Thursday, June 10, 2010

MTQ – FY 2010 Analysis and Commentary Part 3

We have come to Part 3 of my MTQ analysis, and I hope the previous 2 sections have been useful thus far in reviewing the company. I was hoping to get some constructive criticisms but thus far there have been no comments given on either Part 1 or Part 2; so now I am pressing on with Part 3 which is much more qualitative in nature.

Part 3 will discuss the prospects of each division (i.e. Oilfield Engineering and Engine Systems), as well as comment on the prospects and likely business climate for each division and for the Company as a whole in the next 6 months (till MTQ release their 1H FY 2011 results). I will also touch briefly on MTQ’s capital structure in the near-term and their likely cash flow and dividend stream.

Oilfield Engineering Division

Oilfield Engineering has always been the mainstay of MTQ’s business, as my analysis of purchase had described, they are one of the few played in the region which can provide timely and quality service to customers, thereby resulting in repeat business with a loyal customer base. Looking at the results for FY 2010 though, one can see the damage done by the global financial crisis on this division, as oil majors had drastically decreased their spending on E&P amid tight financing conditions; and also because most of these majors have become cautious on spending too much in case they were unable to sufficiently recoup their investments. Note too that oil prices had collapsed from a high of about US$148 per barrel to the current US$70 per barrel, and there could be further weakness moving forward due to the current Euro crisis. MTQ are, to a certain extent, exposed to this risk as they are servicing clients in the South-East Asian region where the players are more sensitive to oil prices. However, there may be light at the end of the tunnel in terms of managing the volatility of the revenue stream for this division (see next para).

In Jan 2009, MTQ announced that they were venturing into Bahrain, a country in the Middle East, and were planning to build a new facility there up to 3 times the size of their Singapore Pandan Loop operations. Since then, they had awarded a contract to build Phase I of the development to a contractor, and work has since begun and is targeted to be completed by early 2011. Assuming the facility starts to attract customers and generates revenues, the revenue stream would be far more stable as the oil majors in the Middle East region are not so affected by fluctuating oil prices; rather their cost of production is probably just US$1 to US$2 per barrel! MTQ would also be able to capture a new base of customers there (barring strong competition from incumbent players, of course) and perhaps also extend their existing business relationships with their current pool of customers to service their Middle Eastern operations. Of course, at this juncture there is still no clarity on business prospects and potential revenues as the facility is under construction; but if assuming all goes well, this new facility could significantly boost MTQ’s business in the long-term.
Another thing to note about this division is its high barriers to entry (in terms of service quality and services offered) and thus it can garner sufficiently high margins of up to 24%. Assuming the Bahrain workshop can command the same premium pricing, and barring fierce price wars initiated by competitors, MTQ should be able to maintain their margins for this division. However, I would expect contributions to only flow in from 2H FY 2012 earliest.

Engine Systems Division

A quick recap on this division – Engine Systems had shown surprising resilience during the downturn and turned in a respective set of results. Part of the reason for this may be attributed to the Bosch Superstore concept which was part of the deal which MTQ signed with Bosch (starts Nov 1, 2009). Therefore, if we extrapolate the positive effects on the division’s business, revenues and margins, I can safely conclude the FY 2011 would be a year of growth, or in the worst case scenario, revenues would remain flat (if compared year-on-year as FY 2010 only had 5 months where Bosch Superstores were operating). The margin improvement to 3.2% was a pleasant surprise and as the legacy units are being divested within MTQES, net margins could rise further; this coupled with synergies from cross-selling Bosch and MTQES’ own automotive parts and diesel engine systems may mean better economies of scale, with minimal additional capital expenditure. Of course, this is assuming that the Euro crisis and subsequent fallout does not have a sharp negative impact on MTQES’ business and throw a spanner in their engine (mind the pun).

With the acquisition of Premier Fuel announced back in March 2010, MTQES has now expanded their Australian coverage to include 10 outlets (inclusive of the one in Northern Territory occupied by Premier). At this point, it is unsure if the Company will channel more of their funds into the Bahrain construction or if they plan to reserve some to acquire more companies to boost MTQES’ capabilities and reach. I can only speculate that Management seems to be want to take a pro-active approach to improve MTQES’ margins and also their competitive capabilities, and this is a good sign as it implies they do not let a business division languish just because it has lower margins and revenues than a more profitable division. A Company must act as a holistic entity and manage its resources well; and thus far this has been demonstrated by Management as they astutely avoided debt and generated good cash flows.

The upcoming AGM would be a good opportunity for me to question Management on their intentions for MTQES, and whether there are plans to grow it further. I shall also wait for the Annual Report commentary by the Chairman to see if there is any MD&A on MTQES; and also browse through the operations review. The AGM should be held sometime in July 2010.

Changes in Capital Structure

MTQ had announced their Bahrain expansion plans and for now, Phase I will make use of internal cash flows and cash reserves to fund. This would also include paying for costs and staff salaries to recruit suitably qualified personnel and train them to appropriately deliver quality service which is in line with the service levels at its Singapore branch. All these activities will mean that substantial expenses will need to be incurred, and it may be quite a while before we can observe the positive effects of such spending on productivity and quality which would translate into revenues, earnings and cash flows.

However, per Management, Phase I will not involve a dramatic change in MTQ’s capital structure as the upfront cost is only about US$9.6 million. Phase II, which will probably commence work in early 2011, will involve much more (though no exact figures were given); and so MTQ will most likely have to fund this phase of expansion through the use of bank financing (i.e. bank loans). With current gearing being very negligible, this increase in bank loans will result in more financing costs and the net cash position which the company enjoys now may also be threatened, depending on how well they can generate operating cash inflows into the future.

On a positive note, in the current low interest rate environment, it may be better for MTQ to take up some financing (paying low rates), and deploy their cash reserves to better effect to maximize returns for shareholders. I believe this is what the Chairman, Mr. Kuah, intends to do in order to conserve cash resources, as he is confident the bank will lend them the money as MTQ has a strong balance sheet and healthy cash flows. Assuming Management knows how to deploy the cash to enhance returns, I would think this is a good strategy to adopt.

Cash Flows and Dividends

That said, cash flows and dividends may take a temporary hit due to the above-mentioned events taking place; and as MTQ uses more cash to fund its new facility and also to expand MTQES’ networks. For FY 2010, MTQ managed to sustain its dividend payment at 1c/share interim and 2c/share final; but for FY 2011 I highly doubt the company can maintain this payout unless operational cash flows turn out to be much stronger than anticipated. Although Mr. Kuah sounded an optimistic note in his interview with NextInsight that dividends at current levels can be sustained, I have a tendency to be more pragmatic (call it “pessimistic” if you wish) and assume the worst – that the Company will have to drop it dividend or in the worst-case scenario, stop paying dividends altogether if the macro-economic environment continues to deteriorate. Although this is an unlikely possibility, it still must be considered as I am currently enjoying a decent yield of 4.37% on my investment in MTQ (based on 3c/share full-year dividend).


I remain cautiously optimistic about the company’s prospects and Management’s capability to grow the business, though I am also mindful of the potential slowdown should the global economy be hit by another “whammy” delivered by the European debt crisis. As to whether I should add to my position or simply to sit and monitor, I am also contemplating my next course of action. Above all, I must strive to maintain a margin of safety on my purchase and to enjoy a decent yield. Capital preservation remains the cornerstone of my investment philosophy.

My next review of MTQ will be after the release of 1H FY 2011 results sometime in late October 2010, or if there are any material corporate developments along the way.


Akatsuki said...

Hi Mw, sorry i side track abit to bring you to the matter with FSL.

To me i think FSL is a value at 0.37 per share.
Reasons are
1)Net asset value advantage: $0.62- $0.37=$0.25 about 67% below NAV
2)Calculation of expected yield for the this year, 1st Quarter already paid 1.5 US cents
2nd Quarter guess will be a conservative estimate about 0.75 US cents, 3rd Quarter guess will be a conservative estimate of 0.75 US cents, 4th Quarter guess will be back to 1.5 US cents
Total Dividends collected: 4.5 US cents = 6.3 Sg cents (conversion rate of 1.4)
This represents about 17% dividend yield
Business wise, FSL will use the 4.8million in its cash position to release the ships that is being retained in the both countries; this is estimated to take about 1-2weeks. The 4.8million is claimable, it just a deposit with the court to release the ships. There will be litigation or lawsuit with Groda shipping Ltd for causing this problems. The client Rosnett will most likely take the ships back since Rosnett is a client of Groda who uses FSL ships, nevertheless even if Rosnett doesn’t want to lease back the ship under their control, according to the IR, they do have other clients wanting to rent their ships. Recall that FSL ships are young and have substantial value to them.
According to FSL, interest payments to loans will not be charged higher by creditor because of this incident.

Akatsuki said...

I not sure whether my estimate for the annualized dividends are conservative enough, what i know is this, FSL has incur a "one time" 10million revenue cost due to this matter, the depreciation rate will remain the same despite being retained and not leased. However the IR said, they could change the dep rate beacuse industry practice is 25 years , they use 20 years, (can this be done? wouldnt that violate the principal of consistency?) The other risk here is that, the two ships are not being release due to other unforeseen problems, the longer the delay the lesser the dividend payout.
Another risk is that, the other 21 ships might have problems due to the economic problems in the UK region, Siba Ships, James Fisher and Schoeller Holdings are FSL clients that are from Europe/UK. Represents 25% of the total revenue to FSL.

Akatsuki said...

Ive have called the IR many times to confrim some facts, but nevertheless people reading this please don't take it to face value, do your own reserach. But for Mz, i want to know your take. What do you think? FSL a Value buy?

Musicwhiz said...

Hi Akatsuki,

Thanks for your contributions to FSL Trust. I haven't looked at it so closely as you have as I have been disappointed time and again by problems which have cropped up, even as one gets solved. To me, the numerous problems just serves to tell me that the original premise of investing in FSL Trust was a mistake, as I had focused too much on what was going to be right (i.e. yield compression at the time), instead of figuring out what could go WRONG! And it's obvious now on hindsight that a lot has gone wrong, from invokation of market disruption clause to the current counter-party problems, to having trouble raising debt due to Dubai World crisis, and having to cut DPU from their lofty (and unsustainable) 100% payout.

In short, I was greedy and I deserved to lose money on FSL. I will not be averaging down no matter how attractive the price versus value is as I do not fully understand the risks; but I hope the Management can do its best to resolve them!

Hope my reply does not disappoint you.


Akatsuki said...

Hey Mz, i think it is also good to look at the positive side of a company when doing value investing. I can feel your disappointment FSL since you bought it quite high. But if i were to ask you this,if you had bought FSL at a much lower price say like 0.50-0.47 would you still be disappointed?

Musicwhiz said...

Hi Akatsuki,

Actually yes, it would still be an issue for me. This is because I have failed to understand the business model fully and appreciate ALL the risks of investing in this kind of structure (i.e. shipping trust).

It's not a matter of price of entry, but to make sure I have margin of safety based on my circle of competence.

And yes, I am very disappointed with this stinker of an "investment". To think I had met the executives and believed all they told me about risk management, justifications for the 100% payout etc. I was greedy, period.


Akatsuki said...

Ic. What advice would you give to someone who is looking to invest in a business trust?
My view is
1)Understand the industry of that trust
2)Anticipate/Consider risks

3)Invest in business trust that have a longer history? say like 5-8years
4)Take every good point of that trust with a pich of salt?

Musicwhiz said...

Hi Akatsuki,

Yes, well as in any investment, we must understand it fully before committing any monies. So you are right to say a long-term horizon is important and we must understand ALL the risks. Also, try to seek out the dark side as analysts will only drum up the +ve aspects.

Other than this, I can't tell you much more about business trusts as I lack detailed knowledge of this area.

Good luck!


Akatsuki said...

Thanks Mz!

Bill said...

hi akatsuki,

if it makes u feel better. ur not alone..thinking of averaging down but dont know if its worth while.

called the IR hotline too and spoke to chen fung how how....he said he is not in the position to advise for shares