no time to take notes (usually I type mostly from memory though I jot down a list of points to ask).

Once again, thanks for your compliments and your support too.


Anonymous said...

Hi MW,

Yes, agrees with Ziwen on your analysis, they are indeed very detailed, and I must add, extremely systematic and well thought through!

Would you mind share with me your analysis methodology and how you dedrive your insights and conclusions? I was quite tempted to buy in some of the BT/REIT seeing some 8 to 12% yield at current depressed prices. But knowing that yield is not everything, and that the underlying businesses are the main reasons if one will to invest, some form of solid analyses is necessary. Thanks you in advance.

musicwhiz said...

Hello Anonymous,

I guess I use a drill-down approach to look at the 3 financial statements, as you can see from my analysis. There are probably other aspects to consider as well such as ratios but I have yet to include them in my analysis in order to make it more detailed.

If you invest purely on yield and not growth, then I cannot comment much because for me, it's more of growth investing. Yield does represent value too but I think you would need to use DCF to properly calculate it (e.g for REITS and Shipping Trusts).