Friday, April 23, 2010

MTQ – Commentary and Review of Recent Corporate Developments

MTQ is not normally a company which releases a lot of corporate updates or announcements. In fact, since its market capitalization is consistently below S$75 million, there is no mandatory requirement for it to report quarterly results; and this actually helps to cut down on manpower costs involved in the additional reporting requirement to SGXNet. However, in the recent month MTQ has released quite a few updates on corporate developments, thus as an investor who keeps a close tab on the company, I feel I should give my thoughts on these developments and how they may impact the company in the next few years.

The first announcement was actually released on March 15, 2010 and concerns the acquisition of a company called Premier Fuel Injection Service Pty Ltd (‘Premier”) by MTQ Engine Systems (Aust) Pty Ltd (“MTQES”). Premier is a privately-owned company and is engaged in the diagnostic and repair of diesel fuel injection parts and engine management systems. The primary reason for this acquisition was to expand MTQES’ network of 9 branches in Australia (recall MTQES also partnered with Bosch as announced back in Nov 2009). Premier is located in Northern Territory, which is one of the few capital cities in which MTQES has no presence in. The consideration for the purchase was A$500,000 (about S$640,000) and will be financed through internal funds and fully settled in cash. MTQES will operate from Premier’s existing workshop for 3+3 years (subject to extension) and they have also employed Brian Agostini (the founding shareholder of Premier) for his technical expertise.

Comments on this announcement – As mentioned in the press release to this announcement, this acquisition will broaden the reach of MTQES and enable MTQES to enhance value to new and existing customers. It can be viewed positively as the transaction did not cost much (valued almost at cost, so MTQ are paying 1x book for it; earnings were not mentioned so unsure what valuation MTQ paid for Premier), and could be funded by internal cash flows are MTQ has a track record of generating steady Free Cash Flows. MTQ was also smart in retaining the founding shareholder to run the business, and this is in line with Warren Buffett’s philosophy of retaining Management to run the business even after he acquires companies. This is because Management usually has the connections and network to enable the business to grow and flourish further. Assuming minimal incremental investment is made into Premier as compared to its revenue-generating potential, this deal could result in enhanced top-line growth for the Engine Systems division and may also result in greater economies of scale as MTQES now have 10 branches within Australia. Gross margins could improve as the deal with Bosch also has a positive effect on the division, while Chairman Kuah Kok Kim hinted that Northern Territory’s proximity to Timor Leste and Indonesia may have positive spillover effects into that region which may lead to further growth for the division. Interestingly, if one traces back to FY 2003 to FY 2005, MTQ had unsuccessfully tried to penetrate the Indonesian market by setting up a subsidiary in Surabaya at the time; and plans were afoot in FY 2004 to expand to other major Indonesian cities. However, by FY 2005, MTQES’s Indonesian operations had yet to turn a profit amid severe competitive pressures, and the division was folded soon after. It is hoped that MTQES had learnt a valuable lesson from 5 years back about Indonesia’s market and not repeat the same mistakes again.

The second announcement and press release were made on April 5, 2010 and involved the award of a contract by MTQ Oilfield Services W.L.L to a building contractor worth US$9.6 million (about S$13.15 million) to construct a 2-storey workshop cum administrative block on the Bahrain International Investment Park, where MTQ’s new facility will be located. The agreement was signed on March 30, 2010 after a rigorous tender process and the entire investment will be funded by a mixture of internal cash flows and bank borrowings (the exact ratio was not mentioned). Mobilisation has already begun and this Phase 1 of the construction is expected to be completed by December 2010. Phase 2 will only commence after initial operations begin at the new workshop cum office.

On a separate note, the press release also makes mention of Tatweer Petroleum, a joint company between National Oil and Gas Authority of Bahrain, Occidental Petroleum Corporation and Mubadala Development Company. They intend to develop the Bahrain oil field in the next 20 years and MTQ views this as being positive for their oilfield engineering division in the long-term.

Comments on this announcement – Finally, the Bahrain expansion is getting on track! Recall that the very first announcement was made on January 5, 2009 about MTQ’s intention to expand into the Middle East, and that Bahrain had been chosen as the country of choice for their expansion due to many positive factors. Since then, MTQ had set up a subsidiary company in Bahrain (which is 100% owned) in June 2009, and then proceeded to increase their injected capital in this subsidiary on March 30, 2010. After nearly 1.5 years of preparation, the construction of the new facility is under way and I am glad to hear that everything is on schedule and is proceeding as planned. MTQ has also identified Bahrain as having huge potential for oil development in the next decade or so, and this paves the way for long-term business in the region, in spite of there being other incumbent competitors. Of course, my question now would be how much MTQ will eventually spend building the facility (taking into account possible cost overruns), and also how much bank borrowings they will require to take up. All these factors will significantly affect MTQ’s near-term dividend payout and also showcase their ability to manage their cash flows. Knowing that Kuah Kok Kim is a conservative and prudent businessman, I am sure he would have computed the correct ratio of bank borrowings to internal cash flows so as to not over-strain the Balance Sheet. On the other hand, using less borrowings and more internal cash may put a strain on the Cash Flow Statement and reduce the availability of short-term working capital as progress payments have to be made to the contractors for the next 8 months till Dec 2010. Hence, this is going to be a delicate balancing act and I hope more insights will be revealed when MTQ releases their FY 2010 results in late May 2010.

The third announcement came on April 14, 2010 and was in two parts. The first part mentioned the sale of land cum property by MTQES at 32 Raynham Street, Salisbury, Queensland on April 12, 2010 for A$975,000 (about S$1.25 million, less agent fees). Considering the written down value (WDV) of the land and building was only A$407,000 (about S$521 million), MTQES will stand to recognize a one-off exceptional gain of about S$729,000. The rationale given for the disposal was for MTQES to continually streamline its operations and that the site at Salisbury posed challenges as it was not optimised to support the level of business activities (implying it was too small and perhaps run-down, with old equipment).

The second part of the announcement was a major one as it mentioned that Mr. Kuah Kok Kim would step down as Executive CEO with effect from July 1, 2010. Stepping into the shoes of CEO would be his son, Mr. Kuah Boon Wee, who has experience in helming the growth of PSA as well as working as the ex-CFO of ST Engineering. He is a very capable and prolific man who has a degree in Mechanical Engineering and is also a Qualified Chartered Accountant. Mr. Kuah Boon Wee has been on MTQ’s board since 2006 but is now resigning from PSA to take on a more active Management role and steer the Company to better organic growth, and also on overseas ventures. Mr. Kuah Kok Kim will remain as the Chairman of MTQ to provide strategic guidance and advice to the Group. This was all part of MTQ’s succession planning to ensure continuity in the business.

Comments on these announcements – The first part about selling the property seems (to me) like a very good tactical move, as retaining an ageing building with old equipment would most likely pose more harm than good. Since MTQES had already consolidated all its operations under one roof since July 2009 (and probably was enjoying better economies of scale as a result), it made commercial sense to put up the Salisbury property cum land for sale to realize some cash. Even though the transaction will result in a one-off gain for MTQ (probably to be recognized in FY 2011), I think the more important aspect of this sale is to claw back some cash of about S$1.25 million, which will boost MTQ’s cash reserves for their expansion plans.

The second piece of news about the leadership handover and succession plan was surprising, though not unexpected. It would seem that the Chairman was already planning for the long-term and putting in place measures to ensure MTQ grew from strength to strength. I guess this may be why Mr. Kuah Kok Kim purchased 93,000 shares in his own name at S$0.72 back on March 17, 2010 (just a few days after announcing the purchase of Premier). With Mr. Kuah Boon Wee’s extensive experience in overseas businesses with PSA, as well as his strong understanding of numbers, accounting and financials from his previous work as a CFO (and bolstered, no doubt, by his prestigious Chartered Accountancy degree), MTQ may be set for much greater growth in the years to come.

It will indeed be exciting to see what the future has to offer for MTQ in the near-term, as their new facility takes shape in FY 2010 and 2011. The Company is on the cusp of steady growth and it should continue to do so in the steady hands of the Kuah Family. I will be providing a FY 2010 review and analysis once the results are out in late April 2010, but note the review may only be posted some time in June 2010 as Boustead and Tat Hong will also be simultaneously releasing their FY 2010 results in May 2010 (I will be kept inordinately busy!).

P.S. - Do note that MTQ had recently revamped their website and it now looks more modern and is easier to navigate, plus it has news announcements stretching all the way back to FY 2001! Check it out to read up more about the Group.


Singapore Stock Picker said...

Actually the company was on The Edge for a few times. But I have got to agree that they are getting a bit more visible through their filings on the SGX.

In my opinion they are sovereign risks regarding what MTQ does, but fossil fuel will be the way to go. Still.

Musicwhiz said...

Hi SG Stock Picker,

What exactly do you mean by "Sovereign Risks"?