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.

See related blog posts:

• The First Class of Minions
• The Type of Debts O&G Companies Have Matters
• A Peek into Offshore Support Vessel Companies' Prospects