Wednesday, April 15, 2009

Ezra – 1H FY 2009 Analysis and Review Part 1

Ezra released their 1H FY 2009 results on April 8, 2009. Below is an analysis of their results as well as a discussion of their prospects. Since this analysis is long (for a reason to be explained in a later section), I shall split it into two parts. Part 1 shall deal with the numbers-heavy portion which includes the Profit and Loss Statement, Balance Sheet and Cash Flow Statement (supported by attached spreadsheets). Part 2 talks more on the qualitative aspects for Ezra, prospects and catalysts for growth in the near future and also comments on other aspects of the Company which I feel are worth mentioning. Be sure to check back in due course for Part 2 of the analysis.

Profit and Loss Analysis

As can be seen from the table above, Ezra’s sales mix has seen quite a change from 1H FY 2008 as it has added a new Energy Services Division. This has contributed US$46.1 million in sales for 1H FY 2009, providing a strong boost to total revenues which have increased 87% year-on-year. However, due to the change in sales mix with more revenues skewed towards Energy Services for 1H FY 2009 (26% compared to 1H FY 2008 4%), as well as the indicative gross margins of just 13% for Energy Services Division, this has dragged down the entire gross margin for the Group from 38% in 1H FY 2008 to just 29% for 1H FY 2009. Moving forward, the Group is prepared to offer an integrated services model to buoy profits by offering a one-stop solution service for customers, thereby hopefully improving on gross margins across all its divisions.

Financial expenses (i.e. interest expenses) increased 71% for 2Q 2009 compared to 2Q 2008 due to the increase in drawdown of bank loans and bills payable in order to fund capital expenditure for fixed assets. Though no vessel was reported to be delivered in 2Q 2009 (the last reported delivery was Lewek Plover in 1Q 2009, specifically November 2008), I believe that the Group needs to draw down on their credit facilities in order to pay equipment suppliers and the vessel builders on progressive payments. These fixed assets are then recognized on a progressive basis through capitalization in the Balance Sheet. Administrative Expenses as a percentage of sales dropped from 28.5% for FY 2008 to 8.5% for 1H FY 2009, mainly due to the absence of a one-off provision for staff made in FY 2008.

Net profit for 2Q 2009 increased a respectable 21% due to the inclusion of the new vessel Lewek Plover, and this is before accounting for the earnings which will be accrued from the start of gas production from Lewek Arunothai which belongs to EOC. Earnings are expected to flow through share of profits of associated company once this happens, and boost this figure further. Net margin for 2Q 2009 was 23.7% compared to 25.5% for 2Q 2008, mainly due to the change in sales mix and the higher financial expenses. If the exceptional gain from EOC is stripped out of 1H FY 2008 results, the recurrent PATMI is US$15.0 million, which means there was a 61% increase in PATMI from 1H FY 2008 to 1H FY 2009.

Balance Sheet Analysis

The one point I would like to highlight immediately in the Balance Sheet is the increase in trade receivables of US$45 million, which is a worrying sign. Ezra’s cash conversion cycle has also increased from 100 days to 130 days, while their current ratio has fallen from 1.5 as at FY 2008 to 1.1 as at 1H FY 2009. All these point to the fact that collections are getting slower from customers and that receivables are building up instead of being converted to valuable cash – an unhealthy sign at any time but more so during this severe recession. The drop in current ratio is attributable to the drop in cash and cash equivalents while bills payable (a short-term liability) increased significantly. Fixed assets also increased by 59% to US$290.2K as a result of the delivery of more vessels, as well as the capitalization of construction costs for vessels.

The above table illustrates the debt profile for Ezra and shows a disturbing trend of increased short and long-term loans, and reflects that total bank loans had increased by 33% in order to finance the newbuilds. According to Ezra, net debt to equity increased from 11.4% as at FY 2008 to 47.1% as at 1H FY 2009, which is disappointing as it shows that they had not managed to generate more cash than they are borrowing. More will be discussed on this under Cash Flow Statement Analysis.

According to the debt breakdown, bills payable was the most common method used to finance purchase of fixed assets, increasing 255% over the period being compared. Long-term loans were also drawn down while short-term bank loans decreased probably due to some pay offs. A comment left by an investor Donmihaihai has questioned me about the increase in fixed assets as well as bills payable and the fact that the numbers do not tie. The table shows an illustration as well as a journal entry on why this could be so. The “missing” US$49.5 million worth of increase in fixed assets which were not explained by the cash outflow could be due to a direct journal entry by debiting Fixed Assets (Vessels and Equipment for example), with the corresponding credit going to Bills Payable directly. This is a perfectly legitimate accounting entry where cash does NOT flow to the Group but is instead remitted directly from the bank to the supplier through an instruction or standing order.

Of course, one can argue that about US$12 million worth of bills payable is still “unaccounted” for after I passed the journal entry. What I am trying to say (and show) is that a Company can employ a variety of methods to properly account for their assets and liabilities with no cash effect, thus it would not be possible to trace every single number in the financials unless you knew the exact transactions involved and also could take a look at Notes To The Accounts (which are not prepared for unaudited financials). Most of the time, no attempt is made by myself to rigorously tie all the numbers back to the financials, unless of course there was suspicion of possible fraud (which would then entail calling in CAD and the forensic auditors). Furthermore, fixed asset additions may also be made from assets under construction or re-classified from assets held for sale, and not necessarily through direct cash injections. Without knowing the exact journal entries involved in the consolidation, it would not be possible to tell. I hope this answers that particular comment which was left on my blog even before I undertook this analysis.

The table above shows that the net debt to equity increased quite significantly at first glance, but a quick check on total debt to equity shows that the increase was not so severe after all. Because of the high cash position and lower debt level as at FY 2008, the net debt was much lower and thus the net debt/equity ratio was just 14.4% (it is 11.4% as stated in Ezra’s presentation slides). Bank loan movement would imply that there was a net cash inflow of US$1.5 million, but it was shown in the cash flow statement as a net outflow of US$3.3 million for repayment of bank loans. The problem here is that the company shows the figure as a net figure of bank loans raised and repaid; thus I will be requesting the Company to disclose these 2 numbers separately in future for easy computation.

Cash Flow Statement Analysis

If there was quite a bit of mention of cash in the previous section, my apologies as there is a significant overlap when it comes to comparing Balance Sheet balances and cash flows. This is due to the indirect method of cash flow statement preparation which takes into account movements in working capital as well as movements in balances as stated in the Balance Sheet.

Ezra disappointed by showing a net cash inflow of only US$259K for 6 months ended Feb 28, 2009 as compared to a much healthier inflow of US$6.9 million for 6 months ended Feb 29, 2008. Much of this can be attributed to the US$45 million increase in trade receivables, as well as a lower amount due from associated company as well as higher interest and taxes paid. The key to resolving this issue would be quicker collections from their customers, most of whom are oil majors and national oil companies, in order to alleviate the cash flow crunch and improve their operating cash inflows.

As for investing cash flows, most of this was dominated by cash outflows for purchase of fixed assets and assets held for sale. US$9.45 million was spent on purchase of other investment, which are unquoted preference shares with a dividend yield. Since this investment has a dividend yield and consists of preference shares, it is positive as it means more future secured cash inflows. These outflows were offset by the proceeds of disposal of assets held for sale as well as dividend from joint venture company. Note that although share of profits from joint venture company Casadilla dropped drastically for 1H FY 2009 due to the loss of Liftboat Titan 1, there was a refund of monies relating to this loss through insurance payout and we should see this inflow being reflected in 3Q 2009. Note too that the deposits of NOK 184 million paid to Karmsund have been refunded in 3Q 2009, so this should significantly improve cash flows even though it is a one-off item. Don’t forget that capex pressures are also eased as a result of the cancellation of the 2 MFSVs which were supposed to be constructed by Karmsund before they went bankrupt.

As for financing cash flows, as explained earlier, proceeds from bills payable was offset by repayment of bank loans. The table shows that total debt actually increased by about US$64.3 million but this is hardly even reflected in the cash flow statement which shows a net cash inflow of US$961K. A possible explanation put forward might be that the loans drawn down are immediately used to pay for equipment and assets, thereby there was no cash effect at all which can be reflected in the Cash Flow Statement. Readers are free to suggest other possible reasons for this “discrepancy”.

The result of all this is a net cash outflow of US$57.5 million. Coupled with exchange losses on fixed deposits denominated in NOK and GBP, the total cash outflow effect is about US$70 million. Unless Ezra improves on their cash management by 2H FY 2009, otherwise I would say this is a very disturbing trend and does not make me feel very comfortable as a shareholder, even though their recent capex reduction plans have put me more at ease.

No dividend was declared for 1H FY 2009 and looking at the state of the Balance Sheet and Cash Flow Statement, it is no wonder that they cannot afford to pay out any cash. It would not be too far-fetched to say that unless their cash inflows improve significantly in 2H FY 2009, there would probably be no final dividend as well (similar to the situation for 2H FY 2008 where no final dividend was declared). Such is the price to pay for investing in companies which require high capex, and in future analyses of companies to invest in I will take this into account.

Please stay tuned for Part 2 of the analysis, which should be ready in about a week’s time.


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