Friday, July 24, 2009

Ezra – Diversification into Deepwater Subsea Operations

Ezra had announced, on July 16, 2009, its next lap growth strategy which involves growing organically through the provision of deepwater subsea services to existing and new customers. This division will be headed by Mr. Paul McKim, a veteran with 36 years of experience in the oil and gas industry. This expansion plan is based on the asset profile which Ezra had committed to date, including the 2 new MFSV and a new heavy lift construction vessel coming on board by FY 2010. Detailed slides were provided to enable readers and shareholders to better understand the wider range of services being provided by this new division, which is an extension of their current Energy Services Division. This new growth strategy and thrust is supposed to take place over the next 5 years, and benefits are said to accrue from 2H FY 2010 onwards.

An analysis of the slides given (which are quite technical unless you are working on the ground in the oil and gas industry) as well as the press release suggest that this is a new strategic direction which Ezra is heading for; and is different from what the Company has previously used to grow from 2003 (time of listing) till the present. To recap, Ezra had been growing their vessel fleet aggressively from IPO till now, by using a mixture of share placements (equity), floating their subsidiary on Oslo Bors (EOC, now their 48.9%-owned associate company), debt (bank financing over the years) as well as sale-and-leaseback arrangements. These methods, for better or for worse, have enabled the Company to grow their revenue base tremendously, and core earnings have also correspondingly climbed over the years. Of late, however, this strategy has been crimped in part because of the global financial crisis, which has led to debt financing nearly drying up, as well as dehydrating the availability of easy funds from the stock market through institutional placements. Their strategy has also weighed heavily on their Balance Sheet as gearing has been consistently high and was expected to go over 1x if not for the cancellation of their 3 MFSV (2 with Karmsund and 1 with Keppel Singmarine). As a result, cracks have been spotted with Ezra’s old business growth model and it was time for Management to plan something alternative which would continue to spur growth.

The proposed new strategy takes into account trends in the subsea market, which is the “hottest” sub-segment within the oil and gas industry as proposed capex for this segment will increase as demand for new wells is expected to increase by 80% till 2012. Douglas Westwood has also forecast that global spending on subsea equipment, drilling and completion is expected to exceed US$80 billion over 2009-2013. In a sense, one can argue that Ezra had been positioning themselves for this new trend as they had placed orders for MFSV which are able to carry out a multitude of functions, which include well maintenance and de-commissioning, amongst others. The fact that their fleet is young and deepwater-enabled also stands them in good stead to grow organically, and their built-up track record for large multi-national clients such as ConocoPhilips and Shell also mean that they should have the support they require to embark on this ambitious growth frontier.

The important thing to note is that Ezra is not planning to achieve this growth through more leveraging; but instead will use its existing asset base to cater to a new market segment. Its committed capex of US$350 million remains the same, and includes the new vessels coming on board as well as to build up their Vietnam yards (HCMC and Vung Tau) and to setup a training centre. The key here is whether such services being offered can complement their existing services to achieve good synergy and thus lead to better margins; and right now that is still a question mark. From studying the Company’s current business model, offshore chartering offers the best margins and this is where the bulk of Ezra’s earnings come from. Fabrication and construction have gross margins of only about 13% and is an integral part of the entire value-added chain of services which the Group plans to provide; though growth from this particular segment (involving their Vietnam yards) would probably be steady due to the low margins and current capacity constraints (their Vung Tau yard is still not operational).

One could then safely conjecture that assuming Ezra is able to package its services in a value-added fashion to customers, they could become Asia’s first Company to offer a “one-stop shop” for oil and gas majors. This would not only boost their chances of clinching contracts, but would also imply that higher value contracts would be awarded as well. With increased economies of scale as a result of the merging and integration of Ezra’s three divisions, gross margins would also be improved and the Group would have better pricing power as opposed to its competitors who can only offer one specialized service. This is the main thrust of the announcement and the part which I feel Ezra’s Management Team is hoping to leverage on to grow the Company.

The full effects of this organic growth will only be felt from 2H FY 2010 onwards, and Management has given guidance for revenue (not profit) growth of 50-60% by 2015, which basically translates into average growth of 10% per annum for revenues. Assuming margins can be maintained or even improved upon, this would also translate into a conservative earnings growth of about 5-10% per annum. Most importantly, the fact that the Group has no need for further funding and financing would mean that they can start to generate more free cash flows, something which it has not been doing for the past few financial years as it embarked on its aggressive asset expansion exercise. The last dividend pay out was for 1H FY 2008 when it successfully listed EOC on Oslo Bors, paying a special dividend of 5 cents per share. Since then, due to cash flow constraints, the Group has not been paying any dividends. It is hoped that once their new operations kick in and begin to generate healthy operating cash flows for the Group, the dividends can also start to flow in from late FY 2010 through FY 2015.

Other aspects of the Group’s operations have been addressed in a DBS Vicker’s research report on Ezra dated July 17, 2009, of which I will pinpoint key issues and give my views on:-

1) Fleet Management Service Provision -> This is an opportunistic move, and if done properly by the Group could enhance current earnings and also enhance the total package offered to customers. The chartering of AHTS on a bareboat basis, however, are subject to the fluctuations in spot rates, and thus profitability is difficult to determine. If Ezra is able to charter these vessels, crew them and lock in a favourable long-term rate, then this would be an added boost; but I share the analyst’s view that this is more a possible bonus than an event which will crystallize with certainty.

2) Lewek Arunothai (Gas FPSO) -> The FPSO has already started gas exportation with PTTEP in June 2009 and billing should commence very soon, which means EOC would be able to recognize revenues starting from 4Q FY 2009. These revenues (and associated profits) will cascade down to Ezra Group through associates’ earnings and will add a small boost to the final FY 2009 numbers.

Another issue which was barely touched on but which has some importance is the second FPSO for Vietnam in which EOC is the front-runner. Due to EOC’s high gearing, it will be unlikely to secure debt financing to fund this massive project and so this will have to be put on hold at the moment.

The pre-emptive fund raising at S$1.185 hints that Ezra’s Management are on the lookout for opportunities to purchase either assets or companies on the cheap, and this placement was to boost their “war chest”. Currently, with limited info on the probable use of the funds (info may be proprietary and hence price-sensitive), we can only assume that the monies raised would be put to good and efficient use.

Ezra’s FY 2009 results will be due in mid-October 2009, so I am unlikely to do any further write-ups on the Company in the meantime unless more significant corporate news or events are announced.

8 comments:

low cost auto insurance said...

The resources are out there. Occidental just discovered a new, big field of oil and gas in California.

musicwhiz said...

Hi there,

Thanks for the tip. I guess you are trying to tell me that there will be continual work for O&G majors, which will then spill down to Ezra ?

Regards,
Musicwhiz

Akatsuki said...

Hi Mz, long time no chat.

Are you happy;Now that your companies' share price are rocketing upwards.

How should a value investor feel during times like this?

Just a question that might not be related to this write up hehe..

musicwhiz said...

Hello Akatsuki,

Yep, it's been some time, hope you are doing fine.

Well actually I feel neither happy nor sad, for my aim in investing is simply to get a decent return on investment in the LONG-TERM, so short-term fluctuations in market price do not really guarantee that I can sustain this over the long-haul. I am more concerned that the business fundamentals of my companies remain sound to tide me through 2011-2012.

A value investor should feel no emotion actually. He should continue to be patient, objective and rational and allocate capital when he sees a good chance of a decent return. I have been searching for ways to allocate capital since March 2009 but thus far have not been able to effectively. Perhaps when 2Q 2009 results are out for companies, I can consider doing so.

Cheers,
Musicwhiz

Akatsuki said...

Ya same here. But could it be that our expectations of a"decent" return was influence by this crisis therefore subjecting us to expect more of a return or margin of safety as compared to normal times? Sry, since it's very hard to chat with u on lp's blog i have to ask your advise here :]

-Akat

musicwhiz said...

Hi Akatsuki,

Hey you could be right ! After all, human beings tend to use mental conditioning and anchoring and factor this into their expectations. I can't say I am totally immune but I have learnt to temper my expectations over the years - there is no surefire way to get rich !

By the way, you can always email me at musicwhiz55@gmail.com for a further discussion if you wish.

Regards,
Musicwhiz

Shingo T said...

Appreciate your writeup on Ezra. Your effort save us readers alot of time.

musicwhiz said...

Hi Shingo T,

It's my pleasure to provide an update on Ezra, though this is just solely my opinion. Anyhow, I will be concentrating more of my analysis on Tat Hong, after their issuance of S$65M worth of RCPS today !

Regards,
Musicwhiz