Sunday 19 June 2016

Lessons for Investing in OSV Companies from Shipping Trusts

I used to own a number of shipping trusts and lost heavily in them during the Global Financial Crisis (GFC). Like shipping trusts, Offshore Support Vessel (OSV) companies own and charter ships to other Oil & Gas (O&G) companies. Are there any lessons that shipping trusts can teach us about OSV companies?

Shipping trusts buy ships and charter them out to shipping companies on long-term contracts. They provide a steady stream of revenue to service the debt used to buy the ships and pay distribution to unitholders. Initially, they started off with a small fleet of ships and low debts. However, over time, they bought more ships and took on more debt as a result. Things went on smoothly initially, until business deteriorated for the shipping companies during the GFC. Spot rates for the ships fell. Although the ships were chartered out on long-term contracts at higher charter rates than the spot rates, shipping trusts were not immune to the shipping slump. Firstly, some shipping companies returned the ships to the shipping trusts upon or ahead of charter expiry to save on chartering expenses. Shipping trusts had to find new employment for the returned ships at the prevailing charter rates, which were lower than the original charter rates. This resulted in reduced revenue for the shipping trusts.

Not only that, the market value of their ships dropped in tandem with the lower charter rates. This resulted in a rising Loan-to-Value (LTV) ratio, which breached the LTV covenant in the bank loans for some shipping trusts. In return for waiving the breach, shipping trusts had to pay a higher interest rate for as long as the LTV ratio was above the threshold. Again, this meant that shipping trusts had less income to distribute to unitholders, leading to lower share prices.

Are any of these difficulties happening to OSV companies? OSV companies are experiencing declining utilisation rates for their ships as some ships have completed their charters. Using EMAS Offshore as an example, its utilisation rate has dropped steadily from 84% in FY14 to 75% in FY15 and to 59% in 1H FY16. The figure below shows that the revenue from ship chartering is going to drop further, unless new charters are found.

OSV Revenue Stream for EMAS Offshore

Due to the impairment in asset value from the lower utilisation and charter rates, EMAS Offshore reported in its 2Q16 financial statement that it "had breached certain financial covenants relating to its borrowings. As at announcement date, the Group had rectified the breach by way of obtaining covenant waiver and/or amendments to the financial covenants by the lenders."

EMAS Offshore is still growing its fleet of ships. It had committed to buy new vessels/ vessel equipment amounting to USD92M as at end Feb 16. Assuming no change to the capital commitment, it will mean that EMAS Offshore has to take on more debt and/or raise equity.

EMAS Offshore has not paid any dividend since its listing on Singapore Exchange in Oct 2014, while its parent company, Ezra, has stopped paying dividend since Feb 2014. This shows the difficult economic conditions OSV companies are facing.

Although I used EMAS Offshore as an example, it is by no means the only OSV company that is experiencing difficulties. POSH's fleet utilisation rate ranges from 57.6% to 69.4% for its range of vessels in FY2015, which is a drop from 63.5% to 84.6% in FY14. It also announced a litigation with a shipping company to recover money owed from the charter hire of 3 vessels in Mar 2016. It plans to buy 15 more vessels with outstanding capital commitment of USD145M as at end Mar 2016. POSH has cut its dividend from 1.5¢ in FY14 to 0.5¢ in FY15.

Having said the above, OSV companies are taking steps to shore up their finances. Ezra issued a 190-for-100 rights issue at a price of $0.105 in Jun 2015 and sold a 60% stake in its EMAS AMC division (now renamed as EMAS Chiyoda Subsea) to Chiyoda and NYK from Japan for a collective USD216M in Mar and Jun 2016. Together with EMAS Offshore, Ezra has proposed divestment of assets. They are also reducing vessel operating cost and actively seeking new charters for the vessels.

In summary, the difficulties previously experienced by shipping trusts are being played out in the OSV sector. OSV companies are still facing a tough time despite the recovery in oil price since Jan 2016. To understand why a rising oil price does not translate into better business for OSV companies, you can refer to The Missing Link Between Oil Price & O&G Profitability.


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