Sunday, 29 October 2017

Which Offshore Support Vessel Companies Will Survive?

Following the success of the minion strategy described in The First Class of Minions, I have continued to use it to place speculative bets on companies which have a reasonable probability of turning around. These include the Oil & Gas (O&G) companies. The first batch of O&G minions are from the upstream Exploration & Production (E&P) companies, as they are the first to benefit from the rise in oil price. See The Missing Link Between Oil Price & O&G Profitability for more info. This group of minions (Interra, KrisEnergy and Ramba) is not particularly successful, with Ramba currently having paper loss of more than 50%.

Nevertheless, it has been 3 years since the oil price crashed in Jun 2014, and it is perhaps time to look further downstream along the O&G value chain, which brings me to the Offshore Support Vessel (OSV) companies. Many companies in this sector are in trouble, such as Ezra, EMAS Offshore, Ezion, Marco Polo, etc. Is this sector poised for a turnaround? While there are some good news for the O&G industry recently, I still have doubts, which explains why these are minion positions instead of full positions. For now, it is more a bet on which companies will survive rather than which companies will turn around and start making profits.

Compared to the semiconductor industry described in The First Class of Minions, the factors that I consider are slightly different. Debt-to-Equity is a common factor for both industries, as companies that have high debts will have difficulty surviving regardless of which industry they are in. Beyond that, there are factors unique to each industry. In the OSV sector, 2 key recurring themes are asset impairments and receivable build-up/ impairments.  

Asset impairments arise because when the companies bought the OSVs during good times, the vessel prices were high. Currently, the vessels are facing low utilisation and low charter rates, which requires their book values to be written down. Receivable build-up/ impairments arise because most companies in the industry are facing financial difficulties and customers might not be able to pay up when the bills are due. Thus, to minimise asset impairments, the companies should have low Asset-to-Equity ratios. Because some companies could own vessels in joint ventures and associate companies, I included joint ventures and investments in associate companies together with Property, Plant and Equipment to determine the asset value that might be written down. 

To check that receivables do not build up, I considered the year-on-year (YOY) changes in Cashflow from Operations (CFO). The preferred period of measurement is for the latest quarter, e.g. 2Q2017 vs 2Q2016, as this reflects the most current business environment, but not all companies disclose the CFO for the latest quarter. Some disclose the CFO for the 6 months or the full Financial Year. 

Finally, there is 1 other factor to consider, which is whether there are any bonds maturing soon. Bonds are held by institutions and individuals and they might not be so willing to consent to extending the maturity of the bonds and/or reducing the interest rate. When that happens, the bonds are in default and could trigger other creditors to also demand for payment. In contrast, banks sometimes have no good alternatives but to continue extending the credit lines to the companies. See The Type of Debts O&G Companies Have Matters for more info. 

Thus, a compilation of the OSV companies based on the above factors are as follows. The 4 last companies have been suspended, but they provide a useful reference for comparison.

Company Period Asset/Eq Cash/Eq Debt/Eq % YOY CFO Bond Maturity
Atlantic Jun 17 1.99 0.02 0.88 -75% (6M) -
CH Offshore Jun 17 1.02 0.04 0.10 -210% (FY) -
Falcon Jun 17 1.74 0.06 0.91 -41% (FY) Sep 20
Mermaid Jun 17 0.81 0.29 0.25 -78% (6M) -
Pac Radiance Jun 17 2.48 0.14 1.97 N.M. (Q2) Aug 18
POSH Jun 17 1.91 0.02 1.12 45% (Q2) -
Vallianz Jun 17 2.29 0.05 1.83 N.M. (Q1) -
EMAS Offshore Nov 16 10.96 0.12 6.47 -61% (Q1) -
Ezra Aug 16 3.22 0.17 3.16 -23% (Q4) Apr 18
Ezion Jun 17 1.83 0.07 1.11 -108% (Q2) Aug 18
Marco Polo Jun 17 -0.60 -0.04 -1.64 162% (Q3) Oct 19

Firstly, on Debt-to-Equity ratio, CH Offshore and Mermaid have low D/E ratios, thus their debts are  more manageable. In particular, Mermaid has more cash than debt. Having said that, CH Offshore is a subsidiary of Falcon Energy, which has high D/E ratio of 0.91. A potential risk is that Falcon might direct CH Offshore to take on more debts and send money to the parent either through special dividends or buying over Falcon's vessels. 

Secondly, on Asset-to-Equity ratio, the same 2 companies (CH Offshore and Mermaid) have the lowest A/E ratio, hence, any potential asset impairments would be smaller than the rest. Do note that the high A/E ratio for some companies may be because some of these companies have already carried out 1 or more rounds of asset impairment. By right, companies that have carried out asset impairments should be safer than those that have not, but I prefer to err on the conservative side and stick to companies that have low A/E ratios. It is also possible that 1 round of asset impairments is not sufficient to fully write down the vessel values to their market values.

Thirdly, on CFO YOY changes, most companies have declining CFO in the latest available quarter. This is due to declining vessel utilisation and charter rates, and customers facing difficulties in paying bills. The only 2 companies that managed to report an increasing CFO are POSH and Marco Polo. However, Marco Polo's CFO before working capital changes is negative. Hence, the only company that passes this criterion is POSH. In addition, POSH is majority owned by the Kuok family, thus it has backing from the owners and the banks. Nevertheless, given that its D/E ratio is a high 1.12, there is possibility of a rights issue to lower debts.

Originally, I also had another criterion based on market capitalisation, which is based on the assumption that the largest companies would survive. On this count, Ezion and POSH have the highest capitalisation.

Thus, my picks for the OSV sectors using the minion strategy are CH Offshore, Ezion warrant, Mermaid and POSH. All 4 have their unique risks on top of industry risks. Ezion was suspended the day I bought the warrants. Let us see how they turn out.

Just a reminder, this post is not a recommendation for anyone to buy or sell any O&G stocks.

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  1. Hi CW,

    Interesting analysis. Kind of agree with u except about the Ezion warrants which I m not so sure.

    If CHO survived, how about Falcon? they r related intimately. If u don't believe Falcon will survive, why will u believe CHO will survive?
    How about Atlantic?

    Just curious n definitely not rebuking ur analysis, which m impressed.

    1. hi Rolf , good to see you around =)

      sorry to jump in like this. but this kinda reminds me of the triyards/ezra saga. the former being "related intimately" to the latter, like Rolf has mentioned. when ezra went kaboom at few years ago, triyards was still doing fine. infact they were pretty resilent. profits were down, but share price was still holding strong.
      to cut the long story short, unfortunately, when you look at them now, due to the fact they were related to ezra, their shares are now suspended. hence, even when you are doing relatively ok, but the relationship with the parent company, does matter quite a fair bit too.

    2. Hi Rolf,

      Nice to hear from you again!

      There are 4 possible outcomes for CH Offshore:
      1. CHO declares dividends and send money to Falcon. Minority shareholders of CHO will get the dividends as well.
      2. CHO buys vessels from Falcon. So far, I'm only aware of 1 such transaction. Hopefully, they keep it this way.
      3. CHO and Falcon jointly guarantee each other's debts. So far, this has not happened.
      4. Falcon sells CHO to raise cash, triggering a general offer for CHO. But given that this is a fire sale, the offer price will be low and privatisation is unlikely to happen.

      Thus, based on the above possible outcomes, and assuming they keep it that way, CHO is a viable minion bet despite Falcon having high debts.

      I understand Atlantic has orders in the pipeline, but they need to secure financing to take delivery of the ships first. In this environment, banks are reluctant to provide financing.

    3. Hi Foolish Chameleon,

      I have Triyards. Agree with you that Ezra posed some problems for Triyards through receivable impairments and joint guarantees for debts. However, the bigger problem for Triyards is that its customers have difficulties paying up for the ships they ordered. One of Triyards' major customers is Ezion. See Know Your Customers Well! for more info.

  2. Hi
    Great way to start the day. Just what I am looking for! My husband bought into some Pac Rad shares when he was "free" in between jobs but now has no time to look into it. I have to quickly ramp up my understanding of this industry cos I frankly know very little. What is your take on Pac Rad? Esp in view of bond maturing in Aug 18. Government-backed financing scheme seems to be keeping it afloat but I am wary that it's a company waiting to sink anyways. I might as well cut loss?

    1. Hi,

      I cannot advise you whether you should sell the stock or not. I can only share that I chose not to buy it because it has high Asset/Equity and Debt/Equity ratios, negative CFO and a maturing bond next year.

  3. you mentioned only ezion warrants and not the shares and bonds. may I understand why? thank you

    1. I'm using the minion strategy to bet on Ezion. It requires the amount to be mentally written off. For the same amount of money, I get more of Ezion warrants than the mother share. Also, if Ezion rises, the warrants will rise more. See Which KrisEnergy Should I Buy? for more info.