Saturday, October 10, 2009

MTQ – Analysis of Purchase Part 1

As promised, I will be posting my analysis of purchase of MTQ Corporation Limited using the same format (slightly modified) as the one I used for Tat Hong last year. I believe the analysis will be broken down into 3 parts and I will NOT post all three parts consecutively. My purchase was first made on September 14, 2009 after the conclusion of my analysis for the company, which took a total of about 2 months plus. As mentioned, since transacted volume is low for this company, I had to straddle and stagger my purchases over a couple of days in order to build up a sizeable stake. As of September 30, 2009, I had allocated about S$20,000 for MTQ, out of proceeds from the divestment of PAH and Swiber. I also made additional purchases on October 2 and October 5 and allocated another approximately S$6,800, bringing total investment in MTQ to about S$27,000 to date. The analysis will be broken down and structured into several key sections, and will be accompanied by tables and charts where applicable.

Introduction and Business Model

Established 38 years ago, MTQ repairs sophisticated offshore oil-drilling equipment at its workshop in Pandan Loop. Its customers operate in neighbouring countries such as Indonesia, Malaysia, Brunei, Thailand and Vietnam. They are the authorized repair workshop for OEMs such as Cameron, Varco-Shaffer and QVM. The Company has 2 divisions – namely Oilfield Engineering Division and Engine Systems Division. The Group also handles the fabrication of steel structures (FY 2008) and engages in OEM manufacturing of components. They are one of the more experienced and reliable yards (according to MTQ’s Group CFO William Fong) and have also recently been recruiting (Recruit Section) QC Supervisor and Welding Supervisor, which is an indication the Company is still doing OK.

It sold off its Subsea Robotics division arm back in FY 2005 as it was loss-making and dragging the Group down. It divested its ROV Fleet and made an impairment provision of S$5.1 million back then. Utilization continued to stay low and the Division had been unsuccessful in its attempts to expand its service range.

The Company has few competitors in the region and only has 1 or 2 in Singapore alone, giving them a significant economic moat when it comes to managing their business. They are also one of the more experienced and reliable yards and their business is not built on order books as each job typically takes just several weeks to complete.

Financial Analysis

Profit and Loss Review

Revenues hit an all-time high of S$89.9 million for FY 2009, up 6.1% from FY 2008, due to increased orders for the Oilfield Engineering division. If we refer to the breakdown in terms of segments, oilfield engineering took up 61.7% of revenues, up from 51.6% in the previous financial year, and growth in revenues was 26.7%. By contrast, Engine Systems’ contribution to revenues dipped from 46.8% to 39%, and revenues fell 11.6%. This was due to a weaker Australian dollar (which has since recovered) and also the cessation of their Indonesian Engine Systems business in the 2H FY 2008. This clearly shows that oilfield engineering division is the main growth driver for MTQ.

Gross margins for FY 2009 (overall) was 36%, down from FY 2008’s 39.7%. I believe the drop was mainly due to the poor margins in Engine Systems division, thus dragging down overall gross margin. Oilfield engineering managed to get an EBITDA margin of 28.5% and net margin of 24.9% for FY 2009, so depreciation only consumed about 3.6% in margins for the division. Engine Systems started out with an EBITDA margin of just 3.6%, which was further narrowed to just 1.4% for FY 2009. It is the Engine Systems division which makes me uncomfortable about MTQ’s business as FY 2008 registered a net loss margin of 6% for this division. As the future potential lies in oilfield engineering, it is comforting to know that Management is building up this division and increasing the revenue contribution portion for this division as a proportion to total revenues. (More on this later)

Profit from operating activities rose 36.2% to S$15.3 million from S$11.2 million a year ago. Core net profit was up 14.3% from S$9.6 million to S$10.98 million but I would expect this to dip with the current recessionary conditions, with MTQ saying that enquiries have slowed and customers are also asking for lower pricing terms. Historical PER is 5.49x based on 68.5 cents and EPS of 12.47 cents. I think that such a PER offers a reasonably good margin of safety as most of future growth probably has not been priced in yet. Issued share capital (minus treasury shares of 7.48 million) stands at 88.059 million shares.

If we trace back to 5-year profitability, MTQ was loss-making in FY 2005 mainly due to the divestment and write-off of the Subsea Robotics Division, while subsequently they have grown top line and also maintained profitability from FY 2006 to FY 2009. A lot of legacy issues had to be settled from FY 2000 till FY 2005 (closing down of Foundry business, Subsea Robotics and Marine Engineering divisions), plus write-offs along the way.

The big boost to profitability (and also cash flows) came from their very timely divestment of RCR Tomlinson, which yielded exceptional gains of S$40.8 million and boosted cash reserves by S$59 million back in FY 2008. I foresee that part of this cash will be deployed to fund their expansion plans in Bahrain (which needs US$20 million), assuming the Company can continue to maintain profitability and positive operating cash inflows.

Balance Sheet Review

The Balance Sheet of MTQ looks very healthy for FY 2009, and the numbers support this conclusion as well. There is a long-term investment of about S$4.1 million presumably referring to the 16 million shares in Hai Leck bought at S$0.26 per share on August 18, 2008 (for a 4.92% stake in the Company). On August 7, 2009, MTQ increased their stake in Hai Leck past the 5% mark (at S$0.23 per share) and became substantial shareholders of the Company. At last check, their stake stands at 16,271,000 shares (5.02%), total cost is about S$4,222,330. Hai Leck’s last done share price is hovering at about S$0.43 (as at Oct 9, 2009), which means MTQ can recognize a paper profit of about S$2.77 million (66%+ gain). Hai Leck is a leading integrated service provider of scaffolding, corrosion prevention and insulation works for the oil and gas and petrochemical industry, and they have just raised funds recently for expansion. Hai Leck has also issued a 1-for-3 warrants issue, exercise price S$0.26 per warrant, and declared a 0.8 cent final dividend and 0.2 cent special dividend (total dividend = 1 cent/share). MTQ’s Violetbloom Investments Pte Ltd is entitled to 5,423,667 warrants (cost is S$54,237) and will get S$162,710 in dividends. This may not be reflected in 1H FY 2010 results yet as the books closure date for both dividends and warrants has yet to be announced.

Property, plant and equipment increased marginally to S$16.4 million versus S$15 million in the previous financial year. From what I understand, MTQ has been investing in upgrading and renewing their PPE every year to ensure their operations remain efficient and that they can cater to larger orders and enable a faster turnaround time. They also invested in “clean rooms” and a dynometer for Engine Systems division to provide a more complete package for customers. It was also mentioned that financing was taken up to purchase “workshop machinery” in the FY 2009 financial statements.

Current ratio has hovered around 1.20+ for FY 2005 to FY 2007, and it was only due to the timely divestment of RCR Tomlinson which enabled current ratio to rocket to 2.31 in FY 2008, and 2.74 in FY 2009. Quick ratio was also very healthy for FY 2008 and FY 2009, at 1.76 and 2.05 respectively. This was because inventories actually dipped in FY 2009 compared to FY 2008, and though cash balances also dipped, there was a net drop in current liabilities due to less tax payable (part of this was capital gains tax on disposal of RCR Tomlinson) and less trade payables.

The strong positive for MTQ is that their balance sheet shows a net cash position of S$28.7 million and S$17.3 million for FY 2008 and FY 2009 respectively. Moving forward, the cash will be used for their organic expansion into the Middle East (Bahrain), and more clarity needs to emerge on how MTQ plans to finance this growth. Mr. Kuah has hinted that MTQ will use a mixture of internal cash flows and bank borrowings, so MTQ may swing into a net debt position in the near future. But if the effects of the expansion can increase operating cash inflows significantly in 4-5 years time, then it is worthwhile to gear up for this as costs are currently low and MTQ has a strong Balance Sheet in place.

NAV for MTQ as at March 31, 2009 stands at S$0.6658 per share.

Cash Flow Statement Review

MTQ’s cash flow has been healthy for the last 5 financial years, with every single financial year registering an operating cash inflow. The clincher came in FY 2008 with the divestment of RCR Tomlinson, which saw a huge S$55.9 million cash inflow under Investing Activities. This move alone has ungeared its Balance Sheet and lifted MTQ into a net cash position in FY 2008 as well as FY 2009.

Its Free Cash Flow (FCF), however, is consistently negative except for FY 2008 when it registered positive FCF of S$2 million. This is a business which requires consistent upgrading of fixed assets and machinery in order to ensure peak efficiency and fast turnaround time. But though there is a constant capex requirement, it does help to note that the business is cash flow positive (for operations) and cash flow is healthy enough to support twice-yearly dividends. (See dividend history and share buyback tables - to be included in a later post)

It is worthwhile to note that there was a purchase of quoted shares of S$5.3 million in FY 2009, most likely relating to their investment in Hai Leck. Taking this transaction out, cash outflows for investing activities would have been just S$4.6 million, almost equal to the operating cash inflow of S$4.5 million. Under financing activities, dividends paid came up to S$2.7 millon while S$3.1 million was spent buying back shares. This would indicate that the bulk of outflows from financing activities were for corporate moves which enhanced returns for shareholders (i.e. dividends and share buybacks)!

Net cash per share stands at about S$0.20 per share as at March 31, 2009.

Watch out for Part 2 of Analysis of Purchase for MTQ in a subsequent post, where I will analyze and touch on their business units history, revenue trends and profitability.


Kavita said...

nice posting

Musicwhiz said...

Hi Kavita,

Thank you for visiting!


JW said...

Hi MusicWhiz,

I truly appreciate your posting and research on this. I will look into it as well for my investment basket.


Musicwhiz said...

Hi JW,

No problem it's my pleasure. I still have areas to improve, so am working on those right now. You can wait for Parts 2 and 3 if you wish, but they won't be posted up quite so soon. :)