Sunday, October 18, 2009

Ezra – FY2009 Financial Analysis and Review Part 1

Ezra released their FY 2009 financial statements on October 15, 2009 and this is my analytical review and take on it, in the same vein as I had done for previous analyses. Note that while I had tried to keep the analysis short and within 1 post, I realized this was not really possible if I were to really do an in-depth analysis, as the Company had grown much larger and more complex since I purchased it 4 years ago. The scale and scope of their operations has expanded significantly and they are a different animal now. The analysis will be split into the usual parts for Income Statement, Balance Sheet and Cash Flow Statement. There will also be discussions on their fleet, shipyard(s), EOC, plans for the future, as well as the latest announcement on the “Ice Maiden”.

Income Statement Analysis

4Q 2009 revenues actually fell 22% from a year back, from US$119.2 million to US$93.5 million; but no explanation was forthcoming from Management as to the reasons for this drop. They concentrated mainly on commenting on FY 2009 revenue, which was up a respectable 23% from US$268.3 million to US$329.4 million. The reasons were due to full-year recognitions of Lewek Kestrel and Lewek Kea for FY 2009 compared to just 2-8 months for FY 2008. There was also 10 months contribution of operations from 1 AHTS, Lewek Plover, which added to the increased revenues for offshore Support Services Division. Marine Services division saw a rise in revenues due to higher fabrication work done as a result of the 3 contracts awarded to Saigon Shipyard, and they are currently working at full capacity. The new Energy Services Division (soon to be incorporated into the Deepwater Subsea Division) saw a rise in revenues of US$17 million, but unfortunately had the lowest gross margins of all the 3 divisions (13%).

Other operating income was not totally comparable, as 4Q 2009 saw an exchange gain but for FY 2009, there were losses from cancellation of shipbuilding contracts which dragged down profits. For FY 2008, the exceptional gain was relating to Ezra’s divestment of EOC by listing it on Oslo Bors. If we compare purely on gross margins, 4Q 2009 saw a big jump in margins from 23.4% to 29.2%, probably due to the change in sales mix. For FY 2009, gross margins were 30.7%, slightly higher than FY 2008’s 29.7%. Margins for marine services jumped from 18% to 24% while for energy services, they remain at 13%, and this probably contributed to the slight improvement in blended gross margins.

Financial expenses (being interest on bank loans and borrowings) are worrying as they increased 34% year on year from US$6.6 million to US$8.8 million, and Ezra has been piling on more debt to finance their fleet expansion as well as to spend on their yard. This will be commented on more in the Balance Sheet and Cash Flow Statement. The main reason for the better performance for 4Q 2009 compared to 4Q 2008 was due to better gross margins, an exchange gain instead of loss, lower admin expenses due to absence of one-off provision for staff costs, as well as higher share of profit from JV. Ezra’s press release mentioned a rise in core net attributable profit by 80% to US$70.2 million, and their presentation slides show a beautiful chart with CAGR 66% for revenue over 6 years, and CAGR 63% for recurrent PATMI over the same 6 years. But the cost of this is higher dilution for shareholders, higher debt and higher risks as well. I shall explain in the later sections.

Balance Sheet Review

Ezra’s Group Balance Sheet actually has a lot more things to be pointed out than their Income Statement; yet somehow press releases and analysts always love to focus more on the Income Statement than Balance Sheet. A Balance Sheet shows the health of the business and is as important (if not more) than the Profit and Loss Statement.

Fixed assets had risen by a good deal due to Ezra’s fleet expansion plan, and everything is going as per scheduled, with 2 MFSVs coming on stream in FY 2010 and FY 2011 and another 4 AHTS as well. Another notable is that AFS investments had increased more than 100% due to the sharp rebound in the stock market, while the long-term receivable from EOC still stands at US$32.8 million. With EOC’s gearing being so high (at 2x+), it will be tough for Ezra to recall this loan, so this is a potential red flag.

Looking under Current Assets, trade receivables had increased by more than 100% from US$87 million to US$182.7 million, and is quite alarming if you compare it against the 23% increase in revenues. It was mentioned that Energy Services gave longer credit terms to customers and this is the division which Ezra plans to build, so this would have increased their receivables days significantly and resulted in their Trade Receivables ballooning in relation to their increase in revenues. I would label this as a red flag as well because the potential for bad debts is much higher with the loosening of credit terms. Though one can see that cash and bank balances remained high at US$161 million (FD + Cash and bank balances), as compared to FY 2008’s US$153 million, most of it was generated from Financing Activities (more under Cash Flow Analysis).

Trade Payables, on the other hand, dropped by about 50% which implied faster payments to suppliers; while bills payable to banks increased by about 100% as Ezra borrowed more from banks to finance higher volume of activity. Short-term bank term loans also increased from US$81.8 million to US$96 million while long-term bank loans more than doubled from US$52.2 million to US$128 million. All these point to worrying signs that debt is growing quickly and though the Company maintains that gearing has risen from just 0.5x to 0.6x, one must look at it from the perspective that the equity base keeps increasing, thus the numerator when divided by the denominator results in a nominally small increase in gearing ratio. The reality is that debt is growing at a fast clip and this is very risky as expansion plans may not pan out as expected. Ezra’s business model is capital-intensive by nature and their Management team is also very dynamic and forward-looking in trying to identify future growth drivers and taking the Company to a new level. Though this may seem like a good thing for shareholders, it entails significant risks and leverage and is an unavoidable aspect of Ezra’s business model. It is not easy to feel comfortable with it due to the high gearing and the frequent fund-raising efforts from the secondary market.

Cash Flow Statement Review

The cash flow statement is worrying because it demonstrates that Ezra is growing purely based on cash from financing activities (i.e. bank loans and share issuance) and not by recycling its operating (working) capital. It was originally my hope as a shareholder just as recently as one year back that Ezra would be able to finally reduce its capex commitments and generate decent and consistent positive operating cash flows, meaning it would have entered the “mature” phase of the product life cycle and would have excess cash (net cash) with which to use for M&A, distressed asset purchases or for paying out as dividends. Instead, apparently I was quite wrong as the Cash Flow Statement demonstrates. The dividend yield is also very pathetic at just 0.74% (1.5 Singapore cents) based on closing price of S$2.02 on October 16, 2009, and I was surprised they did not just retain the cash for expansion as they seem to have many more capex commitments in future.

Operating cash flows were a negative US$26.2 million, mainly due to much higher trade receivables amounts and also lower payables, coupled with lower other payables and accruals. Though operating profit before working capital changes was higher for FY 2009 at US$81.7 million as compared to FY 2008’s US$47.8 million, there was more cash spent on funding customers and paying creditors more promptly, which resulted in negative operating cash flows. Capex remained high as US$190 million was used to purchase fixed assets and assets held for sale, and this was only partially offset by a one-off refund from termination of shipbuilding contracts, or else net cash used for investing activities could have hit US$162 million. This alone, coupled with a net cash outflow of US$26.2 million for operating activities, added up to nearly US$189 million of cash outflows.

It’s very telling when the bulk of cash generated for a company’s full-year operations comes mainly from Financing Activities, but for Ezra it could have been more stark. Bills payable yielded US$24.7 million, while additional bank loans brought in US$89 million and the July 2009 share issuance of 78 million new shares at S$1.185 generated proceeds of US$62.7 million. These 3 activities alone helped to bring in much-needed cash which operating activities could not provide sufficient amounts of, and has, in the process, increased gearing and diluted shareholders. Depending on how you look at it, I would say this is not a very good trade-off.

Capital Expenditure Plans

As of today, Ezra has not announced any further plans for capital expenditure in order to expand its fleet. Thus far, the 2 MFSV and 4 AHTS which are coming on board are proceeding smoothly and there have been no reported delays in the respective shipyards (unlike what happened with Karmsund back in 2008). From the presentation slides Page 10, committed capex as at Aug 2009 was US$190 million, and this is roughly the size of their current cash balance as at August 31, 2009. Estimated spending in the next 2 years amounts to another US$190 million, and I would think this does not include ad-hoc expenditures on accessories such as ROVs (recently bought at US$23 million), and other minor equipment. This would also probably not take into account the new Ice Maiden project in which Ezra announced that they had acquired an ice-class shipset for a new vessel which could operate in harsh Arctic conditions.

From my recent attendance at the EGM and speaking with Management, I do get the feel that current operating cash inflows would probably not be sufficient to sustain the projected level of growth; though Management did not allude to anything. But the fact was that the EGM was for the renewal of the share issue mandate and at a discount too; so that may be a hint of what is to come as the company goes on another growth trajectory. I suspect the Company may be planning either another placement or convertible bond issue to shore up their cash position, and this could be highly dilutive to shareholders or increase their gearing further.

Part 2 shall discuss Ezra’s new division, ROV additions, fleet management contract and also the new Ice Maiden and I will also provide some clues and insights about how I feel about the company moving forward; and the actions I took based on those feelings. Watch out for Part 2 to be posted in 2-3 days time.

8 comments:

simon said...

maybe it's time for you to sell. u made a lot of money out of it anyway. =)

mm said...

MW,

Its been a while since I posted on your website.

keep up the good work.

I always have a MAJOR concern when I look at companies with spiking up in trade receivables and reduction in trade payables.

That means that they are not negotiating hard enough for their payments to suppliers, or they are being TOO LAX in their credit terms with their customers, which is a bad thing cos' it impacts their operating cash flow. Too lax could point to Ezra having issues with their customers credit or ability to pay... and this could potentially be a problem.

I don't like what I see, esp. on Y the revenue is down with no explanation.

Just my small tiny little 2 cts.

Cheers,
mm

Musicwhiz said...

Hi Simon,

Actually I did do a partial divestment of Ezra, and was going to detail it in Part 2 but I guess you beat me to it by asking the question first. I am keeping the rest of my stake in Ezra as pure profits.

More details will be released on the reasons and rationale for partial divestment in Part 2!

Thanks,
Musicwhiz

Musicwhiz said...

Hi MM !

Nice to see you commenting again, and thanks for visiting my blog.

I actually agree with you on all those points, which I why I flagged them out in my analysis as "red flags". In addition, Management did not give a satisfactory explanation for the drop in revenues for 4Q 2009 compared to 4Q 2008, and that is another concern.

Anyhow, I have divested part of my stake in Ezra as a result of the culmination of these red flags, as well as some additional reasons which I will detail in Part 2 of my analysis.

Thanks for the advice.

Regards,
Musicwhiz

Heng Ee said...

Good analysis.

Actually, the signs were there in EZRA's previous reporting.

I sold off my EZRA holdings then, making a small profit.

To my regrets, EZRA jumped from S$1.2+ to S$1.90++ !
It goes to show sometimes, it pays to be patience :)

I like your blog postings. Keep it up !

Musicwhiz said...

Hi Heng Ee,

I guess you're right - previous quarterly results had already shown up this problem, but perhaps I was short-sighted and did not spot it. That's something I can improve on as well. Thanks for your comments and thanks too for visiting!

Regards,
Musicwhiz

Singapore Stock Picker said...

Hey, have you actually thought of selling only when the market reflates further? because if you sell there is a lot of free cash sitting out which might be placed to better use IMO.

Also, I see upside to this stock as the increase in the broader market should drag it up another 10-20%.

I agree with you that Ezra is maybe moving away from the chartering aspects and to fleet expansion. But I think any pending collapse of the stock will be much deeper into the term of the bonds.

Also, have you seen the increase in trade receivables days in relation to the industry average?

Have you also figured the impact of the acquisition of the "Ice Maided" project.

As for project execution, I would have to say that the problem comes from extending the past into the future. that they had problems in the past does not necessary mean they will have difficulty carrying out future FPSO conversions etc.

Nonetheless, my trivial concern about the stock is whether the company is in an expansionary phase due to the youthfulness of Lionel Lee. I'm sure you have seen him and hears how he think etc. Maybe that is a slight concern.

cheers

Musicwhiz said...

Hi Singapore Stock Picker,

I sold based on fundamentals and also because I realize there were errors in the way I analyzed the company, not because I am trying to catch the best market price!

Currently I am already planning where else to inject the monies from Ezra's divestment. Investing is a never-ending journey, and the process (though tiring) is fun!

I did not compare Ezra's competitors' receivables, but the fact is their receivables are ballooning and that's not a good thing.

As for Ice Maiden, it's too early to quantify anything in my opinion, but most likely they will need more cash to fund it. You go figure where they are going to get the cash....

True about FPSO, but then Chim Sao is only their 2nd FPSO and EOC is leveraged to the hilt, so that's where the risk lies. If any delays occur, it would truly be detrimental to Ezra.

Lionel Lee is a visionary, and he is very very good at tapping capital markets to grow. For shareholders' sake, I hope he does not stumble. I chose not to take the journey with him as I see many risks lying ahead.

Cheers,
Musicwhiz