Friday, May 14, 2010

MTQ – FY 2010 Analysis and Commentary Part 1

MTQ released their FY 2010 results on April 30, 2010 during lunch time, one of the earlier companies in my portfolio to release their full-year results (MTQ has a March 31 year-end, similar to Tat Hong and Boustead which will release closer to end-May 2010). Suffice to say the results looked surprisingly good considering their main Oilfield Engineering Division had taken a hit (this was already apparent in 1H FY 2010’s results) and that their Engine Systems had previously been highlighted by me as having very low operating margins. Even with the recent partnership with Bosch to create MTQ’s Bosch Superstores (managed by MTQES in Australia) and the purchase of Premier, I did not have high expectations for the Engine Systems division to pull off a good performance. I was pleasantly surprised on this count, as we shall see in the segment analysis for both divisions. In the meantime, this analysis will follow the usual pattern of financial statement analysis and commentary, followed by business division review (including margins) and lastly discussing prospects, plans, risks and potential hurdles for the Company.

Profit and Loss Analysis

As can be seen in the above table, I had plotted out the 1H FY 2010 numbers which were released by MTQ in November 2009, and alongside it I had added in the 2H FY 2010 numbers, which were derived from subtraction of the FY 2010 from the 1H FY 2010 numbers (MTQ conveniently left out 2H performance, so I had to do my own back calculations).

If we glance at 1H versus 2H, it is quite apparent that revenues improved dramatically in 2H as the dip was only 5.2% and was attributed mainly to Oilfield Engineering. Engine Systems saw a boost in revenues due to the aforementioned Bosch deal, and also the purchase of Premier which expanded MTQES’ network around Australia. Cost of Goods Sold had dropped by 17.1% for 2H against a drop of 15% for 1H, and this showed better economies of scale as MTQ moved along in the financial year. The FY 2010 resulted in a drop of 8.8% in revenues while COGS dropped by a larger 16.1%, resulting in a RISE in gross profit of 4.2%. Cost control is very apparent at this juncture and it was a very good sign that even though revenues fell due to decreased spending by oil majors on E&P, MTQ had managed to eke out a small rise in gross profit due to their better performing Engine Systems division. With the closure of unprofitable segments of MTQES, I believe this division will continue to grow and expand with improved margins as time goes by. Note the gross margin expansion from 36% for FY 2009 to 41.1% for FY 2010. 2H FY 2010 showed the largest margin expansion, jumping from 32.3% to 40.9%. Note that 2H was also the time the Bosch deal was sealed and Bosch Superstores started operating from November 1, 2009 (essentially 5 months of the 2H FY 2010). I cannot stress enough how important it is for gross margins to improve as this signals not just economies of scale, but also indicates possible pricing power. I will be keeping a close watch on gross margins in the upcoming 1H FY 2011 results to see if it continues to improve.

One point to note is the S$1.86 million worth of realized gain from divestment of quoted equities, which is an exceptional gain and should be removed from the computation of recurring EPS. MTQ had purchased quoted shares during the downturn (company not stated), and had proceeded to divest some of these holdings to raise cash (presumably to fund their Bahrain expansion and their Engine Systems division’s initiatives). Later in the Balance Sheet, it will be pointed out that MTQ is sitting on a fairly large unrealized gain (of about S$2.9 million) on its long-term shareholdings (marked-to-market gain).

One disappointing aspect to note is that administrative expenses had increased significantly (by 26%), even though revenue had fallen over the same period. An adequate explanation was not provided in Management’s MD&A and I can only suspect that this relates to higher expenses incurred to beef up their Bosch Superstores, as well as purchases to stock up on new line of items and other associated costs relating to Engine System’s expansion into Northern Territory. It will be worthwhile to question the Management on this increase during the upcoming AGM (and after reviewing the Annual Report) as it is a significant jump in light of the fact that revenues had in fact dropped. Staff costs had also crept up by 6.2% for FY 2010 (of which the majority of the increase came in 2H where the jump was 23.3%), and this could possibly be attributed to increased hiring as a result of the Bosch deal, in order to man the stores amid an increased range of products being displayed. I also took into account the fact that higher staff strength will equate higher training costs and staff welfare as well.

Finance costs were kept under control, dipping 8% year on year, as borrowings remained low. This may be set to change, however, with MTQ embarking on the second phase of their Bahrain facility construction soon. The Group had mentioned taking up debt to fund this expansion, as they wish to leave their cash intact for possible M&A opportunities. Therefore, I can expect a much higher financing cost to impact the bottom line in the year to come.

Profit after tax increased by 10% for FY 2010, but this was due to the fact that there was an exceptional gain of $1.863 million due to sale of equities. Stripping this out, net profit would have been about S$10.2 million (a drop of 6.4%). Net margin cum exceptional gain was 14.7%, but drops to 12.6% ex-exceptional gain (still higher than FY 2009’s 12.2% though). Considering all of the $1.863 million gain came from 1H FY 2010, this means 2H FY 2010 performance was much stronger and pulled up the overall performance for FY 2010, as net profit surged 21.8% to $4.8 million (no adjustment was needed as there was no exceptional gain). Assuming the momentum continues to build up for MTQ’s 2 core divisions, I can expect a reasonably better performance (barring unforeseen higher staff and operational costs) for 1H FY 2011. 2H FY 2011 will likely be impacted by the recruitment and subsequent training of the new Bahrain staff (without associated revenues). See interview on NextInsight as evidence of this piece of news, which I had used to factor into my projections and expectations.

At a valuation of 7.36 times historical earnings ex-exceptional gain, MTQ is not trading at expensive valuations; but neither is it cheap.

Balance Sheet Review

MTQ’s Balance Sheet is still rock-solid, for the fact that it has a net cash reserve of about S$16.9 million, just a slight drop from FY 2009’s net cash reserve of S$17.5 million. However, there are a few aspects of the Balance Sheet which are worth some attention, and I shall devote some attention to these items so that I may remind myself to watch over these “red flags” in the next few reporting periods, to ensure the numbers do not get out of hand. As an investor, that is the least I should be doing.

Trade and Other Receivables had increased by S$5.1 million or 31.5% to S$21.4 million, and this occurred even though there was a dip in revenues by 8.8%. It is always worrying when receivables increase when revenues dip, as it may signal a collectibility problem and potential bad debts moving forward. A possible explanation could be that the Engine Systems Division had garnered more sales as a result of the Bosch partnership, but also at the same time extended longer credit terms to its customers as a result of the increased sales. This has to be clarified by me during the next AGM as I consider this a potential red flag.

The good news is that current ratio had increased to 3.01 from 2.60 and quick ratio improved from 1.94 to 2.09, though this was mainly due to the increase in receivables. Receivables turnover days increased significantly from 66.4 days to 95.7 days, but payables turnover also increased from 68.7 days to 97.4 days. The cash conversion cycle had dipped from 2.3 days to 1.8 days; and though this is not a significant dip, it still presents a worrying trend as the cash conversion cycle is one of the important metrics by which to measure a company’s ability to convert receivables to cash faster than it pays its suppliers. I shall be closely monitoring this in future periods and will label this as a “red flag” as well.

Debt equity ratio has fallen from 7.7% to 4.6%, but with the scaling up of the construction of their Bahrain facility in FY 2011, I would expect this ratio to head higher in the following financial year. The good thing was that ROE remained high at 19.4% with minimal debt, down from 23.9% last year. As long as the Company can maintain such high ROE with minimal leverage, I would conclude it is still doing decently. This fact, coupled with the knowledge that the Company still has a healthy net cash balance, reassures me that my investment is still doing fairly well.

Cash Flow Statement Review

MTQ’s cash flow statement was, thankfully, quite healthy. A quick glance shows that the Group generated a healthy operating cash inflow of S$3.9 million, despite seeing a big rise in Trade Receivables which resulted in an “outflow” of S$8.5 million (quotation marks are used because this Cash Flow Statement was prepared using the Indirect Method). Inventory increase accounted for a cash “outflow” of S$2.5 million, and together these two items resulted in a cash outflow of S$11 million. One reason I can think of was the aforementioned Bosch Superstore customers increased credit terms, and also the stocking up of the Superstores to include Bosch range of products as well as MTQES’ own range, which resulted in the higher inventory figure.

It’s also worthwhile to note that income taxes had fallen substantially to S$2.2 million from last year’s S$7.1 million, which included capital gains tax paid on MTQ’s disposal of RCR Tomlinson. Assuming (and this is a big assumption) that inventories and receivables’ days normalize after MTQES’ expansion gains momentum, MTQ’s cash inflows from operations should improve substantially. However, their Bahrain expansion could throw a spanner in the works as more cash needs to be paid out to hire workers and train them for the new facility; thus both these events may negate each other and the net effect may still be more cash flowing out rather than in.

Purchase of PPE took up about S$5.1 million for FY 2010, slightly down from S$5.7 million the year before. Because of this capex, one can easily note that there is negative free cash flow for MTQ as capex exceeds operating cash inflows; however with the scaling up of MTQES’ operations in Australia and in future, the operation of the Bahrain complex, MTQ may see positive free cash flow in 3 to 5 years time.

Most of Financing cash flows were made up of repayment of bank borrowings as well as payment of dividend. It is quite surprising (to me at least) that the Group can still maintain its dividend payout of interim 1c per share and 2c per share final even though there are spending to build Phase I of their Bahrain complex.

Part 2 shall discuss each business division and their margins, and I shall discuss how each business division is performing relative to last year; and also provide a snapshot of what I feel an investor can expect from each division in the coming year.

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