MTQ – 1H FY 2012 Analysis Part 2

Part 2 of this analysis will focus more on the qualitative aspects of MTQ – the sections which many analysts find tough to quantify, but which I feel is also extremely important for any analysis to be complete. Note though that these observations were made from a combination of interactions with Management, articles/interviews with The Edge Singapore and my own opinions and conclusions drawn out from the facts and data.

Oilfield Engineering – Bahrain Operations

As early as Jan 2010, MTQ had already announced their plans to expand into the Kingdom of Bahrain, and steps and processes had been put in place to gradually ease their way into the Middle Eastern country, from the purchase of equipment to the hiring of staff and the engagement of a main contractor to carry out construction of the Facility for their Phase I expansion. At the time, very good reasons were provided (which, I should add, are still relevant today) and it seemed all smooth-sailing with financing being locked in at good rates and building costs being at a low because of the low construction pipeline at the time. However, with any business, any plans for expansion into a new territory are always fraught with risks; and these came in the form of riots stemming from the “Arab Spring” movement in the Middle East which saw many countries having their leaders toppled. Some coups were peaceful (Tunisia) while others were savage and bloody (Libya), and for Bahrain it was somewhere in between with riots and deaths and destruction of property but nowhere on the scale of a civil war or anarchy.

The rapid unravelling of events took Management by surprise and as a result, electricity supply was hard to come by and was only restored in recent months; while many oil and gas principals and vendors had fled the country due to the instability. Thus, it was only recently in October 2011 that MTQ managed to get its certifications and specifications from API (American Institute of Petroleum) and thus commence business. So the entire 1H 2012 did not see any contributions from Bahrain, but instead took the full brunt of start-up losses from the depreciation of machinery and for staff salaries for new hires and training required to get them up to speed. 2H 2012 should see healthy contribution from Bahrain, though the level of business activity still remains a mystery as MTQ does have several competitors in the Middle East. It is indeed good news that Kuah Kok Kim sees good potential and healthy enquiries for MTQ’s services and product offerings, and the BP Deepwater Horizon disaster also had a positive impact on companies such as MTQ as this meant more stringent checks and frequent repairs required for equipment such as BOP (Blowout Preventers) used on oil rigs in order to prevent accidents of a similar nature and scale.

The new facility is 430,000 square feet and is more than twice the size of MTQ’s Singapore Facility at Pandan Loop. With oil production expecting to rise as a result of spending by UAE and Bahrain’s Government, MTQ can be assured of continued business in the medium-term. Assuming full capacity utilization at their current Singapore facility, and using simple proportion, we should expect MTQ’s Oilfield Engineering revenues to more than double once the Bahrain facility is chugging along at full utilization as well. As to whether gross margins can be maintained at the current high levels, that is open to question; but we have already witnessed some erosion of gross margins due to the introduction of PSL into the picture, though whether this will eventually sort itself out due to corporate integration and increased efficiencies is unknown at this point in time. Suffice to say that efforts are indeed underway to ensure smooth integration and to ensure good cross-selling opportunities. This should definitely come under close scrutiny when the 2H 2012 results are released.

Oilfield Engineering – PSL

There is a little overlap in terms of discussing PSL as I had already mentioned PSL in bits and pieces under the Bahrain section, but nevertheless I shall attempt to elaborate more here. MTQ announced the acquisition of 100% of PSL on July 6, 2011, and the final purchase consideration is US$21.9 million. Of this amount, US$13.51 million is financed by additional bank borrowings (which explains the sharp increase in the gearing ratio) while the remainder was funded by internal cash reserves.

The rationale for the acquisition was that PSL offered a complementary range of products and services which would enhance MTQ’s total offering to customers. PSL also had its own set of customers and acquiring the Company would mean that MTQ could broaden and expand its customer base, thus allowing for more opportunities for bundling of products/services and cross-selling. In addition, PSL also has a machining and fabrication business called PEMAC which will add to MTQ’s capabilities and expand the equipment range which MTQ can repair. Moreover, PSL also holds API certificates which will boost MTQ’s Oilfield Engineering capabilities. As mentioned previously in a blog post about the AGM, MTQ managed to acquite PSL because its parent wished to divest it as it was not forming a core part of the previous parent’s operations, which were mainly based in North America.

According to the article from The Edge Singapore, PSL contributed about $10 million to topline and this was only about two months of revenue and profit contribution, so the potential for higher revenues and earnings is very high. But PSL’s business has lower gross margins as compared to MTQ’s main oilfield engineering business but Mr. Kuah intends to improve them by streamlining its business and selling mud coolers to MTQ’s network of clients. As Bahrain takes off, he is also optimistic that PSL can contribute more and create greater value and synergy for the Group.

Engine Systems Division

Not much was mentioned about Engine Systems division, and I guess that is a blessing in disguise because in the prior financial year, there were already three acquisitions relating to this division which sought to expand their reach in Australia. Rather than chase after acquisitions which may drain cash and make the division look like a serial acquirer, it is better to slow down to integrate these acquisitions into the main business to ensure synergies and alignment of sales strategies, product lines and processes/procedures. It was mentioned that operating profits had increased for Engine Systems, but no detailed breakdown was given with regards to the operating margin; and I am also in the dark about how the three acquisitions are performing (i.e. loss-making, cash-flow positive?). However, it is gratifying to know that revenues are, at least, increasing, and the last communication I had with Mr. Dominic Siu at the AGM told me that the Group will be working to increase the margins for this division (known historically to be rather dismal).

Perhaps I can provide more updates on this division once the annual newsletter arrives from MTQ, but I can make no promises on this.

Investment in Neptune Marine Services (NMS)

MTQ had announced an investment of $12.93 million in NMS back on March 4, 2011 by purchasing 200 million shares in the Company (in a restructuring exercise) at A$0.05 per share. Over the course of 11 trading days, MTQ accumulated another 68.455 million shares in NMS, for a total stake of 268.455 million shares (about 15% of the Company), lowering their average cost from A$0.05 to A$0.0467 cents per share. Total cost of investment comes up to about A$12.5 million after the open-market purchases. As the time of writing, NMS traded at A$0.031 cents/share.

Clearly, NMS is intended to be a strategic, long-term investment for MTQ, as mentioned by CEO Mr. Kuah Boon Wee back during the AGM. The Company does subsea work and it has proprietary technology called NEPSYS which it can use to market itself not just in Australia but also South-East Asia where its focus will be. The Company has just released its Annual Report for the financial year ended June 30, 2011. In it, it outlines the corporate restructuring which had taken place and how it has taken efforts to not just de-gear the Balance Sheet, but to divest off unprofitable assets and divisions in order to beef up their cash reserves and to realign their corporate strategy for sustained growth. Interested readers may download their AR at http://www.neptunems.com.

More importantly, the Company has stated its strategy to grow the business along three paths:-

1) Organic growth and growth of service lines in established geographic regions

2) Integration of services and focus on creating awareness of the “Total Service Solutions” provided by Neptune

3) Developing strategic relationships with key partners

It will be interesting and informative to follow the progress and fortunes of the Company, as Mr. Kuah Boon Wee had also been elected as an independent director of NMS. Of course, this investment cannot be directly compared to MTQ’s previous successful investment in RCR Tomlinson, but I would assume that with his father’s wise counsel with regards to investments in potential turn-arounds, Kuah Boon Wee would have combined it with his own years of experience and made an informed decision. Since it would not be possible to assess the financial impact of this investment in the short-term, it would be better to check back again next year once NMS releases its 1H FY 2012 results in late February 2012.

Hot from the oven: NMS had just announced on November 16, 2011 that it had clinched a contract for the provision of geophysical and geotechnical surveys for the Equus Gas Fields Development Project, and that they had formed an alliance with Greatship Subsea Solutions Australia Pty Ltd to complete the project. The contract value is estimated at A$14.5 million and NMS’ share will be about A$7.35 million, and is expected to commence in late November 2011 and last for 75 days. So apparently, no. 3 on the list is already being rolled out as this is one of the strategic alliances which NMS hopes to hammer down to forge long-term partnerships in order to grow their recurrent revenue stream.

Conclusion

MTQ can rightly be classified as more of a growth company than a yield play, as it has aggressively leveraged itself to expand its business, not only beyond Singapore and into Bahrain, but also through acquisitions (PSL and NMS) which are supposed to be earnings and cash-flow accretive and which will add long-term value to shareholders. Father and son had both commented that MTQ had been too conservative in the past, and now a little leverage would be good to propel the Group to another level. Of course, risks are definitely present as the Group operates in the current environmental of economic uncertainty and turmoil; but with proper stewardship and good control of cash, the Group may yet sail out from the storm unscathed and emerge stronger.

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).

Dividends

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.

MTQ – FY 2011 AGM Highlights Part 2

Part 2 of the MTQ AGM Highlights will touch on Neptune Marine Services, Oilfield Engineering’s recent acquisition of PSL and PEMAC, as well as elaborate on Engine Systems Division.

Neptune Marine Services (NMS)

Naturally, quite a few pointed questions were asked about the recent NMS acquisition, as the Group had pumped in a substantial sum of money into this investment. MTQ was even buying up more shares from the open market recently in order to reduce their cost of investment further from A$0.05 to A$0.0467; but the recent market turmoil has actually pushed down NMS’ share price to as low as A$0.026. No questions were asked during the AGM proper but it was after the meeting that one or two shareholders (myself included) approached Mr. Kuah Boon Wee (KBW) to find out more about NMS.

One shareholder’s concern was that NMS was a micro-cap stock (below 10 AUD cents) and therefore it would be very difficult for valuations to rise and hence the share price would stay depressed for extended periods of time. KBW acknowledged this but maintained that the reason for MTQ investing in NMS was that the restructuring left them with a very clean Balance Sheet and that the divestments meant that cash would be raised and the business model would be very much more streamlined as compared to previously (before the rights issue). KBW was also questioned on how experienced the new CEO Mr. Robin King was in managing such a company, and the reply was that he was sufficiently competent. Another query was – why would MTQ invest in NMS unless synergies were to be obtained, and do the businesses of MTQ and NMS overlap in any way? KBW’s reply was that NMS’ business was subsea, and MTQ was also dealing with subsea business as it was repairing equipment relating to subsea operations; hence there was overlap and both companies are essentially serving the same industry.

My concern was that NMS would take significant time to turn around as the divestments did not ensure that the core business would be profitable and cash-flow positive. KBW mentioned that the current financial year ended June 30, 2011 would look terrible due to the rights issue and significant write-offs, while the next financial year ended June 30, 2012 would look similarly disastrous because of the various other divestments of non-core assets and streamlining of the business. I took that to mean that the business of NMS would only “stabilize” in the financial year ended June 30, 2013; and this also implied that MTQ would take a long-term stance on NMS in that they had the patience to sit through the restructuring to ensure their investment bore fruit. Note also that in the interim, NMS would not be paying a dividend at all, thus unlike Hai Leck, MTQ would not enjoy any yield at all for their waiting.

It will be interesting to continue to monitor the business of NMS and their periodic announcements on ASX to follow the progress of the restructuring, and to see if they eventually bear fruit. Thus far, Mr. Market has been less than kind to NMS and has accorded it a very low valuation; time will tell if Mr. Market was right, or if he had been overly pessimistic.

Oilfield Engineering Division – Acquisition of PSL and PEMAC

Besides the issue of Bahrain, the other major talking point about Oilfield Engineering was the recent announcement of Premier Sea and Land (PSL) and its workshop division called PEMAC. I broached this topic with KBW as well and he mentioned that it was acquired cheaply at about 4.7x PER and 1.29x P/B (I provided him with the numbers which he agreed with). He also mentioned that the business was cyclical in the sense that last year’s earnings for PSL of US$4.1 million was considered one of its “lowest” points, with other years registering much higher net profit. Therefore, it would make it look as if MTQ had capitalized on this temporary blip to acquire this company cheaply.

When quizzed by another shareholder on why the parent would want to divest PSL when it was profitable and had an unleveraged Balance Sheet, the reply was that the parent was a US-based company with operations and revenue derived from North America; while PSL was the only Asian arm with most of its revenue derived from South-East Asia. Hence, there was a mis-match and the parent considered divesting it to focus more on its core regions. KBW also mentioned that MTQ had been aware of PSL for a long time as a competitor and was simply waiting for a good and ripe opportunity to come along to acquire the Company; thus killing two birds with one stone – integrating PSL’s business and product range with MTQ’s, and also eliminating (i.e. buying out) the competition!

I was also asking the CFO about PSL’s half-year performance ended June 30, 2011 (it had a December 31 year-end), but he declined to give exact figures; only saying that it was “better than budgeted”. I guess there was a certain amount of sensitivity in revealing such numbers as PSL is not a listed company; therefore there is no onus for disclosure of such information. As long as PSL is doing well, I have no worries about not knowing the exact numbers; in fact all I wish is that Management know how to integrate it well with MTQ’s core Oilfield Engineering Division and in time to come, produce positive synergies and tangible benefits for the Division.

Engine Systems Division – Acquisitions and Margins

The final aspect to ask about was the Engine Systems Division, which was rather neglected during the course of the meeting as no one was particularly interested to ask about it. Most attention was (of course) directed at Bahrain, PSL and even NMS and I guess most shareholders assumed that Engine Systems Division would just “chug” along like a well-oiled engine (no pun intended). My concern was whether the division’s margins were improving and the CFO assured me that they were working on this. My important question to them was whether the division generated positive cash flows and the reply was in the affirmative.

I also expressed concern that one of the recent acquisitions (three of them as detailed in the AR FY 2011) was loss-making, while the other two were acquired too close to the end of the financial year for any positive impact to be seen. The CFO took a different tack when answering this question – he mentioned that for Engine Systems, scale and coverage were very important. In fact, MTQES was the only Company in Australia which had nation-wide coverage in terms of branch locations; and the acquisitions had helped to make this a reality. With this enlarged coverage, MTQES would be more effective in engaging customers all over Australia, and I took it to mean that this would be positive for the Division over the medium-term (and that the effects would not be immediately apparent).

I had to admit that Engine Systems had come quite a long way since I looked at it three years ago, and even though margins were still thin, they had improved quite a bit since then and I believe it can be attributed to the Management Team’s focus on the Bosch partnership, expanding its range of products such as turbochargers, as well as extending its reach so that it could more effectively serve its customers. These measures take time to show results and therefore, I am willing to be a bystander and observe this Division further before making more conclusions.

This concludes my AGM highlights for MTQ, and I will probably not blog about MTQ for quite a while until it releases its 1H FY 2012 results in late October 2012. Meanwhile, the issue price for the scrip dividend has been announced at 82 cents/share, and my decision would be to take up 100% scrip as I believe in the growth prospects for MTQ.

Note: For a good write-up on MTQ’s AGM, please also refer to this article by Next Insight.

MTQ – FY 2011 AGM Highlights Part 1

I attended MTQ’s AGM held on July 22, 2011 at 10:00 a.m. at Carlton Hotel conference room (new wing). This was my second time attending MTQ AGM since I became a shareholder in late 2009, and last year’s AGM was also held at Carlton Hotel. The difference was the location within the hotel, as the old wing had a cosier environment as compared to the conference rooms in the new wing. One of the directors had complained that it was as noisy as a “fish market” as there were many teenagers and youngsters running around along the corridors.

As I was one of the earliest to arrive, I managed to take a photo of the AGM while there was no one seated (see pic above). We were given an attendance slip stating out IC number and number of shares held, and there were not many shareholders attending the AGM this time although the number of shareholders had increased significantly (overheard this from one of the directors). This could probably be attributed to the Company’s rather aggressive corporate actions throughout FY 2011, which included three acquisitions for Engine Systems Division, a significant investment into an Australian-listed company called Neptune Marine Services; as well as the recently announced major acquisition of PSL and Pemac.

I shall sub-divide this AGM update into two separate parts as putting it all down in one post would be too lengthy, but I will not specifically state the questions that I had asked during the AGM. Since many of my questions did not receive direct responses (I merely deduced the replies from speaking and chatting with Management and steering them towards providing some clarity on various issues), I shall simply narrate the gist of what was mentioned and pass my own judgement accordingly. Also note that there are no hard and fast rules for getting answers at an AGM, even if you ask a direct question during the meeting proper, as Management are likely to want to take it “offline” (more on this in my AGM Part 2 coming up).

Summary of Bahrain Situation – Mr. Kuah Kok Kim

Mr. Kuah gave all shareholders an update on the situation in Bahrain before reading out the resolutions proper. After all, with the news and rumours swirling around Bahrain in the past few months, one cannot blame shareholders like myself for feeling jittery and concerned. He started off by saying that the situation in Bahrain had somewhat stabilized, and that the initial reports of death and destruction had been greatly exaggerated by the media. Of course, he did acknowledge that there were deaths and rioting, but maintained that these occurred mainly on major highways and in larger shopping malls. As the new facility was located in an industrial park far away from the troubles, there was no immediate danger to lives or property and business carried on as usual.

MTQ was, however, affected in the sense that everything got delayed and slowed down a lot due to the riots and trouble. Originally, the first 80% of the construction cum commissioning of the facility went on smoothly without a hitch. The final 20%, however, ran into delays due to the problems surfacing in the Middle East. Though everything has been resolved as of the date of the AGM, the two main delays came from the starting up of power at site (despite submission of applications to the Government, power was only turned on in July 2011), as well as the certifications required from the American Petroleum Institute (API) as many of MTQ’s principals and customers had been driven out of MTQ in the interim due to the violence, and were slow to return to the country.

In the meantime, MTQ focused on in-house training and therefore managed to limit the amount of start-up losses due to the delays; however on this point I feel that Management is trying to cushion the blow as there will be significant start-up losses due to the operational delay of the facility. The Bahrain facility will experience cash burn and unless things get up to speed soon, this may severely impact 1H FY 2012 financials.

A shareholder did ask Management on when break-even can be achieved for Bahrain, and the reply was “not too long”, which basically isn’t telling you much. What this means is simply that Management “expects” the new facility to be up and running soon and thus generating income, but the time frame for this would be uncertain as business reality is also uncertain! In fact, some positive news actually came out of this whole Middle Eastern debacle, in that Bahrain had stepped up their oil and gas exploration activities (this was an unexpected positive development which Management had not anticipated); by drilling more new wells and reworking old wells.

In addition, Saudi Arabia has also been pouring money into Bahrain in order to prop up its economy, due to the large proportion of Sunnis within Bahrain (Saudi Arabia is predominantly Sunni). US$10 billion has been pumped into Bahrain with the help of the Gulf Cooperation Council (GCC). These actions demonstrate that MTQ’s investment in Bahrain was sound, and that their many years of research had paid off as they were buffered from the worst effects of these adverse events.

On another note, Chairman Kuah also mentioned that transfer of duties from himself to Kuah Boon Wee the CEO was essentially complete, and that the new CEO has managed to cope with market demands as a result of the Deepwater Horizon disaster.

Cash and Debt Levels

My main concern with MTQ’s cash balances was that they seemed to be spending quite a lot of it, even as they were gearing up their Balance Sheet for their Bahrain expansion. With their purchase of 68,455,000 additional shares in NMS for about $3.34 million, as well as the $7.24 million cash outlay for the acquisition of PSL and Pemac, it seems that cash is being spent at a pretty alarming rate! Assuming a scrip dividend conversion rate of 45% of shareholders (as was the case for MTQ’s 2 cent/share interim dividend declared back in October 2010), another $950,000 will be paid out. Coupled with the additional $6.3 million capital commitments as disclosed in their Annual Report FY 2010/2011, this means a total outlay of about $17.8 million, out of their cash and bank balances of about $23.8 million as at March 31, 2011. Borrowings stood at $27.3 million as at March 31, 2011 as a result of borrowings to construct their new facility in Bahrain, including hiring new workers, shipping over new machinery and obtaining required certifications to commence business activities. Additional borrowings for Premier would come up to $16.9 million for a one-year loan, and total borrowings would go up to as high as $44.2 million by September 30, 2011.

From the above description, it is worrying to me whether MTQ can maintain a healthy cash balance and have sufficient cash flows for working capital and operational activities. When I quizzed Management on this, the following pointers were mentioned:-

1) MTQ has been generating healthy positive operating cash flow all these years, and the addition of Bahrain will contribute to this cash flow, but of course only after the initial start-up losses and cash burn have been overcome (through some time).

2) Interest rates on new loans now are at historic lows, and MTQ’s Term Loan 6 is denominated in USD which is, at the moment, depreciating against the SGD (which means each instalment payment will become cheaper for MTQ).

3) There is an intention to push some of the debt onto Premier’s books as Premier’s Balance Sheet is un-geared.

4) MTQ’s Engine Systems and Oilfield Engineering are both cash-flow positive, and Premier is also cash flow positive as well as profitable; hence there is not much worry that the finance costs cannot be sustained.

So, the above points do somewhat support Management’s assertion that cash levels would be sustained and that debt levels, though high, are still manageable. However, it would be extremely prudent for me as an enterprising investor (by Graham’s definition) to closely scrutinize the next set of financials for MTQ coming out for September 30, 2011 (1H FY 2012) to review if things are going as planned, or if something is drastically wrong.

Thus concludes Part 1 of the AGM highlights. Watch out for Part 2 soon which talks about NMS, acquisition of PSL and PEMAC as well as the Engine Systems Division.

MTQ – FY 2011 Financial Results Analysis and Commentary Part 3

Onwards now to Part 3 of my MTQ FY 2011 analysis, which will cover a major transaction by MTQ – that of its 100%-owned subsidiary Blossomvale Investments Pte Ltd purchasing 200 million shares in an Australian-listed (ASX-listed) company called Neptune Marine Services Pty Ltd (“Neptune”) at AUD 5 cents each. This was announced in a March 4, 2011 announcement posted on SGXNet, and costs the Company about S$12.93 million, which forms a significant portion of their cash and bank balances; hence I have classified this as a major transaction and am delving deep into the rationale. From the announcement proper, MTQ mentions that it seeks to participate in Neptune’s business as a significant investor and views Neptune’s capabilities as a “strategic extension of its predominantly workshop based operations in Singapore and Bahrain”. Kuah Boon Wee, CEO of MTQ, will also take a seat on the Board of Directors of Neptune. I will be breaking down this transaction into parts by analyzing and reviewing Neptune as a company, its proposed strategic changes made, and providing a summary of the actions taken to date to signify its commitment towards corporate overhaul and re-structuring.

Neptune – Introduction

Neptune is a company which specializes in providing offshore engineering solutions to the oil and gas, marine and renewable energy industries. It was founded in 2003 and is headquartered in Perth, Western Australia. Neptune has a comprehensive focus on subsea services with operations spanning Australia and the UK.

The Company, however, has been performing poorly thus far. In its 1H FY 2011 financial statements ended December 31, 2010 (it has a June 30 year-end), it recorded revenue of A$70.8 million and gross profit of A$22.1 million (gross margin of 31.2%), but posted a loss attributable to shareholders of A$11.5 million (after adding back one-off impairment charges). The main reason for this was the very high administrative cost base of A$31.4 million and also high finance costs of A$2.9 million. In the Balance Sheet, interest-bearing loans came up to A$50 million while cash was only A$8.7 million; and the Company is in a net current liability position (technically insolvent). Cash flows used in operating activities was A$4.9 million, capex was A$2.5 million and repayment of borrowings came up to A$4.4 million, resulting in a cash drain of A$11 million in total.

In view of the above poor results, which stems from Neptune’s inability to control costs and is also a result of unfocused operations spanning too many countries, an operational and structural review was undertaken (with PriceWaterHouse Coopers assistance) and has resulted in an offering to raise up to A$80.6 million. More details of it are provided in the next section. The CEO was also replaced in late November 2010.

Neptune – Summary of the Re-Structuring Review

As can be seen in table above, Neptune is planning to embark on a “Back to Basics” philosophy to streamline operations and to refocus on their core competencies once again. Apparently, the impression I got when I read through Neptune’s original businesses was that they had strayed too far off their core competence and had “diversified” too extensively. This had resulted in expenses rocketing up while profits were being eaten away as some business units may be languishing due to lack of focus or expertise. Apparently, the PWC review also brought up many aspects of cost reduction which should have been implemented in an expedient manner, instead of letting the problems fester and drag the Company so deeply into the red.

Some of the key initiatives include focusing more on organic growth versus an aggressive M&A path, which had pushed the Company into a heavy debt-laden position. The strategic review also identified businesses which are working and which should be retained and grown, versus those which are bleeding money and need to be divested. Overheads were too high and the previous CEO did not maintain a lean ship, hence cost-cutting was to be effected (more on this later). Owning assets is also a very expensive affair (as can be seen with Ezra and Swiber) and so JV relationships were more practical and would be easier on the cash flows. Most importantly, the Company wanted to de-gear its Balance Sheet and save on crippling finance costs.

Neptune – Rationalization of Regions

As can be seen in the table above, Neptune’s business is split up into four distinct regions, of which Australia remains their main base of operations. For Australia, though this region is profitable, staff head count was reduced in light of high overheads and commercial focus on NEPSYS was revised in Jan 2011. NEPSYS is a unique, class approved technology that produces a permanent surface quality weld in an underwater environment. For more on NEPSYS, check out this link.

USA is not sustainable and hence Neptune will exit from the business there, cutting costs and saving valuable cash in the process. As for Asia and Middle East, control will vest from Australia under a streamlined regional management structure. For Europe, though the business is profitable, further steps have been taken to reduce the cost base and to perform a more detailed review of options available to grow the business there.

Neptune – Rationalization of Businesses and Assets

Other than just rationalizing regional operations and streamlining operational control by region, Neptune has also undertaken to rationalize its business units and assets to see where it can achieve the greatest benefits, and to find areas to further cut costs. For USA diving business, the decision is to exit from this and look for other partnerships for NEPSYS. This does remind me of MTQ’s own subsea robotics business which was divested in 2006 as it was expensive and unprofitable. The fabrication business in Australia was also deemed not a “strategic fit” and there are plans to exit this. However, I was wondering if this division could complement Neptune’s other business units as even companies like Ezra have a fabrication sub-division even as they provide marine support services.

The ROV (Remote-Operating Vehicle) Supporter and Neptune Trident are to be sold off as these assets no longer contribute meaningfully to the business, and hence should be divested. As of this writing, Neptune Trident has already been sold off (announced in April 2011) for A$14.025 million (more on this in the next few sections). While Neptune has made clear their focus for re-positioning NEPSYS, I am still unclear as to how this technology can be harnesses effectively to produce good profits and attract more reputable clients. By saying that NEPSYS has the “potential for future profits”, one may take it to mean that the technology is slated for a revamp or re-positioning. Since there have been no concrete announcements or plans relating to NEPSYS as of this writing, I assume Management is still hard at work at the problem.

As for the ROV business, I am unaware of how it contributes to Neptune’s bottom line (I only took a cursory look at the financials and did not drill too deep), but since it is profitable but has low utilization, there is thus potential for utilization to increase if the business is positioned correctly and marketed properly. A “full strategic review” will be performed and I guess we can look forward to some corporate decisions regarding this business unit in the near term.

Neptune – Proposed Financial Effects of Restructuring

The first line of “offense” (if it can be called that!) as depicted in the above table should result in annual savings of about A$9.5 million (for Phases 1 and 2); and these involve cutting staff strength and reduction of corporate overheads to make the organization more lean and trim (it’s surprising how inefficiently some processes and operations are structured as a Company expands over the years). This represents the first drastic cost cutting (for Phase 1) which was executed successfully in January 2011 and which resulted in cost savings of up to A$8.5 million. Another A$1 million will come from further corporate restructuring which also includes (ahem) cutting out some Managerial-level staff which may be redundant.

Interestingly, the divestment of non-core businesses is expected to save from A$2 million to A$4 million, as these businesses probably soak up expenses which not churning up sufficient cash and profits to justify their continued existence. Another positive from the divestment is that cash is immediately freed up which can be used to pay down debilitating debt, and also for general working capital purposes. It is expected that such divestments will result in a one-time charge (i.e. loss on disposal) which will hit the Income Statement for FY 2011 (and which may drag into part of FY 2012 as well), but this is inevitable and moving forward, the annual cost savings and cash retained will actually benefit the Group in the medium-term.

If we assume that Neptune can really reduce overheads and administrative expenses by A$12 million to A$13 million annually, and that the Company can continue to garner contracts of significant size, then there is a very good chance of them recording an operating and net profit down the road.

Neptune – Fund Raising and Contract Awards

Neptune had suggested raising funds of up to A$84 million, but in the end they managed to hit the minimum level of A$60 million, which will allow them to pay off almost all of their debt, and un-gear their Balance Sheet. The rest of the money will be used for working capital. New shares were offered at A$0.05 per share, with MTQ subscribing for 200 million shares as many of the existing shareholders did not take up their pro-rata share of the offer. A total of 1.2 billion new shares were issued, bringing total issued share capital to 1.648 billion shares. NTA per share post-rights issue will be A$0.043 cents against the issue price of A$0.05.

Meanwhile, contract flow continues to remain strong for Neptune, as can be seen from the Table above. In Nov 2010, A$8 million worth of contracts were secured, while in Jan 2011 A$12 million more were secured. This may not seem much when compared to its half-year revenue of A$70 million, but note that the rationalization will cause revenues to drop, but expenses to drop even more, thus ensuring that the overall result is profitability even while operating on a lower revenue base. High revenues make no sense at all if they are accompanied by growing losses and continual bleeding of cash. Australia still has its huge Gorgon project which requires the services of many O&G companies, of which Neptune is one. Since Management claims that contract flow continues to be strong, I guess shareholders like MTQ should be expecting a decent top-line performance. Hopefully, this can be coupled with a pleasing bottom-line performance as well.

Neptune – Recent Updates

As mentioned above, Neptune Trident vessel has already been sold for A$14.025 million. A loss on disposal of A$7.5 million will be recorded in 2H FY 2011 as the Net Book Value of the vessel is A$21.5 million, but the good news is that this generates cash which can be used to pay down long-term debts. The targeted completion of sale is in May 2011.

In another recent announcement on May 17, 2011, Neptune confirmed that key initiatives had been completed. These include the finalization of annual cost savings of A$9.5 million (as previously explained), ongoing marketing and planned orderly sale of ROV Supporter vessel, as well as the planned sales of the Australian Fabrication and USA Diving businesses. At the same time, a board renewal plan was also put in place to appoint three (3) new non-executive directors to the Board via a succession plan.

As a result of these measures, Neptune managed to achieve unaudited, normalized break-even operating EBIT for quarter ended March 31, 2011, before write-downs and one-off costs. Greater impact can be seen on the bottom line only in FY 2012, as the measures take effect for the full financial year ended June 30, 2012.

Neptune – Conclusion

It would seem, from all the available evidence and presentation materials, that Neptune is a so-called “turnaround” play, where a major restructuring can bring about much-needed changes to push the business back to profitability and growth. Neptune reminds me somewhat of MTQ back in 2000 to 2004 where they also engaged in all sorts of businesses, from Foundry to Subsea Robotics, and incurred losses every year till Kuah Kok Kim streamlined all the business units, divested the unprofitable ones, and retained just Oilfield Engineering and Engine Systems. For MTQ’s case, it took about 4-5 years (and a skilful divestment of RCR Tomlinson back in FY 2007) to build up core competencies and streamline costs. I would expect roughly the same amount of time for Neptune to realign its business divisions and achieve the efficiencies which it targets. So for MTQ, this should qualify as a medium to long-term strategic investment. As to how Kuah Boon Wee is able to contribute to Neptune’s fortunes and how MTQ is able to synergize, I am as yet unclear until there are further announcements by either company.

MTQ – Resignation of CFO and Company Secretary Mr. William Fong

On April 29, 2011, it was announced that Mr. William Fong, as Group CFO and Joint Company Secretary for the past 12 years, will be resigning from MTQ with effect from June 15, 2011. The Board has appointed Mr. Dominic Siu as CFO with effect from May 18, 2011. I was certainly saddened when I read this piece of news as I had been liaising with him for about a year regarding matters relating to MTQ, including AGM and the recent news on Bahrain. I had also met up with him before during the AGM and found him to be helpful, friendly and supportive. I’d like to wish him all the best in his future career and I guess I now have to start liaising with the new CFO, Mr. Dominic Siu!

Conclusion

MTQ will be going through a very interesting phase of its growth, with its Oilfield Engineering Division firing off the new FY 2012 with its operations commencing in Bahrain. Coupled with high oil prices and investments by major O&G players to the deepwater segment, as well as more stringent regulations governing BOP after the BP Deepwater Horizon incident, this should bode well for the Division and ensure its slow and steady growth. For Engine Systems, I am confident that MTQES can continue to build on the momentum of recent acquisitions as well as their partnership with Bosch to further improve margins and increase top-line contribution. Of course, this will all take time and watching the growth of a business through the years is a very satisfying process and validates my commitment to being a value investor who has his eye on the business performance of a Company rather than constantly tracking its share price.

As for Neptune, the detailed analysis and summary which was provided above made me realize that MTQ is in this for the medium-term of at least 3 to 5 years, similar to their previous investment in RCR Tomlinson which was divested in 2007. While it may look like a bad idea in the short-term (with Neptune’s recent share price hovering around AUD 3.6 to 3.9 cents), I am also quietly confident of Mr. Kuah Kok Kim and Mr. Kuah Boon Wee’s business acumen in being able to identify suitable investment opportunities in mis-priced businesses to grow MTQ’s business value over the years.

For future reviews of MTQ, I will also be including a review (both financial and operational) for Neptune. The next review for MTQ should only be out in late October 2011 as they will be releasing their 1H FY 2012 results then. In the meantime, I await the final issue price (yet to be decided) for the final scrip dividend of 2 cents/share; and also await the arrival of FY 2011’s Annual Report.

MTQ – FY 2011 Financial Results Analysis and Commentary Part 2

Part 2 of my MTQ FY 2011 analysis will focus more on MTQ’s business division performance, and I will comment on how well each division is doing and what it has achieved over the years. Some history will be useful as well if we were to track the growth and fortunes of these two divisions (Oilfield Engineering and Engine Systems) more closely. However, instead of regurgitating the whole nine yards of what happened for each division for the last ten years, I will instead keep it simple by just focusing on the major events which have occurred in the past financial year (FY 2011).

Oilfield Engineering

Needless to say, the main thrust of the expansion drive in Oilfield Engineering Division is the expansion into Bahrain for most of FY 2011. The land size there is 40,000 square metres and is three times the size of MTQ’s premises in Singapore (Pandan Loop) and will be on a 50-year lease. From my understanding, Phase I has been fully completed and Phase II should kick off soon, and in total it can house 250 employees, most of whom will be locals. A NextInsight Interview with Mr. Kuah Boon Wee (CEO) gave insights to the new facility, with him saying that the complex has been physically constructed and the equipment commissioned. However, due to the uncertain and volatile political situation in Bahrain (and in light of violent riots and clashes between civilians and Government forces), staffing has been kept to a minimum of 25.

The tense political situation and subsequent unrest had also caused delays in certification for MTQ’s Bahrain machinery and business was affected when oil majors shifted their executives out of the country, thus depriving MTQ of the chance to be placed on vendors’ lists. However, some operations had already commenced and revenue was already being booked in April 2011 (FY 2012).

Engine Systems

In late FY 2010, MTQ had announced the acquisition of the business assets of Premier Fuel Injection Pty Ltd, and this was a strategic thrust for them to expand into Australia’s Northern Territory in which they previously had no presence. That purchase was made with A$500,000 and has helped MTQ Engine Systems division to expand its reach.

In April 2010, MTQES entered into a S&P agreement to sell off its premises at 32 Raynham Street in Salisbury, Australia, for a consideration of A$975,000 less agency fees. This will bring in more cash for the Group in order to further expand this division.

Then in August 2010, MTQES purchased Highway Diesel from Permacliff Pty Ltd and paid an upfront consideration of A$1.5 million. This acquisition will allow MTQES to further expand its range of services and repair capabilities and is viewed as being positive in the medium-term.

So all in all, there was quite a lot of activity in this division as well and MTQ are not resting on their laurels and intend to build this division and strengthen it. Next, I will present some of the numbers which I have compiled and use these to comment on the progress of each division, and also theorize on what we can expect in the coming financial year of FY 2012.

Review of Business Divisions and Comments on Prospects

If we look at the numbers for revenue since FY 2005, you will notice that this has trended up from $56 million in FY 2005 to the current $91.7 million in FY 2011, and this shows MTQ had steady revenue growth for the last 7 years. What is more interesting, however, is the relative contribution of their major business divisions to total revenues. Around FY 2008 to FY 2010, Oilfield Engineering was taking up the bulk of revenues and this peaked in FY 2009 with the division taking up 61.7% of revenues, while Engine Systems took up a much smaller 39%. It seems that with the Bosch partnership and the expansion as outlined above, Engine Systems has now begun to contribute more to revenues. In fact, revenue has surpassed that of Oilfield Engineering by about $6 million and now takes up 54% of total revenues against 50.2% a year ago. I would expect Oilfield Engineering to play catch up in terms of revenue contribution as the Bahrain operations get started, and begin contributing to both top and bottom lines.

In terms of segment net profit, Management’s ongoing focus in streamlining operations in Engine Systems has yielded positive results, with revenues in this division not only showing a steady increase, but also yielding growth in operating profits and net profit margin. Segment net profit for Engine Systems has hit a 7-year high of $2.7 million and segment margin is now 5.4%, up from 3.2% a year ago. It would appear that the synergistic collaboration with Bosch has enabled margins and revenue to grow, while keeping costs low. Mr. Kuah Kok Kim did mention in a previous interview with Next Insight that partnering with Bosch widened their customer base, yet did not drive costs up much because all they needed to do was increase shelf space (minor M&E works) and recruit more staff to cross-sell products. The numbers do look much better at the moment compared to just 2 years ago when it seemed that Engine Systems (selling turbochargers and diesel fuel injection systems) would be a drag to MTQ’s otherwise highly profitable Oilfield Engineering business.

For Oilfield Engineering, there was a slight slowdown in activity but with a strong customer base, the division still managed to grow slightly. In view of the BP Deepwater Horizon rig disaster, more stringent certifications will be needed in future for blowout preventers (“BOP”) in order to make sure they are fully functional and serviced within a reasonable period of time. MTQ has the required certifications and is recognized as one of the few players capable of servicing BOP and other O&G equipment.

Plans and Prospects for Business Divisions

Nothing specific was actually mentioned regarding growing each division. In the FY 2011 press release, the CEO mentioned that high oil prices and strong order flow of sophisticated rigs and other offshore vessels bode well for MTQ, and I take it to imply the Oilfield Engineering division will ride on this wave to grow even further. The commencement of operations for MTQ’s Bahrain Facility and subsequent Phase II of construction will also help to boost revenues, and once the Annual Report is out it will shed more light on MTQ’s borrowing costs, so that I can use that as a comparison against the returns derived from their push into Bahrain.

As for Engine Systems, nothing specific was mentioned either but I would expect MTQ to build on the momentum of recent acquisitions in order to broaden their revenue and customer base. There should be more details in the chairman and CEO’s statement which will be released along with the Annual Report some time in July 2011. Also, there will be a chance for me to attend MTQ’s AGM to ask more questions about the business moving forward.

For Part 3, I will be touching on a key move made by MTQ just a while back – the purchase of 100 million shares in NMS listed on ASX for A$0.05 per share. Since this has taken up nearly $12 million worth of cash, I consider it as a major transaction and worthy of more in-depth analysis and coverage. I will end off Part 3 with a few of my thoughts and closing remarks for MTQ, until it releases its 1H FY 2012 results in late October 2011.

MTQ – FY 2011 Financial Results Analysis and Commentary Part 1

MTQ released their FY 2011 financial statements and press release on April 29, 2011. This financial statement release marks a change somewhat for MTQ, as they had finished building their Bahrain facility and have got it up and running for FY 2012. The numbers have also reflected this and at face value, it would seem to have got a lot worse in terms of Balance Sheet and Cash Flow Statement analysis (more on that later). Since January 2009, I had knowledge of MTQ’s intended plans to expand into Bahrain, and they have worked tirelessly for the past 2 years towards that goal. They have gone through a leadership change (Kuah Kok Kim retiring as CEO and making way for his son Kuah Boon Wee) and also turmoil in Bahrain in March 2011 which followed the revolutions in Egypt, Tunisia and Libya. Though there have been some problems getting the facility started, the equipment had already been purchased and staff trained, and it was a matter of time before the Oilfield Engineering Division got a boost from Bahrain operations.

This analysis is more broad-based and will not just focus on the financials (though that will be the main focus for this Part 1), but also touch on other aspects such as business division review (a brief one, without spreadsheets), Neptune Marine Services in which MTQ invested quite a large chunk of money into; and also comment on some other Management changes and qualitative aspects of the Company. I hope these are comprehensive enough for the reader to get a better understanding of where MTQ is headed from here, and what the prospects are like for this progressive Company.

Profit & Loss Statement

Interestingly, revenue grew 11.9% year on year for MTQ, as there was a surge in revenue coming from Engine Systems division due to the recent M&A activities relating to this division. OEM repair and rental also saw Oilfield Engineering’s revenue rise by $2.6 million, thereby contributing a little to the revenue increase. Gross margins dipped only slightly from 41.1% a year ago to 40.9%, but still remained high overall if compared to the last five years where gross margins did not manage to breach the 40% mark. This does continue to demonstrate that MTQ has a competitive edge and can maintain pricing power for the goods and services which it provides.

Net profit dipped to $10.6 million, down 11.7%, but this was in light of a gain on disposal for FY 2010 of $1.9 million and also an adverse movement in fair value of financial instruments. Removing these effects, net profit would have been higher by about 19%. The good news is that operating profit improved 17% for Oilfield Engineering, and 45% for Engine Systems. Engine Systems seems to have gained the much-awaited traction from their collaboration with Bosch, and also as a result of their expansion into Northern Territory and purchase of Highway Diesel back in August 2010.

One notable mention is the 19% increase in expenses even as gross profits only increased by 11.3%. I will attribute this to the increase hiring of staff to man the Bahrain facility, and also increased training costs to ensure these staff are well-equipped with the necessary skills to service the oilfield equipment and blowout preventers which are sent to the workshop.

The very good news is that valuations are far from demanding for MTQ, and I was using the current price of about 84 cents per share which values MTQ at a historical price-earnings ratio of about 7. In recent days the price has fallen to 82 cents which makes valuations even less demanding, yet dividend yield based on FY 2011 is a very healthy 4.8% (4 cents per share, cash or scrip choice is given). Of course, one has to take into account the fact that the Company had taken on significantly more debt (to be elaborated on under Balance Sheet Review) in order to expand and enter the Middle Eastern market, and so perhaps Mr. Market is discounting MTQ’s earning power due to potentially higher finance costs (note that for FY 2011, finance costs only increased marginally from $160K to $258K, though it was a 61% jump). I will mention a little more about prospects and plans for MTQ in Part 2 and delve into each separate division, but note that the Bahrain facility has already been completed and the machinery has been purchased and installed. Operations have already started as at FY 2012 and revenue should start to be recognized in the current financial year.

Balance Sheet Review

In terms of Balance Sheet changes, MTQ had a fair share of them this time round! First of all, PPE went up by nearly 123% ($22.8 million) as a result of the new facility being completed in Bahrain, and all the associated equipment and machinery which was moved into the workshop. Purchase of shares in Neptune Marine Services (“NMS”) listed on ASX also led to an increase in investment securities from $7 million to $17.2 million (up 144%). Reconciliation between cash flow statement and balance sheet is as follows (for those who are interested): $12,917K cash outflow on purchase of NMS shares, net of brokerage minus $2,762K loss on fair value of available for sale investments = $10,155K which is the increase in the investment securities as stated in Balance Sheet.

Trade Receivables dipped 12.6%, which is a positive sign of good cash management as revenue had increased year on year. Current ratio stood at 2.43 for FY 2011 compared to 3.01 for FY 2010, mainly due to the slight drop in prepayments and the increase in short-term loans. However, 2.43 is still a very healthy current ratio; and quick ratio for FY 2011 was 1.76 which also signalled that MTQ could service its current liabilities without problems.

The most significant change in MTQ’s Balance Sheet has to be the level of debt, and the Company took up significant amounts of debt in order to fund its Bahrain expansion and to buy equipment and machinery. Current portion of long-term borrowings increased from $1.7 million to $3.3 million (nearly doubling), while long-term borrowings (>1 year repayment) increased from $1.6 million to $24.1 million. In effect, MTQ’s debt had increased from $3.3 million to $27.3 million; and the Company is now once again in net debt of $3.5 million compared to being in a net cash position of $16.9 million a year ago. Recall that it was the sale of RCR Tomlinson back in FY 2008 which eliminated all the Company’s debt and pushed them into net cash. Now, it seems that the Company is planning to repeat the cycle – invest at very low valuations into an Australian-listed company, and use existing funds + debt to expand its operations to grab a larger slice of the pie and to grow organically as well. More will be mentioned on these plans in Part 3.

It would be interesting to find out the interest rate at which MTQ had borrowed the money at, now that interest rates are hovering near all-time lows. It is known from previous announcements that the loan was disbursed by UOB but the tenure of the loan was not stated. The idea of leverage is to borrow money at low interest rates in order to generate ROE and ROA at much higher rates through business expansion, and MTQ has to ensure that the increase in finance costs does not over-shadow the increase in revenues and associated profits from their business expansion into Bahrain.

ROE was a lower 13.6% compared to 16.3% a year ago, but was still comfortably above 10%.

Cash Flow Statement Analysis

Cash flows were rather “abnormal” for this period (i.e. FY 2011) mainly due to MTQ’s drawdown of loans for their expansion into Bahrain, and also because of their investment in NMS which entailed a large investing cash outflow. Operating cash flows showed a very large inflow of $22.4 million, while capex was very high at $25.8 million, thus resulting in negative free cash flow of $3.4 million. Interestingly, MTQ has only had one year of FCF out of 7 years, but they have managed to not only pay steady dividends over the years, but also increase these dividends. One of the reasons for this could be their strategic investments in shares like RCR Tomlinson and (as yet unproven) NMS. More will be mentioned of NMS in Part 3 of this analysis.

There is nothing much else worthy of mention as readers will know the reasons for the large cash outflow for investing activities and the large cash inflow for financing activities. The key is to review the Cash Flows again for 1H FY 2012 to see if there is any improvement in both revenues and cash flow, in order to pay off the interest expense charged by the bank(s).

For Part 2 of the analysis, I will touch on MTQ’s business divisions and their growth thus far, and also talk a bit about margins and operations. I will also include an interview done by NextInsight with MTQ to glean some insights on the business and to talk about some of the plans and prospects. Part 3 will cover quite a bit about NMS as it is a major investment by MTQ, and close off by talking about Management changes and what we can expect from the Company, as well as my decision on choosing scrip dividend over cash.

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.

MTQ – FY 2010 Analysis and Commentary Part 3

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

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

Oilfield Engineering Division

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

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

Engine Systems Division

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

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

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

Changes in Capital Structure

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

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

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

Cash Flows and Dividends

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

Conclusion

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

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