Friday, August 22, 2008

Swiber – 1H FY 2008 Financial Review and Analysis

It’s been a while since I had blogged about Swiber and related updates from the company. The company released its 1H 2008 financial results on August 13, 2008, and all I can say is that much was in line with what I expected, though quite a large part of its future is still uncertain at this point in time due to the absence of news about potential developments. Swiber’s presentation slides and Raymond Goh’s interview with Reuters did shed some light on the strategic direction the company plans to take, and I shall comment on it in a separate section after my usual financial statement review. I will keep the financial review short as I wish to focus more on the future and prospects for the company.

Income Statement Analysis

As expected, Swiber’s 2Q 2008 revenues increased by 391% from 2Q 2007 to US$124.5 million as a result of them working concurrently on 6 projects instead of 2 in the previous year. From their order book and award of contracts during the Jan to March 2008 period, one can already foresee that their volume of business is indeed growing. Gross margin came in at 25.9% for 2Q 2008 versus 29.4% for 2Q 2007, while gross margins for 1H 2008 weighed in at 25.9% against 28.6% for 1H 2007. I believe the reason for the fall in gross margins is due to the fact that Swiber is contracting third-party vessels for its projects until the new vessels arrive in 2H 2008. Net margins for 2Q 2008 and 1H 2008 were 17.8% and 16.7%, lower than 2Q 2007 and 1H 2007 mainly due to higher income tax expenses and higher interest costs as the company is gearing up.

Balance Sheet Review

The main points to highlight are that trade receivables and property, plant and equipment saw sharp rises in the last 6 months, due to the increased volume of business and also Swiber’s continued investment in new vessels to expand its fleet. Current ratio stood at 1.42 for June 30, 2008 compared to 2.15 as at December 31, 2008. This sharp drop was mainly due to the issuance of bonds, increased bank loans as well as a more than 100% rise in other payables. Net debt-equity ratio has increased from 0.53 to 1.03 times as at June 30, 2008, and this could represent a red flag if debt continues to remain high. However, in light of the nature of the company’s business and the industry in which it operates, I would expect gearing to remain fairly high. The question is whether it will get excessively high in future (i.e. more than 2.0) ? These concerns are addressed later on in my posting on prospects and plans.

Cash Flow Statement Analysis

In the previous quarter, there was a net cash outflow from operating activities which I flagged as a possible area of concern. For 2Q 2008 however, there was a net inflow of cash of US$18.5 million, chiefly due to the sharp rise in other payables and a drop in other receivables (using the “indirect” method of preparing cash flow statement). When compared to 2Q 2007, this is encouraging as net cash inflows increased nearly 6 times while net profit for 2Q had only increased 4 times. Still, such a comparison may be shallow as further analysis is required as to the nature of the “other payables” and the reason for the sharp increase. It could also be due to a timing difference which will result in a net cash outflow in the next quarter. With the indirect method of preparing the cash flow statement, sometimes I feel it is better to look at the full-year picture rather than just one quarter alone.

As expected, most of their cash was ploughed into purchases of vessels and also for assets held for sale (in their sale and leaseback arrangement). This sucked up US$117 million worth of cash in the 2Q 2008. Swiber paid off US$24 million worth of bank loans and raised another US$56.8 million through new bank loans, presumably using their new vessels under construction as collateral. Bond issuance helped to raise US$20.2 million worth of cash which will assist in financing the construction of vessels. It is these new bank loans and bonds which are responsible for raising the gearing of the company.

Valuation

Using a net profit figure of US$32.5 million and annualizing it, FY 2008 net profit will be about US$65 million. Using an exchange rate of 1.41 to the USD, this gives a net profit of about S$91.8 million. Earnings per share is thus about SGD 21.7 cents. At today's closing price of S$1.57, this translates into a PER of about 7.2 times (using a combination of historical and forward pricing). I have highlighted some factors below which may contribute to a higher intrinsic value for Swiber and may be worth considering. Based on my purchase price of S$1.01, I have purchased Swiber at a PER of about 4.65 times, and this gives me sufficient margin of safety in my opinion.

Order Book and Project Bidding

As at June 30, 2008, Swiber had an order book of US$664 million which includes the US$250 million CUEL project spanning 5 financial years. This order book is expected to be recognized as revenues progressively over the next 1.5 financial years, and a recent DBS report mentioned that the new bidding season for contracts will arrive soon from the November to January period. The total bids submitted as at August 2008 is for US$3.57 billion worth of jobs for the next 5 years. If we assume a conservative rate of 20% win, that’s an additional US$714 million worth of additional projects. One thing to remember is that bidding for projects is an ongoing thing and as Swiber expands its regional footprint, the chances of them clinching a project will be significantly higher. Thus, this should only be used as a gauge and not as an exact approximation. One issue with Swiber is that their project-based revenue tends to be “lumpy”, much like a property developer recognizes revenues for properties based on % of completion method. CUEL was the first multi-year dealed inked by Swiber and demonstrates that such contracts do exist in the industry and Swiber is more than capable of clinching one in the near future.

Qualitative Factors to justify higher intrinsic value

When one analyzes a company like Swiber, one may think that it is just another EPCIC player competing in the same space as other similar EPCIC players serving the oil and gas industry. However, several factors have been identified by myself as being of significance in assigning a higher intrinsic value for Swiber. Recall that the intrinsic value of a company is not just based on its financials, but also on “intangible” factors such as Management strength, network of clients, reputation of customers and other factors. These are as follows for Swiber:-

a) Completion of Mampak platform installation work for Brunei Shell on schedule and without incident. This demonstrates that the company is capable of handling larger, more complex projects without compromising on delivery timing and safety. The successful completion of a major project for a large reputable client like Brunei Shell will give Swiber an edge in bidding for future projects.

b) Gradual expansion of territories for client base – Swiber has gradually extended its regional footprint over the last 1.5 years since listing by signing MOU and LOI with parties in various countries. During listing in 2006, it only had clients located in Singapore, Malaysia, Indonesia and India. Currently, its client base has expanded to include Thailand (CUEL), Vietnam (PetroVietnam), Brunei (Rahaman and Brunei Shell) and most recently, Saudi Arabia (Rawabi). Thus, their expanding network shows that they are able to garner the confidence of the local parties in order to work hand in hand with them, and expands their area of influence.

c) Excellent Management Team for Offshore Drilling Services (ODS) – Swiber made a very good move by hiring Mr. Glen Olivera who has nearly 30 years of experience in drilling all over the world. With him to helm the ODS division as CEO (and also taking up a 10% stake in Equatorial Driller Pte Ltd), shareholders can be assured that only the highest quality will be delivered in terms of design and execution, due to this vast experience in drilling.

Prospects and Plans

Swiber has outlined its plans for growth in the next 5 years, and this will mainly be underpinned by its fleet expansion which will take its fleet from the current 30 vessels (to date) to 39 by the end of FY 2008 and then to 48 by the end of FY 2009. Their vessels are mainly to cater for higher value and larger EPCIC projects in which Swiber occupies a niche market, while at the same time, they are also providing offshore support services (OSS) through their fleet of AHT and AHTS.

However, Swiber intends to capitalize on its unique design for Equatorial Driller (ED) to take the company to the next stage of growth. Their immediate focus is to secure a drilling contract either in West Africa or Brazil, while at the same time finalizing the shipyard which is supposed to build the vessel. The vessel can only be delivered 24 months after the signing of the contract with the shipyard, so the estimated date of delivery will be about 4Q FY 2010. Mr. Goh mentioned that the ED will cost a lot less to build than a normal semi-submersible because of the difference in hull design and the lack of a DP2 positioning system. This is due to the target market which Swiber is aiming for as the operations for ED will be in mild waters which do not need DP2 technology. As ED will cost less, a competitive advantage Swiber will have is that they can charge clients lower day rates for the charter of the driller; thus creating a win-win situation for both themselves (their gross margin is preserved) and the client (cheaper day-rates as compared to semi-submersible drillers). I would expect Swiber to announced finalized plans for the ED by the end of September 2008 and hopefully a contract will follow swiftly.

Mr. Raymond Goh had also mentioned in a Reuters interview recently that he intended to maintain the debt-to-equity ratio of the company at about 1 (the current level). In order to do this, there are two possible options: he can either issue more shares through a secondary offering (thus diluting current shareholders) and then drawdown on the medium-term notes and bonds facility (hence preserving the ratio at 1) or to utilized sale-and-leaseback to free up cash and lighten the Balance Sheet (Swiber had already done this twice). The first option seems unlikely as current market conditions (in a bear market, valuations are lower) do not facilitate an efficient use of the capital markets for fund-raising, therefore I feel Swiber will gravitate more towards the second option of using more sale and leasebacks to free up cash for expansion. In light of their capital-intensive nature of business and the fact that larger contracts can only be secured through the expansion of their fleet and capabilities, this is a necessary evil.

In a surprising and (to me) somewhat unrelated announcement, Mr. Raymond Goh has commented that Swiber is studying the offshore windpower market to assess the potential for windpower as an alternative source of energy. In the Reuters interview, he mentioned that he hoped Swiber would be able to clinch a contract within a year with a major European company, and that windpower may contribute as much as 10% to Swiber’s revenue in 5 years’ time. Their powerpoint presentation to analysts does not paint a very pretty picture of windpower as costs have been escalating and many projects are stalling due to lack of funding. Though offshore windfarms are a new and interesting idea, it remains to be seen if a good enough return on investment can be achieved in order to justify future capex in this new business unit. The company may be biting off a lot more than it can chew if it plans to “diversify” its revenue stream. I would rather it focused on its core competence instead of trying too many different things at the same time. Hence, this is one area of worry for me in the near-term, as there are no earnings visibility for windpower and not much is known about the future potential as well as the gross margins for such contracts.

2 comments:

Anonymous said...

Sorry, but could you expound on this? "The first option [issuing more shares] seems unlikely as current market conditions (in a bear market, valuations are lower)"

Thanks!

Z

musicwhiz said...

Hi Z,

What I mean is issuing shares in the current bear market means you are accepting lower valuations for your company and hence more shares need to be issued to raise a certain $ amount (hence higher dilution to existing shareholders). In a bull market, prices are higher so less shares will be issued (lower dilution).

Thus, the company would be better off raising debt when capital markets are weak, or use a different fund raising method like sale and leaseback.

Regards,
Musicwhiz