Friday, April 11, 2008

Ezra - 1H FY 2008 Results Review and Analysis (Part 1)


Ezra released their 1H FY 2008 financial statements on April 8, 2008 after calling for a trading halt at 2 p.m. that day. I shall be reviewing their financials in three parts as I had done with Swiber. The first will touch on their Income Statement, margins and expenses as well as their Balance Sheet. The second will talk about cash flows as well as prospects. The third will comment on the general climate and how it may affect Ezra's business, and also discusses some of their plans for expansion based on their powerpoint presentation slides.

Income Statement Review

For 2Q 2008, revenues rose 92% as a result of 2 additional vessels, Lewek Kestrel and Lewek Kea, being delivered during 1H 2008 as well as the additional vessels contributing for 1H 2008 as mentioned in Ezra's press release. However, this was offset by much higher costs which rose 122% year-on-year, thus eroding gross margin and causing only a 53% rise in gross profit from S$15.8 million to S$24.3 million. Gross margins contracted from 43.8% in 2Q 2007 to just 35% in 2Q 2008, but note that 43.8% is uncharacteristically high for Ezra as their gross margins have usually hovered around 35-38%. If we look at 1H 2008 versus 1H 2007, the gross margin was 38.4% against 38.3% respectively, which is an insignificant difference. Of course, it can be argued that higher costs incurred in SGD have caused the fall in margins as most of their revenue is understood to be denominated in USD (the USD has been depreciating against the SGD, hitting a low of about 1.351 to the SGD recently).

For 1H 2008, core net earnings came up to about S$35.6 million (S$16.6 million as reported by the company for 1Q 2008 + S$19 million for 2Q 2008), while core net earnings for 1H 2007 came up to about S$15.4 million (net off exceptionals). This represents a 131% increase in core net earnings. Net margins for 1H 2008 stood at 26.0% against net margins of 22.5% for 1H 2007 (using core net profits). This shows a slight improvement over the previous year but do note that part of this was due to Ezra's sale of EOC in order to "lighten" its balance sheet and take a lot of debt off its books. EOC contributed about US$5.5 million (around S$7 million) in net profit to the Group for 1H 2008, and is expected to be a more significant contributor moving forward. Also, admin expenses increased by just 47% for 2Q 2008 although revenues rose 92%; but for 1H 2008 admin expenses actually increased by 225% against a 101% increase in revenues. This can be attributed mainly to a one-off provision for staff incentive scheme (announced in 1Q 2008) and also higher staff costs as a result of recruiting more personnel for Ezra's new divisions and to spearhead their expansion plan(s).

Overall, there was nothing particularly outstanding or poor about their performance and I would say things are on-track. However, a close watch on 3Q 2008 financials is necessary to determine the extent of the currency depreciation on Ezra's costs, and whether admin expenses do indeed increase less than revenues (implying economies of scale). Financial expenses for the next quarter are also expected to increase as Ezra's MD has mentioned taking on more bank loans to finance the construction of the 4 new MSFV instead of relying on sale-and-leasebacks. In addition to all these, there will also be expenses incurred in relation to the setting up of their new Energy Services Division (more on this in Part 3) which will impact margins. Thus, in the short-term, I do not see margins improving much.

Balance Sheet Review

Ezra's Balance Sheet has undergone significant change after the sale of EOC, as they now do not have to consolidate EOC into their Group (EOC used to be 100% owned but was divested by Ezra in FY 2007 through a share placement to 88% and subsequently to 48.9% through a listing on Oslo Bors). This has resulted in numbers which are not very comparable, but I will nevertheless touch on a few key numbers which I feel summarizes the current financial position for Ezra.

Current ratio for Feb 29, 2008 stood at 1.64 versus 1.43 for Aug 31, 2007. This was mainly due to the monetizing of EOC into cash as Ezra had sold off a portion of it to institutional investors via a listing on Oslo Bors. This had substantially improved their cash position and allows them to use the cash for growing the business further. A receivable still sits in Ezra's books for about S$45.7 million due from EOC which is classified as "Long-term", I think this receivable will remain there for some time as EOC may need the cash flow and hence may not pay back this amount to the Group any time soon. (Readers should note that for Aug 31, 2007, various assets and liabilities of EOC were classified as disposal group assets and liabilities in accordance with FRS requirements, thus any ratios computed based on Aug 31, 2007 figures may not be directly comparable with Feb 29, 2008).

Note that the Balance Sheet also reflects higher bank term loans (under current liabilties) which have increased by 92.7% from S$59.9 million to S$115.4 million. According to the company, they have reduced their net gearing from 0.9 times to 0.4 times, largely due to the increase in equity base from S$424 million to S$527 million. Bank term loans are used to finance their expansion and this will lead to higher interest costs and eventually, gearing will increase. Several research reports have also speculated that Ezra's gearing could rise in the next few financial years as it has resorted to using debt financing rather than sale-and-leaseback financing. This could be due to the fact that interest rates for borrowing are becoming attractive in light of the sub-prime crisis.

In a recent interview with The Edge magazine, Mr. Lionel Lee mentioned that Ezra did not have any problems thus far obtaining financing for their new vessels and so far all their newbuilds have adequate financing. In the event that the Group wishs to order new vessels for delivery in FY 2010 and beyond, they will probably resort to more debt financing as the market turmoil has caused their share price to plunge, thus making equity financing unattractive.

I will continue with the Cash Flow Statement and Prospects and Plans review in Part 2.

4 comments:

Anonymous said...

Dear Musicwhiz,

It would appear that Ezra is a well-managed company that consistently met its target. Further, the company had diversified in several oil & gas related industries.

Therefore, I believe Ezra will continue to have high growth in the near future. The company may be able to hit close to $100 million net profit for 2008.

So far, Ezra had not surprised us with unpleasant news like Sembmarine and recently Cosco. These caused their share prices to plunge unnecessarily.

I have also observed that Ezra is tightly held by the Lee's family ie 60-70%. This did not include the shareholdings of Ezra's employees.

As Ezra's major shareholders are long term holders, the recent plunge in price must be due to the selling by the minority shareholders. Unlike Cosco with larger free float, can I conclude that Ezra's downside is limited? (for your comment, please)

For this reason, I decided to hold Ezra long term. However, unfounded fear of escalating share price drove me to take loans to buy 25 lots at $3.36 with no safety of margin.

To date, I have managed to reduce my outstanding loan to $30,000 without the sale of my non-performing shares. As I have received my mid-year bonus, I am tempted to accumulate more Ezra shares below $2 instead of repaying my loans.

Further, I will be receiving shares dividends of about $7,000 next month. Some of these came from my non-performing shares.

This reinforced my belief of good and bad debts. Unlike shares, borrowing monies to buy a car is forever a bad debt not counting the maintenance.

ROBERTAY

musicwhiz said...

Hi ROBERTAY,

I actually replied to you already on the Personal Finance Part 7 - Car post in which you posted yoiur previous comment. Please check it out, thanks.

Your belief is that Ezra will enjoy "high growth" in the future, but I would like to sound a note of caution in having high expectations for the company. Past performance is no indication of future performance and times are going to be challenging for the company. Remember that as any company grows larger, it will ge harder to grow and manage because it becomes more complex. If the earnings base is already large, then the % increases will not be that "impressive" compared to when they were starting out from a smaller base back in FY 2003. I would think that 20-40% earnings increase annually is reasonable. We should not expect 80-100% year-on-year as this is NOT sustainable for most companies in the long-run.

Thus, your assumption of S$100 million core net profit for FY 2008 is a little optimistic, I feel. For 1H FY 2008, their core net profit is around S$35.6 million; and if we assume 2H FY 2008 is stronger than 1H FY 2008, then I would say net profit should be in the range of about S$75 to S$80 million. This is on the assumption that they can control escalating costs well amid a USD depreciating environment in which their contracts are denominated in; and that rates continue to be firm for their new vessels to be deployed in 2H FY 2008. As such, the rates for Lewek FPSO 1 are not known.

I will not conclude that any share has "limited downside". It is a very dangerous assumption to make because Mr. Market can always get more manic and sell down the shares to ridiculous prices. This is what margin of safety is for.

To be frank, I would comment that if you purchase without sufficient margin of safety, this is also akin to "bad debt" as your holdings would suffer significant capital loss and it may take years for valuations to catch up with your purchase price (dividends included). Thus, this blurs the line between "good" and "bad" debt; because good debt allows you to leverage to grow your wealth through capital gains and dividends HIGHER than the inflation rate. However, if one is suffering a persistent capital loss becaue one bought too high, then it is akin to not enjoying such leverage at all. Leverage, in this case, has become a bad thing as you must pay interest on loan while your shares may under-perform.

I apologize if I was a little blunt, but basically the lesson here is to recognize that borrowing to buy shares is fine if you purchase with a greater than usual margin of safety, as there is always the loan interest component to service (unlike using cash).

I will adhere to my usual practice of not commenting if prices are reasonable or not for purchase, as the concept of intrinsic value can be very subjective. I just state the facts as they are and leave the decision-making to the astute investor.

Good luck !

Regards,
Musicwhiz

Simon said...

i know this is not relevant, but did u guys see sgx announcement abt rickmers issuing new units? i thought that's quite bad since it's far too expensive with their sky high dividend yields. anyone knows why they aren't raising debt instead? is it because they can't obtain loans?
this sounds bad...

musicwhiz said...

Hi Simon,

I am unable to answer your question as I have not much knowledge of RMT. Perhaps you can try Wallstraits forum. I am aware that there is a thread on RMT there.

Regards,
Musicwhiz