MTQ – Analysis of 1H FY 2011 Financial Statements

For MTQ, which releases its financial statements only half-yearly and not quarterly, it is important for me to review them each time they are published, as the next chance will only come six months later. The Company will publish a newsletter around this time to update shareholders of material developments within the Group, and also to provide a summary of key financials. I had enquired before on the frequency of this newsletter and was told it would only be printed once a year to supplement the half-yearly results, and to provide updates which would otherwise not be available through SGXNet (or rather, considered not materially important enough to warrant an SGXNet disclosure). So here we are again staring at the latest set of results from MTQ, for the period ended September 30, 2010 (which I will refer to as “1H FY 2011” from now on). I shall NOT be presenting any numbers in table format on Excel, as I assume investors and readers of this blog will be able to download and obtain the necessary numbers yourselves from SGXNet. Hence, I will focus on the analysis and commentary itself.

Profit and Loss Analysis

Disappointingly, there was no segmental breakdown provided for the 1H FY 2011 financials which showed the breakdown between revenues and profits for Oilfield Engineering Division and Engine Systems Division. Hence, this analysis will focus solely on the Profit and Loss Statement proper, and whatever insights can be gleaned from the numbers provided in the MD&A and press release will be used to substantiate certain points I wish to make.

Revenues increased by 12% year on year but cost of sales increased by a higher 15%, which resulted in gross profit rising by just 9%. Cost of sales includes depreciation on PPE and the increase in PPE due to the Bahrain expansion as well as the sprucing up of Bosch Superstores may have resulted in higher COGS, which impacted gross margin negatively. Gross margins fell from 41.4% in 1H FY 2010 to 40% in 1H FY 2011. Other Income for 1H FY 2010 was made up of S$1.9 million gain on sale of available for sale securities, which is why there was a drop of 91% for this item for 1H FY 2011. Staff costs rose 16% year on year, and I believe part of this can be attributed to hiring of staff for the soon to be completed Bahrain plant. Finance costs, thankfully, remained within control at just S$78,000 (+8%) but I foresee that this will rise significantly in the coming months as MTQ draws down on its loans to complete the construction of their facility. However, cash flow generation from operations should be healthy enough to offset any interest effects in the Cash Flow Statement.

Profit before tax was S$6.9 million compared to S$8.5 million a year ago. If we strip out the exceptional gain of S$1.9 million, profit before tax improved by about 5%. Net profit margin was 12% against 13.3% a year ago as there were higher taxation expenses incurred of S$1.5 million for 1H FY 2011. Overall, it was a relatively decent performance though I will be commenting on the problems faced based on an interview with Mr. Kuah Boon Wee as featured in The Edge Singapore (week ended November 15, 2010).

Balance Sheet Review

PPE increased by 22.3% from S$18.5 million to S$22.6 million, probably as a result of the Group buying and bringing in machinery for their new Bahrain workshop facility. This explains the increase in non-current assets, which also saw a slight decrease in investment securities amount due to mark to market accounting.

Inventories under current assets also increased 17.7% to S$19.6 million, and I should attribute this to the increase in stocking up required for the Bosch Superstore concept expansion, and also because of their acquisition of an outlet in Northern Territory back in March 2010, and also due to the subsequent purchase of Highway Diesel (a fuel injection business) in August 2010. Cash balances remained pretty much constant at S$20.6 million as at Sep 30, 2010 against S$20.3 million as at March 31, 2010. Bank borrowings did not really increase drastically (just +49.4%) as MTQ probably has yet to draw down fully on their UOB term loans, and I am guessing we will see the full impact only in 2H FY 2011. Total bank loans came up to about S$5 million as at Sep 30, 2010, compared to S$3.3 million as at March 31, 2010. Net cash therefore still stood at about S$15.6 million as at Sep 30, 2010 (about 17.7 cents per share). Current ratio stood at 2.98 for Sep 30, 2010 compared with 3.00 as at March 31, 2010.

Cash Flow Statement Review

It was heartening to see the operational cash flows were once again strongly positive at S$7.38 million, against S$5.75 million a year ago. Acquisition of PPE was very high for 1H FY 2011 at S$5.6 million due to the Bahrain expansion, which translated into a much lower FCF figure of about S$1.7 million. Coupled with the purchase of business by a subsidiary company (which I suspect is Highway Diesel because it was announced that it would cost about A$2 million). As a result of the payments for PPE and the purchase of a subsidiary company, investing cash flows was negative at S$7.3 million (there was a small offset of S$1.3 million cash from disposal of PPE).

Under Financing Cash Flows, the drawdown on bank loans has more than doubled from S$1.1 million last year to S$2.6 million this year, which is a sign that more cash is needed for the new facility. Still, this is way below the amount of operational cash flows generated from the core business, and should not cause too much concern to the shareholder.

2H FY 2011 results should be the one for me to intensely scrutinize as it will probably include some of the start-up losses from the new workshop in Bahrain, as well as the full impact of the loans drawdown for the building of the Phase I and part of the upcoming Phase II.

Prospects and Plans – A Discussion

Oilfield Engineering Division

For Oilfield Engineering, MTQ’s press release mentions that the momentum of rising oil prices should keep the division busy through the rest of the financial year, while the results in this division’s top line (+7% from S$18.6 million to S$19.8 million) show that there was indeed increased demand for the Group’s services. Since the new facility at Bahrain (Phase I) will be operational from CY 2011, I guess shareholders can expect some form of revenue contribution from 4Q FY 2011 onwards, though the start up losses from depreciation, utilities and staff costs may be substantial depending on operating conditions.

In the article from the Edge magazine, where CEO Kuah Boon Wee was interviewed, he mentioned that due to the BP disaster with Deepwater Horizon, there would be much more regulation and inspection required for Blow-Out Preventers (BOP) moving forward. This would probably translate to more work for MTQ as BOP made by MTQ’s customers, one of which is Cameron International, would have to be inspected and certified more frequently. Regulations are set to become more stringent in order to prevent a repeat of the massive disaster which spilled millions of gallons of crude oil into the oceans, making it one of the worst environmental disasters in history. He also mentions that there is a lot of (old) equipment in Saudi Arabia and Indonesia which needs to be inspected and re-certified.

As for the new facility in Bahrain, MTQ maintains that the construction is on schedule and that there is no cost overrun. Machinery is arriving and the training of workers has already begun. He expects the first job to arrive some time next year but warns that there may be start-up losses and “teething problems”. However, he does sound a positive note by saying that there is a lot of “activity” in the Middle East, possibly alluding to better deals and increased workload for this division in the coming quarters. I guess it is reasonable to expect some write-off for preliminary expenses incurred in getting the facility up and running; and as business activity picks up these will soon be a thing of the past, though how much it would contribute to the Group’s revenue and profits is still uncertain and cannot be reliably quantified at this point in time.

Engine Systems Division

For Engine Systems, the much talked-about Bosch superstore concept was actually slower to take off than anticipated, and Mr. Kuah talks about how Australia is such a large country and to be able to connect up the sales network was a challenge; and that they had over-estimated their ability to do so in a short period of time. Although the press release talks of organic growth (through partnering Bosch) and acquisitive growth (through the strategic purchases of Highway Diesel and expansion of MTQ’s network into Northern Territory), the top line improvement was just 13% for 1H FY 2011. Since segmental reporting was not done, I could not assess the impact of the growth on Engine System division’s margins, though of course I would expect an improvement since Mr. Kuah Kok Kim mentioned a while back that there would be no necessity to expend a lot of effort and money to revamp existing MTQ branches with Bosch products.

Mr. Kuah Boon Wee says that the Group is working on improving MTQ’s sales coverage in Australia and also to improve the sales package to customers. The Engine Systems division may also be looking out for potential M&A opportunities to expand their sales coverage, and also to acquire businesses selling complementary products which can help to increase MTQ’s existing customer base and allow them to cross-sell products and services.

Conclusion

An interim dividend of 2 cents/share was declared, which was double that of 1H FY 2010 (at 1 cent/share). However, for this dividend a choice was given for scrip or cash, and I suspect the Kuah family will choose to accept scrip to increase their stake in MTQ, while at the same time helping the Company to conserve cash. As for myself, I will wait for the issue price of the scrip shares to be announced in order to make my decision, but at this point in time most likely I will accept cash so that I can deploy to other opportunities should they come along.

My next update and review of MTQ will probably be in May 2011, when they release their FY 2011 results. In the meantime, I can expect their newsletter to arrive and I will also be keeping track of any corporate developments along the way.