Tuesday, March 03, 2009

Swiber – FY 2008 Analysis and Commentary

On February 28, 2009, Swiber released their FY 2008 financials, and basically dropped a bombshell on shareholders – there were delays in the deliveries of 2 vessels which ultimately meant that project work on some contracts could not be completed in time, resulting in higher costs recognized without associated revenues. The effect of this was a plunge from a net profit to a net loss for 4Q 2008, which dragged down the performance for the entire FY 2008.

After going through the numbers, facts and figures, below is my analysis of the situation and comments on whether the Company can steer through the difficulties it is currently facing, and also to determine if this surprise loss is a one-off incident, or may likely occur again in future. As shareholders and investors, we should be most concerned about what our asset (business) is doing and whether it can continue to give us steady returns over the long-term.

Profit and Loss Analysis

As mentioned, the 4Q 2008 numbers are not pretty mainly due to the late deliveries of 2 vessels – Swiber Concorde (pipelay barge) and Swiber Supporter (dive support work barge). This resulted in delays in completing work for pipeline installation and subsea tie-in and led to increased cost of goods sold without associated revenue being recognized. In addition, a confluence of other factors such as higher sub-contracting costs for an offshore fabrication project as well as costs associated with rapid mobilization and de-mobilization of vessels to handle projects in different locations resulted in a gross loss of US$12.3 million (gross loss margin of 12%). Net loss margin for 4Q 2008 stood at 10.9% as a result too of higher administrative costs associated with increased staff strength due to the expansion of the company, but part of the costs were defrayed by the higher share of profits from associates Principia Asia and Swiwar Offshore. Finance costs rose about 150% due to the increase in bank loans and bonds taken up by the company to finance its capex requirements. This will be dealt with under the Balance Sheet analysis.

For FY 2008, gross margin compression caused gross margin to fall from 28.3% in FY 2007 to just 15% for FY 2008, principally due to the performance of the 4Q 2008. Stripping out exceptional gains from sale and leaseback transactions (S&L), net margin would have been 6.35% for FY 2008 against 18.5% for FY 2007, a drastic drop no doubt.

To put things in perspective, one has to analyze the factors behind this occurrence and put forward a conjecture on whether it is reasonable to assume that it is likely to occur again in the near future. According to the Company’s press release, the vessels which were delayed are slated to be delivered in 1Q 2009 instead, where they will then presumably be able to finish up the job and complete the projects. What was not mentioned though was the probable loss in confidence from their customers as a result of this fiasco, which would hurt Swiber’s reputation for timely project execution. While it can be argued that clients should understand that this credit crunch is unprecedented and was the principal cause for the shipyard’s delay, I would think that Swiber’s reputation would still be somewhat tarnished after this unfortunate incident. This may affect their ability to clinch new contracts and also strain relations with existing customers. However, the Company did announce US$70 million worth of new contracts clinched in the first 2 months of FY 2009; so one can infer that the reputational damage should be fairly contained and customers may dismiss it as a mere one-off incident. Shipyard delays make it difficult to schedule project work and Swiber must have felt this very keenly in 4Q 2008 when global trade financing came to a near standstill and freight rates also plunged. This caused problems for companies such as Ezra as well as they had to cancel their MSFV orders with Keppel Singmarine and Karmsund.

So it can be seen that the effects of the crunch have affected all companies; hence it can be concluded that the reputational damage is mitigated by this fact and also the fact that Swiber has established long-term relationships with customers prior to such an event occurring, which makes it unlikely for the relationship to strain further. I view this as a one-off unfortunate incident for the Company, but it pays to observe if things will go as planned for 1Q 2009 with the eventual delivery of the 2 vessels. Mr. Raymond Goh did mention in the Business Times today that he does NOT forsee any more delivery problems as “the situation has changed (from one of over-capacity in the yard) to one whereby the yards are more desperate for work now”.

Balance Sheet Review

To be honest, Swiber’s balance sheet has considerably worsened from FY 2007 to FY 2008, due mainly to the higher gearing (debt level) as well as the drop in the current ratio. Due to Swiber’s ambitious expansion plans, it had issued bonds and taken up more bank loans in FY 2008, with non-current bank loans increasing by 500%, non-current bonds increasing by 200% and trade and other payables nearly doubling as well. The result of this was a drop in the current ratio from 2.15 in FY 2007 to 1.37 in FY 2008. Most of the current assets for FY 2008 was made up of cash and work-in-progress, which are unbilled portions of completed projects. This will likely reverse itself in FY 2009 to bills or trade receivable and by observing the trade receivables balance for FY 2008 compared to FY 2007, the increase of just 38% compared to an increase of 183% in revenues shows that collections are not a problem. Understandably, this should be because of the nature of Swiber’s customers (mainly oil majors and state-owned oil companies).

Debt-Equity ratio hit 1.01 for FY 2008 as a result of higher gearing to fund their vessel expansion plans. This was a significant rise from FY 2007’s D/E of 0.53 and is a worrying sign amidst this credit crisis. The interest paid on their debt totals about US$11 million and can be comfortably managed by operating cash inflows, but they have a portion of debt due within a year amounting to about US$81 million. Comparing this with their cash balance of US$74.7 million as at Dec 31, 2008 and considering the fact that no other major capex requirements are un-funded, coupled with the steady contract flow for Swiber; I do not forsee the repayment of this debt to be a major problem and there is also a remote chance of a rights issue to shore up their Balance Sheet, heavily geared though it may be. This will be covered in detail under future plans and also the Cash Flow Statement analysis.

ROE (annualized) is 18.9% for FY 2008 but much of this can be attributed to the increase in debt, meaning the quality of the ROE is in question. ROA was pathetically low at just 5.6% for FY 2008 compared to a more robust 13.3% for FY 2007, mainly due to lower earnings for FY 2008 as a result of the aforementioned losses in 4Q 2008 and also the Group’s asset base increasing as it expands its fleet. In future periods, this ratio is likely to stay depressed as the Group grows its asset base further; but it is hoped that earnings can increase at a correspondingly healthy rate to be able to make up for this drop.

Cash Flow Statement Analysis

It is quite deceiving to just look at the Income Statement as the drop of about 20.6% in full year net profit might lead one to assume that cash flows are corresponding poor as well. But in fact, the cash flow for FY 2008 was more robust than FY 2007 mainly due to the previously mentioned 38% increase in trade receivables when revenues surged so much, as well as the fact that there was a net operating cash inflow of US$2.2 million compared to a net operating cash outflow of US$16.8 million for FY 2007. Though small, it shows that the Group can maintain positive cashflow even with decreased earnings, higher income taxes as well as higher interest payments. The main reason for the cash inflows not being higher than they could be can be attributed to the work-in-progress accumulation which has not been billed and collected from customers (a possible timing difference) which could result in more cash flowing in during 1Q 2009.

For investing activities, the capex is pretty apparent for both years as US$92 million was paid in FY 2007 and US$226.3 million paid in FY 2008 to purchase PPE. However, do note that cash also flowed in from disposals of PPE and assets held for sale, as Swiber attempts to replace their older fleet with a newer one. All in all, 10 vessels were acquired in FY 2008 while 6 vessels were disposed of. The details can be found in Swiber’s powerpoint presentation material which can be downloaded from the Company’s website. Net cash used for investing activites ballooned nearly 400% to US$206 million, and constituted a major drag on cash.

The shortfall for this capex has to come from financing activities, of course. During FY 2008, US$235 million was raised from bank loans alone, and another US$92.2 million from the issuance of bonds. While hindsight would dictate that gearing up so quickly in one of the worst recessions in 70 years was a bad idea, it is at least a comfort to know that Swiber has already obtained its bank lines and successfully sold its bonds (which have a 3-year maturity by 2011). Interest costs of US$11 million per annum should be manageable only if the Group can secure sufficient contracts in the next 10 months of FY 2009, which I perceive as a key risk and uncertainty given this protracted downturn. On the other hand, also note that US$133.4 million worth of bank loans were repaid during FY 2008, about 64.7% more than the US$81 million due within one year. If you add in the interest, this comes up to about US$92 million worth of cash outflows for financing activities for FY 2009, which I am confident the Group can comfortably handle due to its order book of US$596 million as at end-FY 2008. Do not forget to factor in the additional US$70 million worth of new projects for 2M 2009, bringing the total order book for end-Feb 2009 to US$666 million, most of which will be recognized in FY 2009.

Prospects and Future Plans

After announcing the scrapping of their plans for the much talked about Equatorial Driller (a relief considering the huge capex burden it would have entailed), the Group now plans to focus its business efforts on managing costs and also on timely execution of projects. According to its press release, a total of 17 new vessels will be added to its fleet for FY 2009, most of which will be delivered in 2H 2009. Assuming Swiber Supporter and Concorde are delivered in 1Q 2009, this means that more of the revenue will be recognized in 2H 2009 due to most of the deliveries being timed for that period. It would also signal lumpy revenues and that quarterly results should not be relied upon too stringently (a case similar to Boustead).

As Mr. Raymond Goh had mentioned, Swiber has the manpower and the contracts awarded to it from Thailand (CUEL), India, Middle East, Indonesia and Malaysia. The only thing lacking are the vessels which are critical to perform the job well and free Swiber from the usage of third-party charters which are not only costly but also run the risk of problematic scheduling. I personally perceive that problems may continue into 1Q 2009 and the early part of 2Q 2009 before things stabilize, which means the Group may see more volatile earnings and margins ahead.

The good news (if it can be considered good) is that no further capex plans are underway, and that all planned capex is fully funded by S&L, bank loans and disposals. It’s akin to the Company just sitting back to wait for the vessels’ arrival, then to use these vessels to generate revenues and recurring cash flows. In order to remain asset-light, Swiber has made use of S&L as well as to jointly-share assets with their partners in the Middle East (Rawabi) and other regions too. They plan to target the shallow water domain in South-East Asia, where they have fewer competitors; as well as sub-sea opportunities in the Indian and Middle Eastern region. Though oil prices have come off a high if US$147 per barrel to currently about US$42 per barrel, Mr. Goh still sees a consistent demand for shallow water EPCIC work as projects which have already begun would not be terminated prematurely, and Swiber has the advantage of being involved in the end-stage of the oil and gas extraction process; so it is very unlikely for contracts to be cancelled. This is unlike Keppel’s business model where oil rigs can be cancelled or deferred as they represent the E&P (Exploration and Production) phase of the oil and gas cycle. This acts as a natural buffer to Swiber’s business and allows for more clarity of cash flows and contract revenues.

On a final note, the Group has also mentioned the possibility of moving their expertise to serve the offshore windpower industry. No additional capex is required and the skills set is apparently transferable as well, thus opening up a window of opportunity for the Group. Though this is just “talk” at the moment, it could be a possible avenue for Swiber to branch out into in future and may become a separate business unit if the potential is large enough.

For industry prospects, most of the presentation material features updated research and quotes from Feb 2009 which support the fact that investment in oil and gas E&P will continue, and the sharp drop in demand for fossil fuels would only exacerbate this under-investment scenario past FY 2010. As a result, most oil companies are continuing to inject monies for capex and oil field discoveries, and they are unlikely to taper off anytime soon.

Conclusion

Ultimately, the value of a company should be determined not just by the quality of its assets and its growth potential, but also the quality of the Management and their ability to allocate capital efficiently to achieve a high ROE without excessive use of leverage. With the credit crunch affecting companies such as Ferrochina, it pays to be prudent and Swiber should focus on generating more FCF once their fleet expansion is complete by end-FY 2010. While some may lament the lack of clarity in the Company’s growth moving forward, the key focus now should be to hunker down and build up vital cash to tide over the protracted downturn, so as to emerge into the sun in future with the necessary resources to take advantage of new opportunities.

In view of this analysis*, I have added to my position at S$0.375 yesterday. My new average cost for Swiber is now S$0.802 and will be updated in my March 2009 portfolio review.

*Disclaimer: This analysis is personal and is not an inducement to buy or sell shares of Swiber Holdings Limited. The author of this blog will NOT be held responsible for any losses incurred due to the reliance on this article for investment decisions or for speculation opportunities.

12 comments:

TYL said...

hi musicwhiz,

not too sure if u remember me, but anyway, what I will like to highlight here do not throw good money at bad money....i believe it pays more to acquire blue chips now rather than to buy SMEs....

it is never easy for a value investor to admit that he bought into a wrong company, but you really need to learn how to take the loss and move on, because that's what buffett does too, he definitely does not throw good money at bad money....

and just a note, i do not want to make any concrete comments, but what i can say is that you should try to get hold of some ppl in swiber's industry and question them before avergaging down again...

musicwhiz said...

Hi TYL,

I do remember you, your blog was not updated for a long time. Quite surprised you popped up suddenly.

Well I have admitted buying wrongly for FSL Trust and Pac Andes, so it's nothing shameful to admit it.

While you are right to say it's not wise to throw good money after bad, I believe you need to give supporting reasons too. Obviously you do not wish to disclose too much as you may know something as an insider, but for me as a retail investor I am unaware of any factors which may cause me to believe my decision to invest in Swiber was wrong.

Swiber's industry - I think you are referring to their EPCIC activities and the oil and gas industry ? Maybe you can comment in general on what you observe but kindly back it up with some facts and figures, thanks.

Regards,
Musicwhiz

P.S. - Even "blue chip" companies can collapse, so nothing is totally safe during this downturn.

TYL said...

hi musicwhiz, so glad and happie that you remember me =)

ya my blog has not been updated for quite some time as I believe not many will appreciate value investing during bear mkt and also partly tied up with other issues...

meanwhile I will like to share with you that I am looking at the other side of the game which is TA, it is a different ball game and truthfully, it gives you more confidence in practicing value investing too, probably you can open up and look into that area as well...fortunately for me, i managed to retain my entire investing capital throughout last year with the help of TA, i sold out all my long-term positions at the start of last year....so right now i can deploy the original capital to snap up some blue chips at fire-sale (and yes blue chips can collapse as well, but at least they have a higher chance of riding out this tough time)....aniwae, WB uses some forms of TA as well, as he managed to sell his petrochina at almost the peak prices.

and btw, did you explore shorting singapore stocks via CFD? as a value investor, i believe you come across many companies which are losing $$ or over-valued, you should make use of this edge in the mkt.

i am really glad to share with you more on swiber or other stuff, but i am afraid the info can be quite sensitive, you can drop me a private email if interested.

ditchdog said...

I don't think musicwhiz is into trading or shorting as it is not his style. I think what TYL has done is to do hybrid investing. What TA does is to tell u which are the levels for entry at support levels. If it cracks and u wanna add more, u wait at the next support level.

One thing bout WB. He totally thinks derivatives are tools of destruction. It is VERY interesting to see his exposure and losses in it despite him hating it. Maybe he hates it cuz he consistently losses money. I cannot understand why someone would use a tool if you don't like it. Very contradicting.

--charlesming
timetohuat.sillypore.com

musicwhiz said...

Hmm TYL,

I am quite surprised when you say that people lose faith in value investing during a bear market. It's more likely for faith in value to be reinforced during times of economic distress, as more people focus on fundamentals instead of sexy stories. In fact, it is during bear markets that value investors can find the most bargains, hence your comments are a mystery to me.

Your view on TA in enhancing value investing is, unfortunately, not shared by me. TA will always be viewed as a form of speculation as we are attempting to make sense of price action rather tahn focusing on the financials of a company and what it does. You may have your own reasons for turning from value investing to TA as well as CFD, but I don't expect to do the same for myself. Thanks for the suggestion though.

I do also find it strange that your blog had stopped updating as at Feb 2008, yet you say you managed to sell everything during that time and stayed out as the carnage played itself out. If you had indeed done as you mentioned, updating everyone should be of prime importance in order to justify that this statement was not made on a "hindsight" basis. In other words, there is no way to affirm your statement as now is March 2009 and looking back, almost anyone can mention that selling in either late 2007 or early 2008 was a good idea.

For me, I do document all decisions and actions taken on a consistent, monthly basis so that there is a historical trace of what I do and the reasons for doing so. While all my decisions may not be correct, at least I show my thought process and learn from it as I go along. This eliminates the chance of me using hindsight to justify a particular action as previous posts have evidence to state otherwise.

Regards,
Musicwhiz

musicwhiz said...

Hello Charlesming,

Thanks for dropping by my blog !

Yes I am a little puzzled and perplexed as to why WB continues to use derivatives even though he knows they are bad, bad, bad ! Perhaps he has his own reasons.....

As for hybrid investing, if it works for someone, they are welcome to use it. I know what works for me in terms of my character, temperament and belief system.

Cheers,
Musicwhiz

TYL said...

hi bro,

anyway i am not trying to justify anything here with regards to my holdings, eventually we only need to answer to ourselves as an individual investor =)

but after hearing that you are so against on TA, guess i shall drop the topic. my sole objective on posting a comment has been reached nevertheless, i.e. to share more info on swiber, hope it helps.

jiayou jiayou for everybody here! =)

musicwhiz said...

Hi TYL,

Absolutely right, we answer only to ourselves regarding our own money cos it's our money, so who's going to bother about it more than ourselves ?

As I reiterate, everyone can have their own methods and styles. Since this is a value investing blog and most of my analysis is focused on corporate fundamentals rather than price action, I fail to see any additional value in using TA unless you are implying it is to time entry and exit (there might be some utility in such cases I admit). However, for thinly traded counters like Boustead and Tat Hong TA does not work effectively, while if one's idea is to hold a company for long-term then TA is kind of irrelevant.

As for sharing of Swiber, I thank you for the info.

Wish you all the best in your investing too !

Musicwhiz

floatingrok said...

My concern is whether Swiber can continue as a going concern if oil price continues depressed at this level for one or two years.

Although the orderbook is still huge at more than US$500m, but if you look at its annual revenue of US$400m plus, I am not that opptimistic. It means the orderbook can lasts for only slightly more than one year. It is right that it is still obtaining orders. For the first two months, it has been US$70m. But, it is strange this time that the company didn't announce what kind of orders they have secured. Previously, the company annouce it when they get it. I suspect this is more like a comfort message that the company want to send to the market , and the orders are more like a repair / maintenance, which may not imply its capability to secure meaningful projects. If the company can't continuously secure projects, I have concerns whether the debt repayments and financial lease obligatiosn that funded its fleet expansion in 2007 and 2008, could drag down the company into mire.

Another concern, is the company's reeivables. As it anounced, it has around US$50m receivables happened in 2007 and it is still negotiating with the customer for collections. If can't, this will put a pressure of its bottom line, especialy when you look at its net profit of around US$40m. The no-collection alone will shoot down the company's whole year profit into negative...

I was interested in this company, especialy the company's long-term outlook (in 5 to 10 years)and its willingness to share the latest developments all the time. But its anual report really discourages me to go ahead to load it.

Please share your thoughts of my concerns.

musicwhiz said...

Hi floatingrok,

Nice comments you made, thanks.

First things first, Swiber's services are EPCIC and catered to oil majors in the O&G industry who are in the late stage of oil extraction, meaning viable oil fields which have been discovered and for which production is about to commence. Hence, the drop in oil prices is unlikely to affect the demand for their services within 1-2 years as many projects are still taking off due to the oil boom over the last few years. If you note, many oil majors recently also announced retaining their budgets for the next 5 years in view of oil prices heading north over time, so capex spending on E&P will likely stay at current elevated levels.

Regarding the orderbook, there are no details on what the projects are, but the Company does say it adds to their order book of US$593 million, so I would assume these are projects of the normal type rather than the low value types you mentioned. Still, it would be great if the Company could provide more clarity, I agree.

For receivables, I am not too worried because for companies such as Ezra and Swiber, most of their work are for reputable oil companies or state-owned oil enterprises such as Brunei Shell and ConocoPhillips (for Ezra's case). Thus, there should not be too much problem in collection - it could just be a timing difference.

Let me copy and paste something I wrote on another forum regarding Swiber. These are what I feel make up its potential, though much of it is still speculative.

1) High barriers to entry in this industry, as well as specialized know-how and a competent, experienced Management Team, which can negotiate for larger projects and can enable the Company to get the job done without lost man-hours and in time. A strong team can also spearhead expansion into regional markets thus raising the potential for more lucrative tie-ups with partners (e.g. Rawabi of Saudi Arabia was one of them).

2) The full fleet of 34 vessels currently can cater to an order book of about US$700 million, as mentioned by CEO Raymond Goh. New additions to the fleet in late FY 2009 will mean the potential to bid for not just higher-value projects, but also projects of greater complexity which may require a longer period to complete; thus giving the Company more long-term stable revenue and cash flows. One example is the 5-year CUEL deal worth US$50 million commencing FY 2009 and ending in FY 2013.

3) Better project execution with its own vessels would mean greater control over scheduling and workflow, thus leading to better efficiencies. Net margins could presumably be higher than 16% which I assumed, and as the recession wears on, deflation may also cause the prices of goods and services to drop in the years to come, making costs lower for companies.

4) Opportunities to leverage on offshore drilling by seizing the right chance to construct the Equatorial Driller vessel. Note that this vessel was originally scheduled for construction by FY 2010 but due to tight financing and unavailability of credit, it was shelved. With construction costs coming down, Swiber may be able to deploy this vessel some time past FY 2010 down the road, which may significantly add a new revenue stream as the benefits of the Driller had already been explained in a prior press release.

5) Opportunities in wind energy contract wins as their vessels can also be used for that (in Swiber's latest FY 2008 presentation slides). On your point about possible idle time causing high fixed costs to erode all of Swiber's margins, I think the fact that the vessels are deployable not just for O&G EPCIC but also for wind energy (wind farms) makes it more versatile than previously believed; and can help the company to cushion the impact from possible idle vessels.

6) More strategic tie-ups with sharing of assets by mutual partners. While I understand that the "sharing of assets" does not neccesarily result in the assets being off-balance sheet for Swiber, it could nevertheless mean that their potential capex is reduced as they leverage on the strength of their business partners. Partnering would also help to expand the scope of work they can provide and help them garner more complex contracts which may require various vessels or structures with differing functions. Of course, the X:X profit-sharing ratio means Swiber will not fully accrue the benefits of these projects, but winning them in the first place would be a first of sorts, and can pave the way for continued customer retention.

One last thing - the Annual Report you are looking at is probably the FY 2007 one. Why don't you wait about a month for the FY 2008 one to be published ? It would allow you to make a better decision as it is more current.

Regards,
Musicwhiz

floatingrok said...
This comment has been removed by the author.
floatingrok said...

Woo, such a long reply, impressive!

Regarding the orderbook, if you look at the oderbook of shipyards at around 3 to 4 years, I won't say the orderbook is fantastic. Do understand Swiber is different from shipyards, thus, if this orderbook size is due to the nature of projects and normally oil majors are not likely award a porject at a long lead time, then i would be more comfortable. It would be good if we have some idea of the size of its peers.

Regarding receivables, I am referring to the provision of US$4m debts in FY08. According to the reply to SGX, if my understanding is right, this was due to the no collection from one customer (not a major customer) for one project completed in 2007. The total amount is estimated at around US$50m...Swiber has taken provisions for that already, logically, I would think the worst scenario.., particularly in this market environment.

Regarding your point 2, totally agree that a larger fleet will give the bidder more credit and help it secure larger projects. Just one question, do you mean 34 vessels can cater for US$700m orderbook PER YEAR? If so, is it reasonable to think that some vessels could be idle this year, if the revenue is less than US$700m in FY09? Personally don't think it is likely to hit such a revenue level.

Do agree with you that the growth story of Swiber is fantastic. But, I am still concerned if they can survive if oil price unfortunately remains at US$50-60 for two years ( In the latest oil report, EIA's forecast is US$42 in 2009 and US$56 next year, if my memory is right). Not to say the company won't be able to get any orders, the question is whether the operating cashflow from the depressed orderbook can sufficiently cover its debt repayments and financial lease obligations? In other words, what is the breakeven revenue per year, assuming the margin is the same as before, or a slightly higher margin since they have more owned vessels?

Hope this discussion could make the issue clearer, since we are putting our own money in.

BTW, the same as you, I am also vested in China Fishery. Stable and defensive business, strong market position, and a definite benefitiary of the coming super inflation, when the financial system is running normally.