Thursday, October 29, 2009

MTQ – Analysis of Purchase Part 2

Part 2 of my Analysis of Purchase will focus mainly on the various business divisions within MTQ and their performance since FY 2001 through to FY 2009. I have compiled tables for segment and business unit analysis based on net profit and EBITDA margins. Note that ALL information stated here is extracted from MTQ’s Annual Reports from FY 2001 through FY 2009, including press releases and financial statement filings on SGXNet (in other words, it’s all public information). I will also end off Part 2 with a little industry news and updates as this impacts the business of MTQ in the long-run and is thus considered important.

Business Divisions and Analysis

Oilfield Engineering Division

This division is in charge of maintenance of equipment and assets relating to oil fields and oil rigs, and MTQ is the authorized working partner for some of the world’s largest OEMs in wellhead equipment, and is accredited to carry out manufacturing and repair works in accordance to American Petroleum Institute Standards. The work they do includes (but is not limited to) reconditioning of Blowout Preventers (BP), drilling equipment, valves and manifolds etc. EBITDA margins are decent at an average of 26.6% over 5-years, with the most recent FY 2009 registering an EBITDA margin of 28.5%. For FY 2009, oilfield engineering now takes up 61.3% of revenues and constitutes 92.5% of EBITDA (the lion’s share).

Within this division are 3 business segments, namely oilfield equipment repair segment, fabrication segment and equipment rental segment. The main contributor for revenues come from their oilfield equipment repair segment, which services oil majors who send their equipment over to MTQ for repairs. They are the authorized workshop for OEMs such as Cooper Cameron, Shaffer Varco and QVM. The equipment rental business was only launched in FY 2005 to complement the existing oilfield engineering repair business, due to the increase in volume as oil prices rose and oil majors committed more capex to E&P acitivities (thus driving up the number of oil rigs and rig-related machinery and equipment).

Surprisingly, after digging up the FY 2001 AR, it showed that MTQ had exited the foundry business in Malaysia due to lack of competitiveness and limited growth potential. They were also heavily into marine sector (repair of ships and related shipping equipment) before deciding to exit due to severe competition and higher wage costs. The exit was done in FY 2002 and an exceptional gain was booked in FY 2003. Thus, it would seem that years of streamlining this division has finally made it the best revenue contributor, and that the Group has found its niche.

From the analysis, since FY 2001 to FY 2004, EBITDA margins for this division averaged about 13.6% as the Company was mainly doing fabrication work, and also because for FY 2001 and FY 2002, there were contributions from the marine engineering business which had lower margins. Margins improved dramatically from FY 2005 onwards, starting at 21.3% and ending in FY 2009 at 28.5%, averaging 26.6% over these five financial years.

During FY 2004, this division turned in a lacklustre performance due to slower E&P spending by oil companies amid a cyclical downturn. But MTQ took the opportunity to upgrade their equipment and assets as well as manpower training. It was anticipated (at the time) that higher investments in drilling equipment over time would ensure adequate workflow for the division in future years. Their equipment renewal and upgrading program ensured faster turnaround times and greater efficiency (see milestones).

It should be noted that for FY 2001 and FY 2002, this division did significantly better than in FY 2003 and FY 2004 when MTQ reported a cyclical downturn in the oil and gas industry. Note too that for as oil prices have remained high, FY 2007 through FY 2009 saw much increased revenues for this division.

Milestones and Progress for Oilfield Engineering Division

· FY 2001 – Hived off all oilfield activities into Metalock Oilfield Services Pte Ltd;
· FY 2002 – Secured repair works from petrochemical plants and refineries on Jurong Island. Planning to renew and upgrade facilities;
· FY 2003 – Secured strategic business alliance with OEM, and became authorized workshop for Cooper Cameron, Varco-Shaffer and Hydril;
· FY 2003 – Invited by listed Indonesian drilling contractor PT Apexindo Pratama Duta Tbk to participate in providing drilling equipment and services;
· FY 2003 – Addition of 2 new boring machines, 1 vertical boring machine (capable of 30-ton load) and 1 heavy duty horizontal boring machine with table load of 25 tons and full CNC capabilities;
· FY 2004 – Successfully completed the engineering, fabrication and assembly of an inlet manifold skid for the extension of 5 additional wells on an oilfield platform;
· FY 2004 – Successfully adopted the twin welding procedure which significantly improved production time;
· FY 2005 – Equipment rental business launched within the division
· FY 2005 – Strengthened sales force to foster better and stronger business relationships with OEMs and rig builders.
· FY 2006 – Capital investments made to upgrade the workshop’s capabilities to handle more complex jobs which are beyond the capabilities of smaller competitors
· FY 2007 – More spent on upgrading and renewing machinery and equipment to cope with increased work activities.
· FY 2007 – Plans for new expansion into the fabrication of subsea production structures.
· FY 2009 – Regulatory approval obtained to construct a new state-of-the-art facility in Bahrain similar to the one in Singapore, but on a larger scale.

RCR Tomlinson

RCR Tomlinson Limited (“RCR”) is a multi-disciplinary engineering company listed on the Australian Stock Exchange (ASX), and in FY 2003 MTQ acquired an additional 3% interest in RCR for A$229,320 (about S$240,000 – 1,274,001 shares at A$0.18 each) , increasing their interest in the Company to 22.9%. At the same time, in FY 2003, they made a bid of A$0.25 per share for all the remaining shares in RCR that MTQ does not already hold. They had already acquired 19.9% of the Company in FY 2002 (June 2002) but it was not disclosed in the Notes as to how much they paid for it.

In FY 2004, it was reported that MTQ’s bid for buying over RCR was unsuccessful but they managed to raise their stake to 28% from 22.9% (buying over additional shares at A$0.25 per share) and re-classified it as an associated company. In FY 2004 AR, it shows their cost of investment as being S$5.306 million. With 1% of RCR being represented by 424,667 shares, 28% would represent about 11,890,676 shares. This would mean their cost per share is about 44.6 Singapore cents per share (by deduction).

In FY 2005, the Group’s share in RCR was diluted to 22% from 28% after a share placement exercise conducted by RCR in December 2004 (to raise A$10.3 million). And in FY 2006, MTQ were further diluted to 19% as a result of another share placement exercise by RCR (but the Group did spend some money to purchase additional shares in RCR).

As at FY 2007, MTQ’s share in RCR stands at 16%, consisting of 18,910,806 shares which are valued at market value S$36.04 million. As reported, their cost is only S$18.51 million and total unrealised gain is S$17.53 million, representing a gain of almost 94.7% !

In FY 2008 MTQ disposed of their entire stake in RCR and netted an exceptional gain of S$40.79 million, which means they sold it at a market value of S$59.386 million. As a result of this, they netted cash of S$59.3 million and declared a special dividend of 24 cents per share.

Engine Systems Division

This division started off as the “Turbocharger” division (from FY 2001 AR) and was finally renamed to its current name in FY 2003 after the acquisition of RM Diesel Pty Ltd in August 2002. They distribute turbocharger and fuel injection parts and provide turbocharger services.

Much of this division’s revenue is dependent on the Australian economy as they are Australia’s largest independent turbocharger sales and service company. In FY 2003, this division successfully entered the fuel injection spare parts business by acquiring the business of RM Diesel Pty Ltd (Australian company), thereby making inroads to Melbourne and Perth. The division also acquired Turbo Torque Pty Ltd (a Brisbane-based Turbocharger sales and services outfit) in late FY 2003. In the same financial year, they also incorporated a subsidiary in Surabaya to cover the Indonesian market.

EBITDA margins for this division are much poorer than for oilfield engineering, averaging about 11% from FY 2001 to FY 2004. There was a sharp drop in EBITDA margin from FY 2005 onwards (at 5.8%), and in FY 2006 the division recorded an EBITDA loss of –5.4%, with a total 5-year average of just 1.4% (I would term this “dismal”). Suffice to say that it is fortunate that oilfield engineering’s contribution to revenue is steadily increasing since FY 2006 (from 34.5% to the current 61.3%), otherwise my misgivings about this division would probably cause me to avoid MTQ altogether. The shift shows that Management is aware of the poorer performance of this division as compared to oilfield engineering and are thus shifting their resources and energies towards growing that instead.

On a net profit basis, engine systems has always had very low margins, and is not the sort of business which I can see the Management continuing for an extended period of time as it was only profitable in FY 2009 and was bleeding most of the time from FY 2005 to FY 2008.

Milestones and Progress for Engine Systems Division

FY 2001 – Named “Turbocharger” division. Recognized first full-year contribution from Dynamic Turbocharger Services (Australia) Pty Ltd [DTS] which was acquired in November 1999.
FY 2001 – Studying feasibility of leveraging on the competencies of DTS as the leading independent supplier of turbochargers in the Southern Hemisphere (i.e. Australia) and replicating its business model in South-East Asia.
FY 2002 – Plans to introduce value-added services to complement its existing turbocharger operations.
FY 2003 – Renamed “Engine Systems Division”, and entered the fuel injection spare parts business by acquiring the business of RM Diesel Pty Ltd (Australian company). Also acquired Turbo Torque Pty Ltd (a Brisbane-based Turbocharger sales and services outfit).
FY 2003 - Incorporated a subsidiary in Surabaya to cover the Indonesian market.
FY 2004 – Integration of fuel injection business into nation-wide network. Also, plans to expand to other major Indonesian cities.
FY 2005 – Severe competitive pressures and costly integration efforts caused the division to plunge into a loss for FY 2005, despite a marginal increase in revenues of 3%. Indonesian operations have yet to make a positive contribution to the Group.
FY 2005 – New facility set up in Rockhampton, Central Queensland, to support the mining industry; and the division is actively pursuing new markets which could provide vertical integration.
FY 2006 – New systems integration process put in place which consumed Management time and resulted in significant cost overruns.
FY 2006 – Establishment of “Sonic” brand, an MTQ-owned brand name, in the auto aftermarket performance products segment.
FY 2006 – Expansion of fuel injection parts distribution business throughout Australia.
FY 2007 – Able to offer better product range to customers and consolidated its position as a “one-stop-shop” in Australia.
FY 2007 – MTQ was appointed as Master Distributor for SIEMENS VDO for fuel injection in Australia and New Zealand.
FY 2008 – Investment in clean rooms was made in Dendanong and Adelaide to ensure MTQ maintains high technology standards.
FY 2008 – Investment in a vehicle dynometer for Dandenong operations to provide a complete service package for customers.
FY 2009 – Financial crisis and bad weather conditions in Australia have dampened performance of this division. Development of “clean room” facilities has seen growth in the overhaul of common rail pumps.
FY 2009 – More resources will be channelled to grow sales of “Remanufactured” turbochargers and fuel pumps; and the division will look for opportunities to expand product portfolio through Denso and Bosch. (Incidentally, just yesterday on October 28, 2009, it was announced that MTQ had tied up with Bosch for a strategic partnership to distribute Bosch products in Australia).

A segmental net profit analysis by business division is provided in the tables below:-

Industry News and Updates

Since most of MTQ’s business relies on oil majors spending capex on E&P and investing in oil rigs, it pays to monitor this industry to see if there is indeed sustainable demand for MTQ’s services.

From my understanding of the oil and gas industry due to my investments in Ezra (and previously Swiber), oil majors did cut back on a lot of spending during 2008 as oil prices plunged from a record high of US$147 per barrel to US$30 per barrel. Prices have since rebounded to hover around US$70 per barrel, and with the recession ending soon for most economies, there is room for higher demand for energy which may push prices up further.

The latest news is that Petrobras has commissioned 28 high-capacity oil rigs to explore Brazil’s latest oil find, and more rigs will come on-stream in future as there have been significant oil finds recently, which will require more repair and refurbishment services for oil majors. In other words, the pie itself is growing and MTQ is strategically positioned to provide their oilfield engineering services to these clients.

The oil and has majors who are operating from the Middle East will also need their equipment repaired, and with MTQ’s reputation they will send their equipment to MTQ once they establish their new facility there. This has good long-term implications and an investor must be very, very patient in order to reap long-term benefits.

As of this post, oil prices are hovering around US$80 per barrel, which is a high for 2009 thus far. With the sustained recovery in the economy, this will trickle down to higher demand for oil and gas and will act as an impetus to push oil prices higher over the long-run. The weak USD is also contributing to the rally in commodities in general (with Gold prices hitting an all-time high recently).

Watch out for Part 3 of Analysis of Purchase in a subsequent post. Part 3 will discuss dividend history, share buy-backs, insider purchases, prospects in Bahrain, as well as provide a pros and cons analysis which led to my final decision to purchase.

Note: MTQ had just released their 1H FY 2010 results yesterday. I will be doing an analysis and review some time in the next few weeks; as well as provide a brief summary for my end-Oct 2009 portfolio review. Note too that my portfolio review will be done on November 1, 2009 instead of the previously mentioned October 31, 2009.

Friday, October 23, 2009

Ezra – Full Divestment, Rationale and Lessons Learnt

This was not supposed to be such a quick follow-up post to my just concluded Analysis of Ezra’s FY 2009 financials, but certain corporate actions made by the company necessitated my immediate action and attention and which compelled me to act.

Securing of US$1 Billion Chim Sao FPSO Project by EOC

Immediately after my posting on Wednesday morning October 21, 2009 of Part 2 of my analysis and rationale for partial divestment, Ezra dropped a bombshell by announcing that its 48.5% associated company EOC had clinched the much talked-about Chim Sao FPSO deal, which was worth US$527 million for the first 6 years and US$477 million assuming an option is exercised to continue for another 6 years. Thus, the total value of the contract is US$1,004 million over 12 years, or if smoothed out equally, will represent revenues (not profits) of about US$83.7 million per year. The worrying aspect of this announcement is how EOC are going to fund the conversion of a deadweight tonne oil tanker into an FPSO as they are already very highly geared (2.31x as at August 31, 2009). It immediately became clear to me that EOC (through Ezra) would have to do some fund-raising to be able to take on this project, and I was proven right (see next section on Issuance of Convertible Bonds).

Note that although the press releases from Ezra and EOC both tout the value of the contract and talk about stable revenue contributions and asset utilization for at least the next 6 years, I actually analysed the situation and came up with a different perspective:-

1) Assuming additional revenues of US$83.7 million per year, and assuming a very healthy net margin of 20% (gross margin for Offshore Support Services is 38% as at August 31, 2009, so 20% is reasonable to assume for net margin, albeit a little optimistic), this means an additional US$16.74 million worth of profits accruing to EOC each year. Since Ezra owns only 48.5% of EOC, this means they only recognize an additional US$8.12 million per year on a Group basis. This only constitutes about 11.6% of their core FY 2009 net profit, and thus cannot be considered very significant. This is because of the risks to be factored in when taking on a project of such massive size (see point 2).

2) The first FPSO deal clinched by Ezra and announced in 2006 experienced many delays and hiccups as first gas took very long to achieve, and in fact it was only today (October 22, 2009) that Ezra announced that the client had commissioned and accepted the FPSO, with almost a year of delay between deployment to production of first gas. Originally, it was announced that Lewek Arunothai would contribute to 1Q 2009 revenues; but this has since been pushed back all the way to 1Q 2010. This demonstrates the technical difficulty of operating an FPSO, and for the Chim Sao Project the complexity may again lead to delays of a similar nature.

3) Note that EOC mentions that the FPSO would be owned by “4 entities”, though it does not give details of these entities and whether they are part of Ezra Group. Assuming that the entities are external parties, this may imply that EOC may only share up to 25% of the revenues accruing from the FPSO. This makes Point 1 assumptions drop by 75% to just about US$2 million accruing to Ezra Group per year.

4) The EOC announcement also mentions that EOC and a Vietnamese partner will be operating the FPSO, which essentially means the risks are borne by EOC in terms of operational capabilities and execution. Note that a delay similar to the one experienced by Lewek Arunothai could result in additional costs and damages should the client decide to pursue legal action (which I assumed did not happen, but one cannot assume the same for Chim Sao Project).

Viewed from this perspective, it would appear that the deal may not be as lucrative as envisaged, especially if it comes from the angle that the revenues accrued to Ezra Group may not be significant (pending more clarity on the 4 entities and shareholding structure for the new FPSO), but that EOC is taking on a large portion of the costs and risks relating to the financing and operation of the FPSO. There is also concern from yours truly on EOC’s ability to finance an FPSO since its gearing was so high, and I was frankly very surprised that they clinched the deal, as during the EGM I had brought up the point to Management that I did not think EOC would be able to handle the second FPSO as it was highly geared (they did not give me a reply on this).

Issuance of 5-Year 4% Convertible Bonds Worth US$100 Million

As predicted, Ezra announced on the morning of October 22, 2009 that it would be issuing (through DBS), 5-year 4% convertible bonds worth US$100 million, presumably to fund the FPSO as well as for expansion and general working capital purposes. The details can be found in the release on SGXNet, so please check it out on your own. Effectively, they argued, the convertible bond would lower their gearing when converted (conversion price set at S$2.50 per share) to just 8%, and “strengthen their Balance Sheet”. Perhaps they also forgot to mention that in the case where the bonds are NOT converted, they represent even more debt being piled on to their books (Ezra is now taking up the gearing since EOC is already massively over-leveraged). And even if they are converted, the only reason gearing drops is because the share capital base increases by 55.86 million while debt drops as a result of the conversion. So in effect shareholders have to choose between even more debt (and associated interest expense of 4% per annum) or 8.5% dilution based on the existing issued share capital of 658 million shares.

Personally, I feel that this may not be the last time Ezra heads to the capital markets for fund raising, and it is making me very uncomfortable as to how the Group persistently and consistently raise money through financing activities and not operating activities. Their cash burn rate is basically very high and the Group seems to thrive on issuance of shares and increasing their debt. I had once erroneously assumed that Ezra would be able to achieve stable positive operating cash inflows once they had stopped their fleet expansion and tied up their long-term charters; but it seems that this was not to be. Their relentless focus on expansion by taking on the second FPSO and also the purchase of Ice Maiden confirms that more dilutive fund-raising is on the cards, and probably a lot more debt will be loaded on both EOC and Ezra’s Balance Sheets. This is an unacceptable situation to me as an investor.

Other Pertinent Factors

As mentioned in my last post analysing Ezra’s financials, the receivables level has remained persistently high for the last few quarters which shows that revenues are recognized aggressively, while cash collections have taken a back seat. This is a very alarming trend and may indicate some problems with collection even though, as Ezra states, their clients are reputable multi-national oil companies and oil majors who would (presumably) have no problems in paying on time. As their Energy Services Division was the fastest growing division for FY 2009, and since most of the ballooning in receivables came in during FY 2009; it would be safe to assume that this division had the longest credit terms extended, and it is currently doubtful as to whether these receivables are collectible.

During the EGM, Management had also mentioned that their Vung Tau yard would take a back seat and would be left as a Greenfield project. This was somewhat surprising as my understanding was that Saigon Shipyard was already fully utilized and excess capacity for fabrication contracts could be channelled to the new yard instead. This could imply that there is no urgency to build up their new yard, or there is a lack of funds to develop this yard further without once again tapping the secondary market.

Ezra’s Business Model – High Revenue and Profit Growth at the expense of Positive Operating Cash Inflows and Balance Sheet Strength

Ezra’s business model is inherently as described in the title above – boasting high CAGR growth in revenues and profits but most of the time neglecting their Balance Sheet and Cash Flows. Frankly, this had not changed since FY 2005 when they conducted their sale-and-leaseback transactions to free up cash and quickly expand their fleet, and they are now finding ways to get cash from the markets and from loans once again. The old-fashioned method of funding growth through recurring operating cash inflows seems to have been forgotten in their relentless quest to secure higher profits and revenues. This is an untenable situation for me as an investor and my original rationale for investing in Ezra (with the flawed assumption that it would cease aggressive asset buildup and instead build up a war chest of cash) is now gone.

Full Divestment and Lessons Learnt

As a result of the explanations above, and coupled with the discomfort I felt during the EGM, I have fully divested my position in Ezra today at a price of S$2.05, booking a gain of 226% of the remaining portion of my stake (the previous batch was sold at S$2.01 on October 16, 2009). The total realized gain on divestment of Ezra is around 222% for my entire stake, and taken over 4 years this amounts to approximately 55.6% per annum. This will be fully reflected in my month-end October 2009 portfolio review.

Notwithstanding the fact that I had booked a gain on the divestment of Ezra, I will still classify Ezra as an investment mistake and model “case study” on the type of companies to avoid investing in; due to the fact that such an aggressive model does not constitute a prudent value investment and also the fact that leverage is so high (blended gearing of EOC + Ezra) makes this a very risky investment whether during good times or bad. There is much to learn as I mull over my efforts and analysis over the last four years; including analysing all quarterly reports, reading all Annual Reports, attending all AGM/EGM and speaking to key Executives of the Company. Another minor point I would like to bring up is also of the “marketing” and “glossy” nature of the press releases churned out by the Company, similar to those which I mentioned for Swiber (which I had divested in August 2009). A lot of the positives and optimism has been factored into Ezra’s share price at this point in time, and it is trading at a dangerously high valuation considering there are so many risks in execution and also with a weak Balance Sheet and Cash Flows.

As a result of what I had learnt, it would seem that I had been speculating rather than investing as my original premise for investment was itself flawed. In short, I was mistaking myself to be investing when actually my grounds for investing did not conform to value investing principles. For this, I am regretful and will endeavour to learn from this mistake and avoid repeating it when analysing future companies for investment. More focus will be placed on Balance Sheet strength, net cash position and recurrent operating cash inflows instead of just Profit and Loss and margin numbers.


I would like to express my gratitude to Donmihaihai and d.o.g. (initials for “Disciple of Graham”) for highlighting salient aspects of Ezra’s Balance Sheet and Cash Flows to me and which helped to complement my own research into Ezra. Donmihaihai’s post on Ezra can be found here, while d.o.g.’s take on Ezra is detailed in this link, in which I had also contributed my thoughts, views and opinions. I humbly accept constructive criticism for making this post, but be warned that any post which constitutes troll behaviour will be immediately and irrevocably deleted without further warning.

Disclaimer: All views expressed above are personal and do not constitute a recommendation to either buy or sell shares of Ezra. I will not be held responsible for any actions relating to the profits or losses made as a result of relying on this blog post. Note that such decisions involve hard-earned money and should not be taken lightly or frivolously.

Wednesday, October 21, 2009

Ezra – FY2009 Financial Analysis and Review Part 2

This is part 2 of my analysis and will focus on dicussions on EOC, shipyard, fleet management contracts and other salient aspects. Note that there are many facets to a company and I choose to cover those which I feel are more impactful in terms of the long-term prospects of the Company, and I may leave out minor aspects this time around if they do have any significance in this discussion.

EOC and Shipyard Updates

It was recently announced on October 12, 2009 that EOC’s Lewek Champion was awarded a contract worth US$11.2 million by NuCoastal, and this was confirmed to be a bridging contract as the vessel is now between projects, and is under negotiation for more long-term charters to ensure cash flow stability. The other two vessels Lewek Conqueror and Lewek Chancellor are both chartered out to Brunei, though the charter for Chancellor is ending in Nov 2009 and it under negotiation now. Lewek Conqueror has the longest firm charter extending till March 2014, but for the other two vessels (excluding the FPSO Lewek Arunothai), the contracts are shorter and have to be renewed.

Another issue is that 48.5%-owned EOC has very high debt-equity ratio of 2.31x (up from 2.12x as at August 31, 2008) and it was NOT mentioned on how EOC planned to reduce this gearing. If this gearing was added to Ezra’s gearing, it would present a significantly different picture as the overall gearing of the Group would be substantially higher. Recall that Ezra managed to hive off EOC in a separate listing on Oslo Bors in 2008, freeing up cash in the process and also removing a large chunk of their (then) debt. But the debt cannot be wished away, and it now resides on EOC’s Balance Sheet instead. This could be a major risk moving forward as EOC owes a sum of US$32.8 million to Ezra and as yet will be unable to pay up unless they find a way to reduce their gearing. The good news is that EOC have positive operating cash inflows but also has high capex requirements (op cash inflow +US$37.8 million for FY 2009 but invest cash outflow US$107 million). Thus, most of the cash still has to come from financing activities (+US$68.7 million for FY 2009) to finance this growth.

As for Saigon Shipyard, according to Management it is now operating at full capacity and they see the potential for more fabrication and construction contracts in the near future. Note too that the yard will be used to construct the new ice-class vessel Ice Maiden and this will require more cash outlay. At this point in time, not much else is known about how much time, effort, resources and cash is needed for this project. Management also mentioned scaling down the development of their second yard at Vung Tau for now and it remains a Greenfield project.

Fleet Management Contracts

Ezra recently announced a fleet management contract whereby they get to provide expertise to manage 4 AHTS owned by a specialized fund, in return for a 50% share of the profits. From my conversations with Management at the EGM, it seems that this Fund had been one of many which tried to “flip” vessels during the boom years in 2007, buying and selling quickly to make instant gains. Unfortunately, it got caught by the financial crisis and could not sell off its vessels at a profit (their value had since gone down) and these vessels are now being constructed and will be chartered out to clients once completed. Since the specialist fund has no idea how to operate these vessels (as they were just an opportunistic bunch) and has no manpower available, they engaged Ezra who will provide the manpower and the expertise. Thus, this represents a fixed cost to Ezra (to deploy any excess capacity to man these 4 vessels) and can be viewed as pure profit as no capex is required. However, I also get the impression that such deals are ad-hoc in nature as it’s not every day that you see Funds sitting high and dry with assets lying idle. Hence, this may be one of the methods Ezra uses to grow without capex but I do not think it can be done so consistently enough.

Purchase of ROV (Remotely Operated Vehicles)

Ezra also recently announced the purchase of 5 ROVs for US$23 million from Triton, in order to install them onto their own vessels to enhance operational capabilities. Further clarification at the EGM told me that these ROVs would actually be installed onto the vessels itself (instead of being used independently) to conduct deep-sea operations and this can significantly enhance the operating flexibility of each vessel, which is in line with Ezra’s commitment to providing more value-added services to customers.

FPSO Matters

It has been reported that EOC is the front-runner for the Chim Sao FPSO Project in Vietnam, but that due to financing issues, EOC could not successfully bid for the project. This is quite a pity because it EOC can secure this second FPSO it would really be able to showcase their talents and put them on the global stage against major FPSO competitors. As such, its gearing level is simply too high to take on more debt at this point, and I feel a share placement or some other form of innovative financing may be required for it to secure the Chim Sao Project.

Meanwhile, Lewek Arunothai has also encountered teething problems in drawing first gas and the delay has been extending since 2Q 2009. Management has said that the gas is not yet commercially recognized by the client and they hope revenues will be able to flow in to EOC from 1Q 2010 onwards. Otherwise, since the announcement of the FPSO contract in 2006, it has been about 3 long years with still no revenue contribution from this FPSO.

Deepwater Subsea Division

Management has come up with a comprehensive set of presentation slides for the formation of their new deepwater subsea division and they have plans to package complete solutions for clients so that they can become a “one-stop solution” for customers. This will make Ezra a more attractive service provider and also mitigate risks for customers as they will have to deal with just 1 party instead of more than 1, and with vessels ready to be deployed at many stages in the O&G cycle. I hope that this division can improve its gross margins from the current 13% and also garner higher value contracts since Ezra will be offering packaged solutions. It remains to be seen if more significant capex is needed but from the way Ezra’s business model has worked in the past, I suspect this trend will continue at least until 2015 (which is the time they projected till).

The “Ice Maiden” – An Ice-Class Vessel

If one looks closely at the share placement fund proceeds utilization, Ezra had spent about US$6.15 million purchasing the shipset of a vessel called “Ice Maiden” from Silters & Co. This is an ice-class vessel which is capable of working in harsh Arctic waters and was part of a high-profile Shell contract back in 2007 before it was abandoned in 2008 due to cost overruns. Ezra has mentioned that they bought the vessel at “distressed” prices and that such vessels, being rare, can command premium charter rates. Ezra’s shipyard will build the vessel and it is expected to be completed around FY 2011/2012; so not much will be known about this until then, and whether or not it can be chartered out (and at what rates). In terms of expanding their deepwater subsea offerings, this represents a maiden (but tentative) step in the right direction but I would caution that it is premature to be too optimistic at this point as there are still many unknowns and uncertainties surrounding this latest acquisition, even though the press release is worded with a very positive slant.

Partial Divestment of Ezra – Rationale and Reasons

As a departure from my usual investment philosophy of buying and holding, I had decided to divest a portion of my holdings in Ezra at a price of S$2.01 last Friday October 16, 2009. This divestment has wholly covered my entire cost of investing in Ezra and my remaining stake in Ezra represents pure profit. I will account for the partial divestment by using weighted average costing (i.e. S$0.629 as my purchase price), thus recognizing a gain of about 220% on my investment. This is due to the “Matching” concept used in accounting whereby the revenues generated from partial divestment must be matched to the exact costs relating to the revenues; so even though the total proceeds represent a return of my full cost I still have to account for it as such. The reasons for the divestment have been stated all over my analysis, but I will summarize them here (and add a few more) for simplicity and convenience:-

1) Valuations are high at about 13x and a lot of positives, optimism and expectations have been factored in. In short, Ezra is probably trading at a premium to intrinsic value based on valuations alone, and other factors I had mentioned in my analysis has also heightened the risk in the Company;

2) Weak and leveraged Balance Sheet as shown by gearing rising and debt levels increasing,

3) Cash Flow Statement shows negative operating cash flows and most of Ezra’s cash is coming in through financing (i.e. bank loans, bills and share issuance),

4) A certain amount of uncertainty and risk lies ahead in its venture to expand their deepwater sub-sea segment, and I have no doubt it will be capital-intensive, which implies more fund-raising in the future either through dilutive share placements or perhaps even issuance of convertible bonds.

5) Ezra’s business model entails growth through expansion of their asset base, and these assets are costly and specialized. Thus, they always have to incur capex on expensive assets in order to deploy them for cash flows. I have asked and confirmed that the payback period for a vessel is about 4 years; but that is assuming charter rates stay at current levels and that the vessel can be utilized all the while (i.e. no down time or idle time).

6) Risks would include delays in delivering vessels on time, thus incurring penalty charges from the client which could wipe out a significant portion of their profits (due to high fixed costs and depreciation per day); as well as the risks of managing a more complex corporate structure as a result of rapid expansion.

Evolution of my Value Investment Philosophy

Admittedly, the partial profit-taking on Ezra represents a fundamental shift in my investment philosophy, and is a result of modifications and evolution from reading up and thinking on various issues. I was reading up a lot on when a company was considered over-valued, how to hedge my risks, when to sell as well as portfolio management techniques. I have realized that portfolio management is a necessary part of being an investor, and even value investors need to know when to divest (whether partially or completely). Warren Buffett continually divests if he sees better opportunities, if a company has exceeded his computation of intrinsic value or if the original intention to invest has changed.

Selling off an investment which is trading at 13x and perhaps deploying the proceeds to another company which is trading at 4-5x is a more efficient way of allocating capital, as Mr. Market may have realized the value of certain companies much faster than I had anticipated. Note that I have not totally exited this investment as I believe there is still potential for growth in Ezra; but for now my risks have been mitigated and the rest of my stake represents pure profits. Based on my holding period of 4 years and a gain of 220%, this translates into an average annual gain of 55% (not accounting for compounding effects). The gains will be reflected as an addition to “realized gains” in my next portfolio update on October 31, 2009, and my portfolio cost will also be adjusted accordingly.

Sunday, October 18, 2009

Ezra – FY2009 Financial Analysis and Review Part 1

Ezra released their FY 2009 financial statements on October 15, 2009 and this is my analytical review and take on it, in the same vein as I had done for previous analyses. Note that while I had tried to keep the analysis short and within 1 post, I realized this was not really possible if I were to really do an in-depth analysis, as the Company had grown much larger and more complex since I purchased it 4 years ago. The scale and scope of their operations has expanded significantly and they are a different animal now. The analysis will be split into the usual parts for Income Statement, Balance Sheet and Cash Flow Statement. There will also be discussions on their fleet, shipyard(s), EOC, plans for the future, as well as the latest announcement on the “Ice Maiden”.

Income Statement Analysis

4Q 2009 revenues actually fell 22% from a year back, from US$119.2 million to US$93.5 million; but no explanation was forthcoming from Management as to the reasons for this drop. They concentrated mainly on commenting on FY 2009 revenue, which was up a respectable 23% from US$268.3 million to US$329.4 million. The reasons were due to full-year recognitions of Lewek Kestrel and Lewek Kea for FY 2009 compared to just 2-8 months for FY 2008. There was also 10 months contribution of operations from 1 AHTS, Lewek Plover, which added to the increased revenues for offshore Support Services Division. Marine Services division saw a rise in revenues due to higher fabrication work done as a result of the 3 contracts awarded to Saigon Shipyard, and they are currently working at full capacity. The new Energy Services Division (soon to be incorporated into the Deepwater Subsea Division) saw a rise in revenues of US$17 million, but unfortunately had the lowest gross margins of all the 3 divisions (13%).

Other operating income was not totally comparable, as 4Q 2009 saw an exchange gain but for FY 2009, there were losses from cancellation of shipbuilding contracts which dragged down profits. For FY 2008, the exceptional gain was relating to Ezra’s divestment of EOC by listing it on Oslo Bors. If we compare purely on gross margins, 4Q 2009 saw a big jump in margins from 23.4% to 29.2%, probably due to the change in sales mix. For FY 2009, gross margins were 30.7%, slightly higher than FY 2008’s 29.7%. Margins for marine services jumped from 18% to 24% while for energy services, they remain at 13%, and this probably contributed to the slight improvement in blended gross margins.

Financial expenses (being interest on bank loans and borrowings) are worrying as they increased 34% year on year from US$6.6 million to US$8.8 million, and Ezra has been piling on more debt to finance their fleet expansion as well as to spend on their yard. This will be commented on more in the Balance Sheet and Cash Flow Statement. The main reason for the better performance for 4Q 2009 compared to 4Q 2008 was due to better gross margins, an exchange gain instead of loss, lower admin expenses due to absence of one-off provision for staff costs, as well as higher share of profit from JV. Ezra’s press release mentioned a rise in core net attributable profit by 80% to US$70.2 million, and their presentation slides show a beautiful chart with CAGR 66% for revenue over 6 years, and CAGR 63% for recurrent PATMI over the same 6 years. But the cost of this is higher dilution for shareholders, higher debt and higher risks as well. I shall explain in the later sections.

Balance Sheet Review

Ezra’s Group Balance Sheet actually has a lot more things to be pointed out than their Income Statement; yet somehow press releases and analysts always love to focus more on the Income Statement than Balance Sheet. A Balance Sheet shows the health of the business and is as important (if not more) than the Profit and Loss Statement.

Fixed assets had risen by a good deal due to Ezra’s fleet expansion plan, and everything is going as per scheduled, with 2 MFSVs coming on stream in FY 2010 and FY 2011 and another 4 AHTS as well. Another notable is that AFS investments had increased more than 100% due to the sharp rebound in the stock market, while the long-term receivable from EOC still stands at US$32.8 million. With EOC’s gearing being so high (at 2x+), it will be tough for Ezra to recall this loan, so this is a potential red flag.

Looking under Current Assets, trade receivables had increased by more than 100% from US$87 million to US$182.7 million, and is quite alarming if you compare it against the 23% increase in revenues. It was mentioned that Energy Services gave longer credit terms to customers and this is the division which Ezra plans to build, so this would have increased their receivables days significantly and resulted in their Trade Receivables ballooning in relation to their increase in revenues. I would label this as a red flag as well because the potential for bad debts is much higher with the loosening of credit terms. Though one can see that cash and bank balances remained high at US$161 million (FD + Cash and bank balances), as compared to FY 2008’s US$153 million, most of it was generated from Financing Activities (more under Cash Flow Analysis).

Trade Payables, on the other hand, dropped by about 50% which implied faster payments to suppliers; while bills payable to banks increased by about 100% as Ezra borrowed more from banks to finance higher volume of activity. Short-term bank term loans also increased from US$81.8 million to US$96 million while long-term bank loans more than doubled from US$52.2 million to US$128 million. All these point to worrying signs that debt is growing quickly and though the Company maintains that gearing has risen from just 0.5x to 0.6x, one must look at it from the perspective that the equity base keeps increasing, thus the numerator when divided by the denominator results in a nominally small increase in gearing ratio. The reality is that debt is growing at a fast clip and this is very risky as expansion plans may not pan out as expected. Ezra’s business model is capital-intensive by nature and their Management team is also very dynamic and forward-looking in trying to identify future growth drivers and taking the Company to a new level. Though this may seem like a good thing for shareholders, it entails significant risks and leverage and is an unavoidable aspect of Ezra’s business model. It is not easy to feel comfortable with it due to the high gearing and the frequent fund-raising efforts from the secondary market.

Cash Flow Statement Review

The cash flow statement is worrying because it demonstrates that Ezra is growing purely based on cash from financing activities (i.e. bank loans and share issuance) and not by recycling its operating (working) capital. It was originally my hope as a shareholder just as recently as one year back that Ezra would be able to finally reduce its capex commitments and generate decent and consistent positive operating cash flows, meaning it would have entered the “mature” phase of the product life cycle and would have excess cash (net cash) with which to use for M&A, distressed asset purchases or for paying out as dividends. Instead, apparently I was quite wrong as the Cash Flow Statement demonstrates. The dividend yield is also very pathetic at just 0.74% (1.5 Singapore cents) based on closing price of S$2.02 on October 16, 2009, and I was surprised they did not just retain the cash for expansion as they seem to have many more capex commitments in future.

Operating cash flows were a negative US$26.2 million, mainly due to much higher trade receivables amounts and also lower payables, coupled with lower other payables and accruals. Though operating profit before working capital changes was higher for FY 2009 at US$81.7 million as compared to FY 2008’s US$47.8 million, there was more cash spent on funding customers and paying creditors more promptly, which resulted in negative operating cash flows. Capex remained high as US$190 million was used to purchase fixed assets and assets held for sale, and this was only partially offset by a one-off refund from termination of shipbuilding contracts, or else net cash used for investing activities could have hit US$162 million. This alone, coupled with a net cash outflow of US$26.2 million for operating activities, added up to nearly US$189 million of cash outflows.

It’s very telling when the bulk of cash generated for a company’s full-year operations comes mainly from Financing Activities, but for Ezra it could have been more stark. Bills payable yielded US$24.7 million, while additional bank loans brought in US$89 million and the July 2009 share issuance of 78 million new shares at S$1.185 generated proceeds of US$62.7 million. These 3 activities alone helped to bring in much-needed cash which operating activities could not provide sufficient amounts of, and has, in the process, increased gearing and diluted shareholders. Depending on how you look at it, I would say this is not a very good trade-off.

Capital Expenditure Plans

As of today, Ezra has not announced any further plans for capital expenditure in order to expand its fleet. Thus far, the 2 MFSV and 4 AHTS which are coming on board are proceeding smoothly and there have been no reported delays in the respective shipyards (unlike what happened with Karmsund back in 2008). From the presentation slides Page 10, committed capex as at Aug 2009 was US$190 million, and this is roughly the size of their current cash balance as at August 31, 2009. Estimated spending in the next 2 years amounts to another US$190 million, and I would think this does not include ad-hoc expenditures on accessories such as ROVs (recently bought at US$23 million), and other minor equipment. This would also probably not take into account the new Ice Maiden project in which Ezra announced that they had acquired an ice-class shipset for a new vessel which could operate in harsh Arctic conditions.

From my recent attendance at the EGM and speaking with Management, I do get the feel that current operating cash inflows would probably not be sufficient to sustain the projected level of growth; though Management did not allude to anything. But the fact was that the EGM was for the renewal of the share issue mandate and at a discount too; so that may be a hint of what is to come as the company goes on another growth trajectory. I suspect the Company may be planning either another placement or convertible bond issue to shore up their cash position, and this could be highly dilutive to shareholders or increase their gearing further.

Part 2 shall discuss Ezra’s new division, ROV additions, fleet management contract and also the new Ice Maiden and I will also provide some clues and insights about how I feel about the company moving forward; and the actions I took based on those feelings. Watch out for Part 2 to be posted in 2-3 days time.

Thursday, October 15, 2009

The Revival in IPOs

It’s been quite some time since I’ve blogged about Initial Public Offerings (i.e. IPO), with my last post on this being dated April 2009 and the previous one was more than 2 years ago in August 2007! Over this time, I have learnt a lot more about the nature of IPO and also how their appearance (and disappearance) tends to coincide with economic cycles. Let me elaborate further.

It has been noticed by me that when markets crash and valuations hit extreme rock bottom, no companies out there will be willing to list. This is because they will be unable to raise much money are the valuation multiples used would be rock-bottom, and also since they are one of the few who may choose to list, they may also be subject to greater scrutiny by the investing public. The rationale for listing will always be to raise funds, and of course the more funds raised with the same number of additional issued shares, the better, as there will be less dilution to the founding shareholders.

Conversely, if we look at the situation at the height of the bull market in 2007, IPO were being churned out like clockwork and all sorts of kachang-puteh companies (i.e. companies without much substance) could list without much problem. All one needed was to spin an attractive growth story, fill in some nice-looking numbers and come up with glossy marketing material and everyone would pile in to catch a piece of the action. I remember it being so bad that forums were filled with punters (they call them “stags”) who bet on the closing price on the first day of IPO and how many % they would be above their offer price. Sadly, I must admit that I was also one of the uninformed who tried my hand at applying for one of these “hot issues” , till I realized better some time later and stopped altogether. All sorts of companies, whether good, bad or ugly, will be able to list at lofty valuations during a bull market, and the onus is up to the investor to ensure he does his due diligence so as to avoid massive losses when such promises of growth do not come true.

Taking a glance back at our local bourse over the past 1.5 years, I noted a still healthy pipeline of IPOs all the way till September 2008 (the month of the Lehman Brothers collapse). In October 2008 there was just 1 IPO (China Kunda) and another in November 2008 (Otto Marine), after which the IPO pipeline totally and completely dried up until January 2009 (Westminster – Catalist) and February 2009 (Japan Foods – also Catalist). From this simple observation, it can be concluded that the sharp plunge in valuations from the October 2008 to March 2009 period caused the IPO tide to recede, such that no companies wanted to list at all for fear of getting very poor valuations. Ironically, if a company were to choose to list at such low valuations, and if its business model was a sound one, one would actually be able to get a very good price at IPO to be able to hold long-term, as one would be buying into a company at depressed valuations (similar to buying a company already trading on SGX at low valuations).

Once March 2009 passed, and valuations took a sharp upward swing in May 2009, the IPOs started trickling back. It began with Teho in June 2009, then followed up with 3 companies each in July, August and September 2009, making it a total of 10 companies in just 4 months, compared to just 2 companies in the first 5 months of 2009. Now the trickle is becoming somewhat of a torrent, with 3 IPO aspirants planning to list at about the same time (Ziwo on Oct 8, Goodland Group also on Oct 8 and Hengyang Petrochemical Logistics on Oct 9). Judging from the response to the new IPOs (all closed “above water”) and also the recent news about the IPO market “hotting” up in Hong Kong and China, I have no doubt that sentiment and valuations are indeed on the rise, allowing many firms to realize their “dream” of listing and gaining recognition. As I write this, another IPO aspirant called Jason Marine is trying to list on Catalist by selling shares at S$0.21 apiece. The shares will be traded on October 21, 2009.

The discerning investor would have to plough through thick wads of prospectus to be able to differentiate the wheat from the chaff, but I feel this is unnecessary; for IPOs are generally “priced to perform” and are usually using low or moderate historical PERs to justify their pricing. Moving forward, whether these PERs appear low or not would be judged based on the future performance of the businesses which these companies are involved in. I can safely say that only 1 out of 10 IPO companies has characteristics which make it investment-worthy; but even then my track record with IPO companies has been less than stellar. Ultimately, it would still be more prudent for the investor to look for companies which have track records and have been listed for a good number of years, as they offer more information on whether they had delivered on earlier promises and whether they can successfully weather economic storms. With the stock market hitting new year-to-date highs, one must be even more cautious and discerning when ploughing through newly-listed companies looking for bargains.

Saturday, October 10, 2009

MTQ – Analysis of Purchase Part 1

As promised, I will be posting my analysis of purchase of MTQ Corporation Limited using the same format (slightly modified) as the one I used for Tat Hong last year. I believe the analysis will be broken down into 3 parts and I will NOT post all three parts consecutively. My purchase was first made on September 14, 2009 after the conclusion of my analysis for the company, which took a total of about 2 months plus. As mentioned, since transacted volume is low for this company, I had to straddle and stagger my purchases over a couple of days in order to build up a sizeable stake. As of September 30, 2009, I had allocated about S$20,000 for MTQ, out of proceeds from the divestment of PAH and Swiber. I also made additional purchases on October 2 and October 5 and allocated another approximately S$6,800, bringing total investment in MTQ to about S$27,000 to date. The analysis will be broken down and structured into several key sections, and will be accompanied by tables and charts where applicable.

Introduction and Business Model

Established 38 years ago, MTQ repairs sophisticated offshore oil-drilling equipment at its workshop in Pandan Loop. Its customers operate in neighbouring countries such as Indonesia, Malaysia, Brunei, Thailand and Vietnam. They are the authorized repair workshop for OEMs such as Cameron, Varco-Shaffer and QVM. The Company has 2 divisions – namely Oilfield Engineering Division and Engine Systems Division. The Group also handles the fabrication of steel structures (FY 2008) and engages in OEM manufacturing of components. They are one of the more experienced and reliable yards (according to MTQ’s Group CFO William Fong) and have also recently been recruiting (Recruit Section) QC Supervisor and Welding Supervisor, which is an indication the Company is still doing OK.

It sold off its Subsea Robotics division arm back in FY 2005 as it was loss-making and dragging the Group down. It divested its ROV Fleet and made an impairment provision of S$5.1 million back then. Utilization continued to stay low and the Division had been unsuccessful in its attempts to expand its service range.

The Company has few competitors in the region and only has 1 or 2 in Singapore alone, giving them a significant economic moat when it comes to managing their business. They are also one of the more experienced and reliable yards and their business is not built on order books as each job typically takes just several weeks to complete.

Financial Analysis

Profit and Loss Review

Revenues hit an all-time high of S$89.9 million for FY 2009, up 6.1% from FY 2008, due to increased orders for the Oilfield Engineering division. If we refer to the breakdown in terms of segments, oilfield engineering took up 61.7% of revenues, up from 51.6% in the previous financial year, and growth in revenues was 26.7%. By contrast, Engine Systems’ contribution to revenues dipped from 46.8% to 39%, and revenues fell 11.6%. This was due to a weaker Australian dollar (which has since recovered) and also the cessation of their Indonesian Engine Systems business in the 2H FY 2008. This clearly shows that oilfield engineering division is the main growth driver for MTQ.

Gross margins for FY 2009 (overall) was 36%, down from FY 2008’s 39.7%. I believe the drop was mainly due to the poor margins in Engine Systems division, thus dragging down overall gross margin. Oilfield engineering managed to get an EBITDA margin of 28.5% and net margin of 24.9% for FY 2009, so depreciation only consumed about 3.6% in margins for the division. Engine Systems started out with an EBITDA margin of just 3.6%, which was further narrowed to just 1.4% for FY 2009. It is the Engine Systems division which makes me uncomfortable about MTQ’s business as FY 2008 registered a net loss margin of 6% for this division. As the future potential lies in oilfield engineering, it is comforting to know that Management is building up this division and increasing the revenue contribution portion for this division as a proportion to total revenues. (More on this later)

Profit from operating activities rose 36.2% to S$15.3 million from S$11.2 million a year ago. Core net profit was up 14.3% from S$9.6 million to S$10.98 million but I would expect this to dip with the current recessionary conditions, with MTQ saying that enquiries have slowed and customers are also asking for lower pricing terms. Historical PER is 5.49x based on 68.5 cents and EPS of 12.47 cents. I think that such a PER offers a reasonably good margin of safety as most of future growth probably has not been priced in yet. Issued share capital (minus treasury shares of 7.48 million) stands at 88.059 million shares.

If we trace back to 5-year profitability, MTQ was loss-making in FY 2005 mainly due to the divestment and write-off of the Subsea Robotics Division, while subsequently they have grown top line and also maintained profitability from FY 2006 to FY 2009. A lot of legacy issues had to be settled from FY 2000 till FY 2005 (closing down of Foundry business, Subsea Robotics and Marine Engineering divisions), plus write-offs along the way.

The big boost to profitability (and also cash flows) came from their very timely divestment of RCR Tomlinson, which yielded exceptional gains of S$40.8 million and boosted cash reserves by S$59 million back in FY 2008. I foresee that part of this cash will be deployed to fund their expansion plans in Bahrain (which needs US$20 million), assuming the Company can continue to maintain profitability and positive operating cash inflows.

Balance Sheet Review

The Balance Sheet of MTQ looks very healthy for FY 2009, and the numbers support this conclusion as well. There is a long-term investment of about S$4.1 million presumably referring to the 16 million shares in Hai Leck bought at S$0.26 per share on August 18, 2008 (for a 4.92% stake in the Company). On August 7, 2009, MTQ increased their stake in Hai Leck past the 5% mark (at S$0.23 per share) and became substantial shareholders of the Company. At last check, their stake stands at 16,271,000 shares (5.02%), total cost is about S$4,222,330. Hai Leck’s last done share price is hovering at about S$0.43 (as at Oct 9, 2009), which means MTQ can recognize a paper profit of about S$2.77 million (66%+ gain). Hai Leck is a leading integrated service provider of scaffolding, corrosion prevention and insulation works for the oil and gas and petrochemical industry, and they have just raised funds recently for expansion. Hai Leck has also issued a 1-for-3 warrants issue, exercise price S$0.26 per warrant, and declared a 0.8 cent final dividend and 0.2 cent special dividend (total dividend = 1 cent/share). MTQ’s Violetbloom Investments Pte Ltd is entitled to 5,423,667 warrants (cost is S$54,237) and will get S$162,710 in dividends. This may not be reflected in 1H FY 2010 results yet as the books closure date for both dividends and warrants has yet to be announced.

Property, plant and equipment increased marginally to S$16.4 million versus S$15 million in the previous financial year. From what I understand, MTQ has been investing in upgrading and renewing their PPE every year to ensure their operations remain efficient and that they can cater to larger orders and enable a faster turnaround time. They also invested in “clean rooms” and a dynometer for Engine Systems division to provide a more complete package for customers. It was also mentioned that financing was taken up to purchase “workshop machinery” in the FY 2009 financial statements.

Current ratio has hovered around 1.20+ for FY 2005 to FY 2007, and it was only due to the timely divestment of RCR Tomlinson which enabled current ratio to rocket to 2.31 in FY 2008, and 2.74 in FY 2009. Quick ratio was also very healthy for FY 2008 and FY 2009, at 1.76 and 2.05 respectively. This was because inventories actually dipped in FY 2009 compared to FY 2008, and though cash balances also dipped, there was a net drop in current liabilities due to less tax payable (part of this was capital gains tax on disposal of RCR Tomlinson) and less trade payables.

The strong positive for MTQ is that their balance sheet shows a net cash position of S$28.7 million and S$17.3 million for FY 2008 and FY 2009 respectively. Moving forward, the cash will be used for their organic expansion into the Middle East (Bahrain), and more clarity needs to emerge on how MTQ plans to finance this growth. Mr. Kuah has hinted that MTQ will use a mixture of internal cash flows and bank borrowings, so MTQ may swing into a net debt position in the near future. But if the effects of the expansion can increase operating cash inflows significantly in 4-5 years time, then it is worthwhile to gear up for this as costs are currently low and MTQ has a strong Balance Sheet in place.

NAV for MTQ as at March 31, 2009 stands at S$0.6658 per share.

Cash Flow Statement Review

MTQ’s cash flow has been healthy for the last 5 financial years, with every single financial year registering an operating cash inflow. The clincher came in FY 2008 with the divestment of RCR Tomlinson, which saw a huge S$55.9 million cash inflow under Investing Activities. This move alone has ungeared its Balance Sheet and lifted MTQ into a net cash position in FY 2008 as well as FY 2009.

Its Free Cash Flow (FCF), however, is consistently negative except for FY 2008 when it registered positive FCF of S$2 million. This is a business which requires consistent upgrading of fixed assets and machinery in order to ensure peak efficiency and fast turnaround time. But though there is a constant capex requirement, it does help to note that the business is cash flow positive (for operations) and cash flow is healthy enough to support twice-yearly dividends. (See dividend history and share buyback tables - to be included in a later post)

It is worthwhile to note that there was a purchase of quoted shares of S$5.3 million in FY 2009, most likely relating to their investment in Hai Leck. Taking this transaction out, cash outflows for investing activities would have been just S$4.6 million, almost equal to the operating cash inflow of S$4.5 million. Under financing activities, dividends paid came up to S$2.7 millon while S$3.1 million was spent buying back shares. This would indicate that the bulk of outflows from financing activities were for corporate moves which enhanced returns for shareholders (i.e. dividends and share buybacks)!

Net cash per share stands at about S$0.20 per share as at March 31, 2009.

Watch out for Part 2 of Analysis of Purchase for MTQ in a subsequent post, where I will analyze and touch on their business units history, revenue trends and profitability.

Monday, October 05, 2009

A Review of Past Divestments

I had mentioned in one of my previous posts about reviewing past divestments in order to ascertain if they were indeed good choices or bad decisions. This is because the measure of an investor is not only in the performance of the companies he currently owns, but also the decisions he had made in the past with regards to companies which he felt did not fit his criteria. Measured as such, one can safely conclude that certain decisions should have or should not have been made. Of course, there may be other extenuating factors involved in each decision, but let’s keep the analysis simple for now in order to avoid confusing parallel possibilities which may open up further complex debates. Luckily, I had kept very meticulous records since I started investing in Dec 2004, and I have the exact details (down to the dollar) of each trade and divestment gain/loss, which is why I can compile a very accurate portfolio summary of realized gains to date.

Below is a table in which I have detailed the companies I used to own (all the way since I started investing in the stock market, to date) and the original rationale for divestment. These are also chronicled under my “Investment Mistakes” section which you are free to access to read on more details on why I sold each company, and to be truthful many were divested before I adopted value investing (except, of course, for the more recent ones). The next table then shows the difference between my original cost, my divested price and the last done market price. The simple table does not account for dividends along the way, but seeks to determine if a decision was, on hindsight, a good or poor one based on current information about the company and also how it has been doing since I divested it. Admittedly, a full and detailed analysis would take up a lot more space (and probably more posts) than this, so I am keeping it simple just to illustrate the principle of reflection on one’s decision and how it can help improve one’s thought process and investment philosophy.

As can be seen above, much of my 2005 record consisted of various IPO “stags” (i.e. selling IPO shares on the first day of trading to make an immediate profit), short-term trading positions and one lousy contra loss. Most of these were totally clueless bets based more on sentiment and price action than fundamentals. Even up till mid to late 2007, most of the companies I bought were purely speculative, and this was partly due to the irrational exuberance in 2006 through late 2007 which infected penny stocks as well, causing them to rise along with the tide. Only my last two divestments were of a purely investment nature based on my value investing philosophy; I can safely say that before mid-2007 I was a trader and one of my trades even used rudimentary Technical Analysis methods which a friend had taught me (UTAC).

The above table shows the effects of divestment when comparing against the last done share price (or for the delisted companies, against the exit offer price). It can actually be seen that for the trading positions, I might have done way better in hanging on to those positions, especially in fundamentally sound companies which grew over time. But if you note, the “duds” can fall as much as 80-90%, and one of them (Celestial) was even suspended due to some issues with convertible bonds. Thus, a meaningful comparison of whether it was wise to divest can only come from my latter decisions which were more geared towards investment, rather than mindless speculation. On the whole, it can be summarized that for companies with viable business models and growing earnings, it would have been much wiser to buy and hold (i.e. invest) rather than trade them for short-term gains.

If I view the divestments relating to Trek, Global Voice and C&O Pharmaceutical, it would be apparent that the decision to divest early and quickly upon first signs of trouble were wise, and have led to the successful deployment of the funds to more worthy investments. This is because these companies did not have an enduring economic moat or high barriers to entry, and thus were prone to loss in market share. Global Voice was one of the consistent loss-makers back from 2005, and even with a slew of marketing-style press releases and even the CEO voicing support for the share price (then at 6.5 cents), it could not stop the inevitable tumble to the current 2.5-3 cents. An EBITDA profit (as always mentioned by the company) does not count – in fact cash flows and net profit are far more important measures of business success than simply using EBITDA (which conveniently removes the effects of depreciation and amortization) and revenues.

To conclude, this rather academic exercise is just to show how holding on to good companies can result in very massive gains over the years, as demonstrated by Pearl Energy, Labroy Marine and even Olam (though now I argue that gearing is too high for this to be a good investment). Conversely, one should also bail out the moment an investment does not stand up to scrutiny, otherwise it may end up as another Global Voice or worse still, get suspended like Celestial Nutrifoods.