Thursday, April 23, 2009

Ezra – 1H FY 2009 Analysis and Review Part 2

Part 2 of my analysis focuses more on the Group’s prospects, plans and strategies and how these can sustain the business in the years to come. My investing style is such that analysis of numbers and ratios only forms one part of a holistic review of the business, as I believe numbers alone do not tell the whole story about a Company and thus cannot solely be relied upon for margin of safety with respect to a potential investment. Rather, a company is the sum of its quantitative and qualitative aspects, hence one should analyze these aspects to the best of his ability in order to come up with a reasonable conclusion as to the merits and demerits of an investment.

Fleet Expansion Plans and Updates

Total current fleet capacity for Ezra is 246,600 bhp (brake-horsepower). The aim is for the Group to reach a total bhp of 318,600 by FY 2010, representing an increase of 29.2%. The good news is that in Part 1, I mentioned that the capex requirements for 2 MFSV from Karmsund have been eased. Thus, this would indicate better gearing and hopefully more healthy cash inflows in future periods. 2 MFSV and 2 liftboats are scheduled to enter Ezra’s fleet by FY 2010, and for FY 2011, there is one more planned MFSV (this should refer to the Keppel Singmarine MSFV which is currently under review). No formal announcement has yet been made on Ezra’s part about the proposed cancellation of this MFSV, though it was reported by Keppel Corp that Lewek Shipping (a subsidiary of Ezra) was negotiating the cancellation of the contract, forfeiting the deposit paid.

The capex requirement for the vessels is US$275 million, which should be obtained from the drawdown of more bank lines and bills payable. From prior announcements, Ezra has already obtained the necessary funding and can draw down on these credit lines when required. Ezra’s relationship with their bankers remain healthy as their vessels are pegged to long-term charters, thus cash flow visibility is strong; giving the banks no incentive to “pull the rug” from under them. With Lewek Arunothai set to begin gas production in 3Q 2009, this should also reduce EOC’s high gearing.

Another US$75 million has been earmarked for their Vietnam Yard expansion and Energy Services Department. I suspect this is for their new yard in Vung Tau whereby the land has already been obtained but for which construction has yet to commence. Their current yard in Ho Chi Minh (District 2) had already clinched 3 contracts with a total orderbook of US$214 million, of which 68% (about US$145.5 million) is still outstanding and should be spread out between FY 2009 and FY 2010. With a gross margin of 20%, this should translate into gross profit of US$29 million spread out over the two years. The Group is also focusing on improving their suite of products for Energy Services and to integrate this into their offering so as to improve margins and snare larger customer contracts. Currently, Energy Services division is the up and coming new division of Ezra but the gross margins are noticeably poorer at 13% compared to 40% for Offshore and 20% for Marine.

Territorial Expansion Plans and Oil Demand

Ezra currently is targeting territories such as South America, Africa, North Sea and China as potential areas of expansion even amid this severe crisis and recession. Though the Energy Agency has forecast the lowest energy demand in 5 years as a result of the global downturn, oil majors remain committed to pump in capex for oil and gas E&P activities as an under-investment may mean trouble once the economy recovers and demand surges. I am a believer that oil prices will continue to trend upwards once the recession eases due to the lack of significant capex being ploughed into E&P, as a few major projects have been derailed due to lack of financing. According to the presentation slides, oil majors such as Petrobras are going to invest in E&P until 2013, while Africa holds the majority of global deepwater O&G reserves. These have yet to be tapped and represent good potential areas where Ezra can offer their services as their fleet is tipped to be 83% deepwater-capable. I view this as a potential strong earnings contributor in future as shallow water reserves dry up and oil majors need to drill deeper in order to extract. Also, I do not believe oil is going to run out within 50 years, thus the Group can still continue to do well in the medium-term due to this consistent demand.

Prospect – EOC’s Second FPSO Contract

EOC is bidding for another FPSO contract in Vietnam and it has been reported that they are the surprising front-runners for this contract. Unfortunately, there has been no progress made on this thus far as EOC has been unable to obtain appropriate financing for this huge project (the capital outlay for such an FPSO is very large). Hence, this project is under negotiation still at the moment as both parties hammer out the technical details of the FPSO. If EOC manages to clinch this contract, it would significantly boost earnings and cash flows, but on the flip side it will also increase gearing in the near-term.

Prospect – Recurring Charter Contracts

Ezra recently reported clinching US$47 million worth of new and renewal contracts for their vessels, which shows strong demand for these vessels. Previously, some comments on Ezra had highlighted the dangers of vessels laying idle as running costs are significant and depreciation on these vessels can be very high. Some of the vessels are also on operating leases through sale and leaseback arrangements and thus have to make payments to their lessors regardless of whether the vessels are being deployed on contracts. Hence, it is imperative that the Group snare back to back contracts as far as possible (except for mandatory dry-docking) so that their assets are put to productive use. Any idle time would represent a significant drag on cash flows and earnings, and this is an inherent risk in their business model. But with the O&G segment remaining buoyant even during this difficult time, I am confident the Group can continue to achieve high vessel utilization rates.

Final Dividend for FY 2009 ?

Due to the massive capex and funding required for its new deep-water capable vessels, it is no surprise that the Group has not declared either a final dividend for FY 2008 or an interim dividend for 1H FY 2009. The last dividend declared was a special dividend of 5 cents per share (post-split) for 1H FY 2008, for which I had received. That was due to the sale and subsequent listing of 51.1% of EOC on Oslo Bourse, thus flooding the Group with cash.

Looking at the state of their cash flow statement for the past few quarters, Management has to remain prudent in their gearing and not over-leverage for fear of incurring high interest charges and crimping their cash flows. The increase in receivable collection days from 100 to 130 days is also a sign of poor receivables management, which is surprising considering about 80% of their customers are oil majors or national oil companies.

All I can conclude is that the Group had better buck up in terms of improving its collection cycle, and also to demand payment faster from customers for work done. Notwithstanding the financial crisis, Ezra should tighten its credit policy and not let its collection cycle deteriorate further.

Because of the factors stated above, I will not be expecting any final dividend from the Group for FY 2009 when they report their results in October 2009; unless they show a significantly improved cash position for 3Q 2009. Even so, it may be better for Management to hoard more cash during tough times and only start paying dividends once things improve.


Jeremy Ow Tai Pang said...

Hi, MW. Thanks for sharing with us your insights on Ezra. I do hope that Ezra can improve on it's collection of payments cycle. Hopefully, you can get to receive some dividends from Ezra this year.

musicwhiz said...

Hello Jeremy,

From what I understand from emailing the IR of Ezra, the poorer cash collection cycle is due to the new Energy Services division which grants longer credit terms to its customers due to the nature of work. For Offshore division, the receivables days are generally better.

To me, it seems that Energy Services is not such a good division as gross margins are poor and collection is also long. However, as Ezra is trying to package holistic solutions for its customers, I guess this is a necessary evil to ensure a complete and competitive "package" is offered to entice the customer to sign on larger contracts and to maintain a long-term relationship.