Wednesday, November 16, 2011

MTQ – 1H FY 2012 Analysis Part 1

MTQ released their 1H FY 2012 results on the morning of October 31, 2011, and it capped a long-awaited update from the Company after its recent spate of acquisitions and troubles in Bahrain. Suffice to say that I did wait with some trepidation for the results and had expected it to look very poor due to the high amount of leverage taken up not just for the expansion in Bahrain, but also for financing the deal for the acquisition of Premier Sea and Land (PSL). This analysis will, like SIAEC’s, also be divided into two parts for ease of reading.

Part 1 will dwell on the usual financial numbers and key ratios (which have sadly deteriorated), as well as discuss on cash flows and dividends; including financial effects of recent corporate developments. Note that since 1H results did not include a detailed segmental breakdown of revenues and operating profits/margins, information could only be gleaned from the press release and associated notes to the financial statements as found in Section 8 of the SGXNet announcement. I will try my best to make sense of the information provided and draw conclusions from thereon. Part 2 will talk about MTQ’s divisions (Oilfield and Engine), plans and prospects (including Bahrain and PSL), industry outlook and also provide some summary of the key initiatives the Company is planning, based on an interview with Chairman Mr. Kuah Kok Kim in the November 7 issue of The Edge Singapore.

Income Statement Analysis

From the financial numbers above, it can be immediately noted that there was a significant jump in revenues of 40% to $62.6 million for 1H 2012. This can be attributed to the acquisition of PSL which was first announced on July 6, 2011. Therefore, there would have been about two months of consolidation of PSL’s results into MTQ Group’s results, and the positive effects are already showing in top line, though not in the bottom line as yet. For MTQ’s next report for FY 2012 due by end-April 2012, there will be a full additional six months of revenue cum profit contribution from PSL, so it will provide a better indication of how well that division is performing and contributing to overall Group profitability.

It would seem from the performance review that PSL is considered a separate division by MTQ and is not part of the Oilfield Engineering division, as the results were stated separately. This is rather puzzling as my understanding was that PSL was supposed to be acquired in order to complement the current business of Oilfield and provide a boost to earnings and revenues from the introduction of a more complete suite of products for customers (refer to previous The Edge Singapore’s interview on acquisition of PSL). Anyhow, I had broken down the numbers in the table above in order to provide more clarity, and perhaps I will drop an email to the CFO to further clarify certain numbers (especially operating profits) which were not disclosed.

For the last half-year (1H 2011), Engine Systems overtook Oilfield Engineering’s share of revenues, taking up 52.3% against 47.7%. The gap has further widened in 1H 2012 as Engine Systems now takes up about 45% versus 40% for Oilfield Engineering. However, assuming we combine the revenue contribution from PSL into Oilfield Division, the % will then jump to 55%. Considering Bahrain has not even started contributing yet, it would seem that future revenue growth would focus more on the Oilfield Division compared to Engine Systems.

Looking at the numbers, it would appear that PSL’s contribution to the total revenue pie is rather significant, as it constitutes about 15% of the enlarged revenue base. Considering this represents barely two months of revenue (and profit) contribution, it would be interesting to observe what the numbers would be like when PSL is recognized on a full-year basis. Nevertheless, a good indication should be given at MTQ’s next results release for FY 2012 by end-April 2012. An interesting fact which was mentioned during the AGM by Mr. Kuah Boon Wee was that PSL was currently at the bottom of its cycle, as its earnings were bottoming out, and with the upturn in commodity prices and the still-booming oil and gas exploration industry, this will eventually bode well for PSL. The key, of course, is integration of PSL’s operations into MTQ’s such that there are synergies and better opportunities for cross-selling and bundling services/products to customers. More on this in Part 2.

Unfortunately as well, no information was given regarding the breakdown of operating profit or profit before tax of the various divisions, therefore it would be impossible to provide a detailed breakdown and analysis in this post. What I can merely do is to discuss some qualitative aspects of each division in Part 2 and summarize the efforts made since the last AGM to grow each division organically, and the fruits of those efforts in broad and general terms. When FY 2012 results are released, segmental information should be provided, and it will then be possible to give a more detailed and insightful breakdown.

Balance Sheet Review

Moving on the Balance Sheet, it can be noted that there have been significant changes since the last reporting date six months ago (as at March 31, 2011). This is due, in part, to the acquisition of PSL and the associated debt taken up as a result to fund the acquisition. One would note that fixed assets, goodwill, receivables and inventories have increased significantly, and can all be traced to not just the acquisition of PSL, but also the investment in the Bahrain facility. On a more dour note, cash and equivalents fell from $23.8 million to $15.7 million, and will be covered in greater detail in the next section.

Though current assets increased to $73.9 million, current liabilities doubled to $54.6 million, resulting in current ratio falling from 2.99 to just 1.35. If we factor in inventories and prepayments to compute the quick ratio, it looks even worse as the ratio plunges from 1.96 to 0.93, indicating lack of liquidity should inventory move too slowly. The main culprit for this is the increase in the debt load of the Group from $27 million six months ago (the Bahrain expansion Phase I had already accounted for this) to $$45 million (which includes about $19 million additional loans taken up for the acquisition of PSL). This additional debt load had pushed up gearing and net debt now stands at $30 million. Annualized ROE has also deteriorated to 11.5% against 14% a year back. Finance costs had increased five times to $505,000 for 1H 2012, and I would keep an eye out for finance costs in future periods as I do not think MTQ can reduce its debt burden so quickly.

The catch here is this – is MTQ decision to gear up a proper and correct one considering there are good opportunities for synergistic acquisitions and also good prospects for its Bahrain Facility? Given that the cost of debt is almost at an all-time low and their business model is a proven one with many years of track record, I guess I can give the Management the benefit of the doubt, for now. The key, I guess, is to keep a close eye on the numbers and to ask the right questions, because a growth company if not managed well can quickly sink into trouble, especially one which has geared up for an increased level of business activity which may not be readily forthcoming.

Cash Flows

The cash flow statement of MTQ is much more fluid and interesting as compared to SIAEC, though whether this represents a good thing or not is up for debate! Due to the numerous major corporate events during 1H 2012, there were also many movements in the statement which represent one-off items, and I will provide details on these and explain their impact (or lack thereof) in subsequent periods. As the Bahrain operations have yet to commence and pick up steam, please note that for this reporting period, operating cash flows portion may not be fully representative of the Group’s cash flow abilities.

There was a significant drop in operating cash inflows for 1H 2012 to $3.3 million, down 55% from $7.4 million a year ago. The main culprit for this is the increase in receivables and prepayments of about $7.2 million, probably due to the ramping up of activity in Bahrain and also due to the acquisition of PSL which saw the subsidiary’s Balance Sheet consolidated into MTQ Group. At face value, this large increase represents a worrying sign which should be monitored to review if it is merely a timing difference, or if it may represent problems in collection. Slightly higher income taxes were also paid (of $2 million) due to the non-deductible nature of some expenses. [Note: It is perhaps interesting to point out that for FY 2011, operating cash inflow came in at a very high and healthy $22.4 million, though this was subsequently offset by the high capital expenditure for the Bahrain expansion.]

Investing cash flows is where most of the “action” took place, and I am personally hoping that things will quieten down in this department soon. Actual capex was surprisingly low at just $5 million, and reflects the fact that most of the capex for Bahrain had already been incurred during 2H FY 2011. The main outflows, therefore, were two one-off items – that of the purchase of PSL costing $20.7 million (and likely to cost a little bit more due to the audit of the consolidated NTA position of PSL), as well as the purchase of more shares of Neptune Marine Services (NMS) costing $3.1 million. The result was a net outflow of $28.7 million. The good news (if it can considered that) is that negative FCF is just a small $1.7 million, and close monitoring must be made to ensure the operating cash flow impact is due to a timing difference (as previously stated).

For financing cash flows, not much is required by way of explanation as the previous section had already discussed the issue of MTQ’s gearing; therefore I am not surprised to see an inflow of $19.4 million being part of proceeds from bank borrowings. It is small comfort to me that the Chairman and CEO both chose scrip dividend to reduce the amount of cash outlay for payment of dividends to just $975,000. With such gearing, I would closely monitor their interest expense and cash outlay to make sure they are not over-stretched. Management is surprisingly sanguine over their prospects and do not seem unduly worried about their higher gearing and net debt position (I will provide justifications for this in Part 2, though I still maintain some reservations).


There’s probably not much to say regarding dividends, and the first major surprise came the same time last year when MTQ doubled its interim dividend from 1c for 1H 2010 to 2c for 1H 2011. The catch, of course, was that there was an option for scrip for the 2c dividend, and the Chairman and CEO both chose scrip to reduce the cash outflow impact and smoothen out the cash flow statement. This has continued for the next two dividends as well (including the current 2c interim dividend). Knowing that the two top guys will be choosing scrip and knowing that they feel confident about the direction the Company is headed, I have also been choosing scrip on the last two occasions and will probably continue to opt for scrip this time round as well. It is a cheap and cost-effective way to increase my stake in the Company and also to compound my dividends.

Part 2 will focus more on the qualitative aspects for MTQ, and will include a discussion on Bahrain (details to be supplemented with an interview with Mr. Kuah Kok Kim with The Edge Singapore), oilfield engineering division, PSL, a brief mention on Engine Systems, and finally on NMS.


setan said...

Hi MW,

Sorry for asking as I don't have any finance background.

What is the purpose of measuring current ratio?


Musicwhiz said...

Hi Setan,

Current ratio measures the ability of the business to pay off its current and most pressing liabilities, therefore it is a measure of Balance Sheet strength. The formula is current assets divided by current liabilities. So it is usually expressed as $X of assets to support $1 of liability. If this X drops below $1, then the business is "technically insolvent".

Hope this helps.


setan said...

Hi MW,

Thanks for clear explanation.

So the current ratio would be the higher the better.

Am I right?


Musicwhiz said...

Hi Setan,

Not necessarily so. A too-high current ratio (say 3 and above) would imply the company may be hoarding cash or having dangerously high Trade Receivable levels, and this may pose risks to growth (in the first instance, since ROE will be eroded by the cash hoard) and bad debts (in the second instance, since Trade Debtor days may increase due to slower collections). One must look at the composition of the current ratio and not just the number in isolation. A recent example would be GRP which has a current ratio of 5+, it was hoarding too much cash which was not being put to good use for growth (thus eroding ROE significantly) and also not being paid out as dividends.