Saturday, 23 December 2017

Investing Lessons Learnt for 2017

The year 2017 is drawing to a close. It is time to reflect and recap the investing lessons learnt. The largest loss on a single stock this year is Triyards, which has been suspended. In addition, Ezion is also suspended and First Ship Lease Trust (FSL) looks like it is on the edge after failing to refinance its debts on schedule. There are 3 valuable lessons learnt from these episodes, namely, (1) know your customers well, (2) watch out for restricted cash, and (3) understand value-in-use.

Know Your Customers Well

The expenditure of an upstream customer is the revenue of a downstream customer. Hence, it is extremely important to know your customers well. If the customers are doing well, likely the suppliers will also do well. Conversely, if the customers are not doing well, likely the suppliers will also fare poorly. This relationship is most evident in the Oil & Gas (O&G) industry, as troubles at upstream customers affect downstream suppliers. An example is Triyards, which is affected by the woes at Ezion, which is one of its major customers. See Know Your Customers Well! for more information.

Understanding the industry value chain will allow investors to know whether troubles will hit and whether a recovery is in progress. See Is A Recovery for Oil & Gas Shipbuilders Near? as an example.

Restricted Cash

Having cash on the balance sheet is good, but if the cash is restricted or pledged to the banks, it is of limited use to the company (except for setting off debts owed to the bank that restricts the cash). A case in point is Ezion, which has USD93.5M in cash and cash equivalents as at end Jun 2017. However, USD89.7M of this was "earmarked by the banks for various facilities granted". In other words, it only had USD3.8M as usable cash. Ezion promptly suspended trading of its shares upon announcement of the financial results.

Likewise, Triyards reported it had USD19.8M in cash as at end May 2017, of which USD16.8M was restricted cash. Another company that has restricted cash is Hyflux. Out of SGD222.0M in cash as at end Sep 2017, SGD73.7M is restricted bank balances.


For investors in FSL, value-in-use (VIU) would be a familiar concept, because it has an important implication on whether the trust could survive the shipping downturn. When a company buys an asset, it is recorded at historical cost. However, the carrying value of the asset is dependent on (1) the price that the market is willing to pay for it, or (2) the cashflow (on a discounted basis) that the asset can bring over its economic lifespan. When the market is depressed, such as in the shipping and O&G industries, the market value and revenue that the asset can earn are depressed, affecting the VIU. This in turns affects the Loan-to-Value ratio, interest rate payable and whether banks are willing to refinance when the loans fall due. The company will also have to take an impairment charge on the asset.

VIU is not a concept unique to FSL or the shipping or O&G industries. It is applicable to all companies and is worth watching, especially for companies facing a downturn in their business conditions.


The above are the investing/ accounting lessons learnt for 2017. Let's hope that I will learn the lessons well and have better performance next year.

It is Christmas season this weekend. Wishing all readers Merry Christmas and Happy New Year!

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Sunday, 17 December 2017

What Keppel Offshore & Marine's Order Book Can Tell Us

I sold Keppel Corp at $6.16 in Jan this year, expecting its Offshore & Marine (O&M) segment to start showing losses. Yet, for 3 consecutive quarters, Keppel O&M has surprised me with either breakeven or a small net profit of $1M. How did it achieve this feat, and will it continue to at least break even for the coming quarters?

The answers can be partially found in Keppel O&M's order books. Fig. 1 below shows the order book based on the financial results for Q3 FY2017.

Fig. 1: Keppel O&M Delivery Order Book for Q3 FY2017

As shown in the figure above, Keppel O&M has been completing the projects ahead of time. For deliveries in FY2018, the gross contract value is $1,052M, but it has completed 85% of the contracts, leaving only $156M yet to be completed. Similarly, for deliveries in FY2019, it has completed 78% of the gross contract value. The faster Keppel O&M completes the contracts now, the less revenue it can report in the subsequent quarters. 

Fig. 2 below shows the changes in % completion of Keppel O&M's order books for the past 3 years, based on the financial results for Q3.

Fig. 2: % Completion of Keppel O&M Order Book

The figure validates the point that Keppel O&M has been completing the contracts well ahead of time. For deliveries 2 years out, the % completion has risen from 54% in 2015 to 78% in 2017. The good news is that Keppel O&M has been winning more orders this year for deliveries 3-4 years later. For these new orders, there is still a lot of work to be carried out.

Although Keppel O&M has been completing the orders speedily, customers are not eagerly awaiting to collect the vessels, given the difficult business conditions in the Oil & Gas industry and likely difficulties in securing financing for the vessels. Referring to Fig. 1 above, as at end Sep 2017, there are vessels worth a total of $3,515M waiting to be delivered in the last 3 months of 2017. 

Not all of these orders will be delivered. Some will be deferred. For as long as the vessels are not collected by owners, the vessels will hold up valuable working capital. Nevertheless, for vessels in which the owners are unwilling or unable to take delivery, Keppel O&M might be able to sell off the vessels to other third parties, similar to the deal between SembCorp Marine and Borr Drilling.

For an anlysis of which customers are proceeding with their orders as planned and which are deferring their orders, you can refer to Fig. 3 below. By right, if customers are proceeding with their orders as planned, the orders should move up one time zone as the time progresses, i.e. a order meant for "delivery 2 years later" in 2015 should become "delivery next year" in 2016 and "delivery with the same year" in 2017. The advancement of these orders are indicated by the blue lines. For orders that are deferred, they stay in the same time zone or even later. The deferments are indicated by the red lines. Some orders might also be split such that parts of it are on schedule while other parts are deferred, e.g. Petrobras orders in 2015 ended in 3 time zones in 2016. These are indicated by the orange lines.

Fig. 3: Movement in Keppel O&M's Deliveries

From the figure above, it shows that deferments have slowed down from 2016 to 2017 and more orders are progressing as planned. Now is the time to wait for customers to show up and collect their vessels. As mentioned above, $3,515M worth of vessels are waiting to be collected in the last 3 months of 2017. 

Moving forward, there are 2 points to watch for Keppel O&M. Firstly, will customers collect the vessels they ordered (or Keppel O&M sells them to third parties) and secondly, will they get enough new orders to replenish these orders which are mostly completed. 

Sunday, 10 December 2017

Is A Recovery for Oil & Gas Shipbuilders Near?

In recent months, there have been talks about green shoots in the Oil & Gas (O&G) industry with the gradual recovery in oil price. In particular, SembCorp Marine managed to sell 9  jack-up rigs to Borr Drilling for USD1.3B in Oct. Are O&G shipbuilders & rigbuilders finally poised for a long-awaited recovery?

The answer can be found in the industry value chain, because an upstream customer's capital expenditure is a downstream supplier's revenue. If the customer is increasing its capex, it means that the supplier will likely see increasing revenue in the coming quarters. Conversely, if the customer is decreasing capex, the supplier will likely see decreasing revenue subsequently. 

In my last week's post on A Peek into Offshore Support Vessel Companies' Prospects, I listed the capital commitments of the various Offshore Support Vessel (OSV) companies listed on SGX. Their capex will have an impact on the small- to mid-cap shipbuilders that build OSVs, such as Nam Cheong, Triyards and Vard. Even though some of the OSV companies reported increasing lease commitments from charterers, the capital commitments are mostly declining as the companies either (1) stop placing new orders, (2) cancel orders, and/or (3) charter vessels from other vessel owners, which could be returned if business conditions were to take a downturn. The capital commitment figures, obtained from the companies' Annual Reports, are reproduced below for easy reference (all figures are in US dollars).

Capital Commitment
Company Period Current Previous
Atlantic Dec 16  $      42.2  $    100.9
Falcon Jun 16  $    501.1  $    501.1
Mermaid Dec 16  $        0.5  $    373.6
Pac Radiance Dec 16  $      69.6  $    209.4
POSH Dec 16  $      85.6  $    138.6
Vallianz Mar 17  $    198.2  $    270.0
Ezion Dec 16  $    440.9  $    258.5

After the publication of the Annual Reports, the companies have continued to cut capex. Ezion announced in Feb a reduction in capex of USD270M, while Falcon announced in May that it had cancelled orders for 3 out of 4 jack-up rigs. Ezion's decision to defer its capex dealt a serious blow to Triyards, which is building 3 of Ezion's service rigs (see Know Your Customers Well! for more info). Falcon has another oil rig worth USD86.9M completed but has not taken delivery of. The builder of Falcon's oil rig is believed to be Keppel Corp (Falcon is listed as a client in Keppel Corp's Offshore & Marine order book in its financial results presentation).

For Keppel Corp and SembCorp Marine, the more important customers are the international oil drilling contractors. Some of them report their fleet availability regularly, such as Borr Drilling, Ensco, Maersk Drilling, etc. Borr Drilling's fleet status report for Nov shows that it currently has 13 oil rigs. Of the 13 rigs, 5 are in warm stack and 4 are in cold stack. Only 4 have active contracts. Ensco's report as at 19 Oct shows that it has 37 jack-up rigs, of which 7 are available for contracting, 6 cold-stacked and 2 preservation-stacked, leaving 22 in active utilisation. Maersk Drilling's fleet utilisation as at 1 Dec is 11/15 (i.e. 11 out of 15) jack-up rigs, 4/4 semi-submersibles and 2/4 drillships. Given that there are still slack in the industry, Borr Drilling's purchase of 9 jack-up rigs from SembCorp Marine is the exception rather than the rule and does not signify more O&G orders to come for the rigbuilders.

Thus far in 2017, Keppel Corp's new O&G orders are for Floating Production, Storage and Offloading (FPSO) conversions and Liquefied Natural Gas vessels. None of its new orders are for jack-up rigs, semi-submersibles or drillships. Likewise for Sembcorp Marine.

Hence, despite talks of green shoots in the O&G industry, my opinion is that a recovery for the O&G shipbuilders and rigbuilders is still quite far off. The upstream sectors have to recover first before the benefits trickle down to the shipbuilders and rigbuilders. See The Missing Link Between Oil Price & O&G Profitability for more info.

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

Sunday, 3 December 2017

A Peek into Offshore Support Vessel Companies' Prospects

I wrote about my speculative bets in Offshore Support Vessel (OSV) companies in Which Offshore Support Vessel Companies Will Survive? This is a defensive way of betting on OSV companies, as I look for companies that have low debts, low impact from asset impairment, low probability of receivable build-up/ impairment as well as no bonds maturing in the short term. Actually, there is another way of betting on the OSV companies, which is to look at the potential revenue streams the companies have in the future. As discussed in Oil & Gas, Show Me the Orders!, orders are a leading indicator of how well the companies are likely to do in the next few years.

How do you know the the potential revenue streams of OSV companies? OSV companies charter out their vessels to other companies. It is a form of operating lease. Hence, quite a no. of OSV companies report their operating lease commitments as lessor. The table below tabulates the lease receivables based on their latest available Annual Reports. All figures are reported in millions of US dollars. Please note that some companies include customers' options to extend the vessel charter in the figures.

Lessor Commitment
Company FY Current Previous
Atlantic Dec 16  $    240.1  $      15.2
Falcon Jun 16  $      48.3  $      85.8
Mermaid Dec 16  $         -    $         -  
Pac Radiance Dec 16  $      54.1  $      66.9
POSH Dec 16  $    337.1  $    176.4
Vallianz Mar 17  $    646.7  $    254.2
Ezion Dec 16  $ 1,451.3  $ 1,181.3

Thus, based on the above table, some companies are getting a lot of new orders, such as Atlantic, POSH, Vallianz and Ezion. 

However, before you get too excited, in order to meet these orders, the OSV companies either have to own the vessels already, order new vessels, or lease the vessels from some third parties. When companies order new vessels, they incur capital commitments. When companies lease vessels from third parties, they incur operating lease commitments as lessee. Both capital commitments and operating lease commitments as lessee are reported in the Annual Reports. The table below tabulates the capital commitments and operating lease commitments as lessee for the above-mentioned companies.

Capital Commitment Leasee Commitment Capital + Leasee
Company FY Current Previous Current Previous Current Previous
Atlantic Dec 16  $      42.2  $    100.9  $      50.4  $        1.7  $      92.5  $    102.6
Falcon Jun 16  $    501.1  $    501.1  $        0.4  $      14.2  $    501.6  $    515.3
Mermaid Dec 16  $        0.5  $    373.6  $      14.7  $      11.8  $      15.2  $    385.4
Pac Radiance Dec 16  $      69.6  $    209.4  $      48.8  $      55.3  $    118.4  $    264.7
POSH Dec 16  $      85.6  $    138.6  $      94.9  $    105.0  $    180.5  $    243.6
Vallianz Mar 17  $    198.2  $    270.0  $    177.4  $      98.8  $    375.6  $    368.8
Ezion Dec 16  $    440.9  $    258.5  $    124.5  $      83.5  $    565.4  $    341.9

As shown above, most of the OSV companies are cutting back on their capital commitments. On the other hand, some are increasing their operating lease commitments as lessee. This is a more sustainable and flexible way of operating the business, as they can return the vessels to the third parties after the expiry of the leases if business conditions were to go down. 

For companies that rely on capital commitments, it will mean that the debts of the companies will increase. In addition, there will be more assets to impair, bearing in mind that the capital commitments mean that the vessels are already ordered and waiting to be delivered. These vessels are likely ordered a few years ago when oil price was still high and therefore vessel prices were high too. Moreover, would banks be willing to provide further financing to the OSV companies to take delivery of the vessels, considering that they probably have had enough of non-performing loans from the Oil & Gas (O&G) industry? If there is no financing, there will be no new vessels, and there will be less orders to fulfil. For this reason, even though I like O&G companies with increasing orders, I am not prepared to bet on some of these OSV companies. I prefer to play more defensively.

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

P.S. I am vested in CH Offshore, Ezion warrants, Mermaid and POSH.

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