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.

Value-In-Use

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.

Conclusion

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!


See related blog posts:

• Know Your Customers Well!
• Is A Recovery for Oil & Gas Shipbuilders Near?
• Effects of New Accounting Rule on Leases

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. 

See related blog posts:

• Is A Recovery for Oil & Gas Shipbuilders Near?
• Oil & Gas, Show Me the Orders!
• Understanding Shipbuilders' Balance Sheets

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.

See related blog posts:

• What Keppel Offshore & Marine's Order Book Can Tell Us
• Know Your Customers Well!
• A Peek into Offshore Support Vessel Companies' Prospects

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.

See related blog posts:

• Which Offshore Support Vessel Companies Will Survive?
• Oil & Gas, Show Me the Orders!
• Is A Recovery for Oil & Gas Shipbuilders Near?

Will GL Rise Like Mandarin Oriental?

When Mandarin Oriental shot up from USD1.50 to a peak of USD2.81 after it announced a strategic review for its The Excelsior Hotel in Hong Kong, I did not pursue the stock. But when City Developments announced that it was privatising its hotel subsidiary, Millennium & Copthorne, I decided to take a closer look at the hotel groups listed on SGX. As discussed in Some Hotels Could Be Very Valuable!, there are indeed hidden value in hotel stocks, arising from the fact that the hotels are sitting on the land for a very long time and are seldom revalued. Nevertheless, without a near term catalyst to sell or revalue the hotels, the undervaluation in hotel stocks will probably continue for a very long time.

Last week, I discussed about Stamford Land, a developer and hotel owner in Australia. This week's story is about GL (formerly known as GuocoLeisure). Like Stamford Land, GL owns 16 hotels in the UK, of which 15 are in London. The current book value of these hotels is USD1,015.3M. Based on a search of the hotel transactions in Europe in 2016, the average price per room for hotels in London is EUR291,000 or USD347,000 per room (see HVS website). GL operates 5,110 rooms in London (based on information in 2014 Annual Report). Assuming the hotel transactions mentioned above are accurate reflection of the market value of GL's hotels, the value of GL's 15 hotels in London could be worth USD1,771.8M. This is 75% above the book value of USD1,015.3M. Adding these "revaluation surplus" back to GL's equity, the net asset value would increase from USD0.84 to USD1.42, or from SGD1.13 to SGD1.91.

Again, for undervalued stocks, you need to ask what is the catalyst that would unlock shareholder value. As discussed in Some Hotels Could Be Very Valuable!, the reason why hotel stocks are undervalued is because they have not sold hotels for a long time and there is no reason to believe why they would do so and return money to the shareholders in the near term. However, unlike Stamford Land, there is a potential catalyst for GL. Due to the construction of the High Speed Rail in London, one of GL's hotels, Thistle Euston, was compulsorily acquired by the government in Jul 2017. The transfer of land is scheduled for completion in Oct 2017. Thistle Euston has 362 rooms. Going by the market value of USD347,000 per room, the market value of Thistle Euston should be USD125.5M. What is the book value of this hotel? USD9.0M.

Of course, there are many things that could go wrong with my estimate of the value of Thistle Euston. For one, it is a leasehold property. Perhaps it might only have a few years left on its lease and therefore not worth as much. Secondly, GL might have leased the hotel and/or land from the original lease holder and therefore has to share the compensation with the original lease holder. Thirdly, since it is a compulsory acquisition by the government, perhaps the government might not pay as much as what the private sector would. Fourthly, it is a 4-star hotel and might not be worth as much as USD347,000 per room. Still, even if it is worth only 25% of the reference value of USD125.5M, its value would be USD31.4M, still 3.5 times higher than the book value of USD9.0M. I am eagerly awaiting news about the price GL receives for the hotel.

Actually, regardless of what price the hotel is sold, the profit from the sale of the hotel is relatively small. The investment thesis for GL is not how much profit GL can make from the sale of Thistle Euston, but a realisation by the market that GL's hotels are undervalued and re-rate it to closer to its "revalued" net asset value of SGD1.91.

Will GL rise like Mandarin Oriental? I am vested in GL and I certainly hope so.

See related blog posts:

• Some Hotels Could Be Very Valuable!
• Not All Hospitality Trusts Are Created Equal

Some Hotels Could Be Very Valuable!

When Mandarin Oriental announced that it was carrying out a strategic review for its The Excelsior hotel in Hong Kong, its share price promptly shot up from USD1.27 at the beginning of the year to USD2.81 at its peak in Sep. There was talk that the sale of The Excelsior would have added nearly USD3 to its share price. Mandarin owns a total of 17 hotels through subsidiaries, associates and joint ventures. Imagine how valuable the entire group would be if all its hotels could be valued at similar valuations.

I did not pursue Mandarin, since its share price had already shot up. However, when City Developments announced that it was privatising its hotel subsidiary, Millennium & Copthorne (M&C), I decided to take a closer look at the hotel groups listed on SGX. There could be something valuable about hotels that insiders know but the market does not know.

One of the hotel groups I looked at was Hotel Grand Central. It owns 14 hotels in Singapore, Malaysia, Australia, New Zealand and China. Grand Central revalues its properties every 3 years. The last revaluation was carried out in 2015. The current value of the freehold land on its books is $221.0M. It also disclosed that if it had used the historical cost model to record the book value of the land (i.e. no revaluation), the book value would only be $42.5M. The market value of the freehold land is actually 5.2 times the book value if there were no revaluations! Some hotels are sitting on very valuable land! It suggests that hotel groups that do not carry out regular revaluations might be worth a lot more than their book values and share prices suggest.

The next hotel group I studied was Stamford Land. It is a property developer focusing on the Australian and NZ markets and owns 7 hotels in Australia and NZ. Unlike Grand Central, Stamford Land does not revalue its properties. The hotels were mostly acquired between 1994 and 2000. The current book value of the hotels is $375.0M. The figure below from JLL shows how hotel sale prices in terms of price per room have risen in Asia and Australia since 2000. From 2000, the price per room in Australia has risen 3 fold from USD100,000 per room to USD300,000 per room.

Fig. 1: Hotel Sale Price Per Room Since 2000

Separately, I managed to search for hotel transactions in Australia which could serve as a reference for the market value of Stamford Land's hotels (see Tourism Australia website). The valuations are shown below. Note that the valuations are just for reference as there could be many factors affecting the valuations of different hotels.

Fig. 2: Valuation of Stamford Land's Hotels Based on Comparison Approach

Based on the hotel transactions, the market value of Stamford Land's hotels could be worth about SGD611.9M. This is 63% above the book value of $375.0M. Adding the "revaluation surplus" back to Stamford Land's equity, the NAV would increase from $0.57 to $0.85.

However, before you get too excited, value stocks need a catalyst in order for the market to recognise their value. The reason why Stamford Land is undervalued is because it has not sold its hotels in the past 20 years. There is no reason to believe why it will sell them now or in the next 20 years and return the money to shareholders. For this reason, I did not buy a lot of it.

A potential catalyst worth tracking is that the CEO role has been handed over from the father to the son. In the Annual Report 2017, the new CEO mentioned about exploring the viability of setting up a REIT. This might unlock shareholder value. But do not bank on it in the immediate term.

In conclusion, hotels are boring business. But they could be very valuable!


See related blog posts:

• Will GL Rise Like Mandarin Oriental?
• Not All Hospitality Trusts Are Created Equal

Singapore Savings Bonds – 2 Years On

It has been 2 years since the launch of the Singapore Savings Bonds (SSB) in Oct 2015. How have the SSB interest rates changed in the past 1 year and how have SSB performed compared to the more traditional Singapore government bonds, i.e. Singapore Government Securities (SGS)? The comparison for the 1st year (Oct 2015 to Sep 2016) is discussed in Singapore Savings Bonds – A Year On. This post continues the discussion for the 2nd year (Oct 2016 to Sep 2017).

The most important factor for both SGS and SSB is interest rates. In the 1st year, interest rates went down. However, in the 2nd year, interest rates went up, especially during the Nov to Dec 2016 period which saw US Federal Reserve raising interest rates again in Dec 2016 after a 1-year hiatus. Figs. 1 and 2 below show the 10-year interest rates for the 1st and 2nd year.

Fig. 1: 10-Year Interest Rate for Year 1

Fig. 2: 10-Year Interest Rate for Year 2

For the 2nd year, the highest 10-Year SSB interest rate achieved is 2.44%, for the tranche issued in Feb 2017. This is still lower than the all-time high of 2.78%, for the tranche issued in Nov 2015. The all-time low is 1.75%, for the tranche issued in Sep 2016. The current SSB interest rate is 2.07%.

If you have bought the 1st tranche of SSB in Oct 2015, the interest rate for the 2nd year would have stepped up from 0.96% to 1.09% in Oct 2016. The market price of SSB is a constant $100, as it is capital protected by the government. In comparison, the coupon (i.e. interest rate) for SGS is constant while the market price of SGS varies with prevailing interest rates, rising when interest rates fall, and falling when interest rates rise.

How does this 1st tranche of SSB compare with the corresponding 10-year SGS bond? Figs. 3 and 4 show the price performance of the SSB and 10Y SGS for the 1st and 2nd year.

Fig. 3: Price Performance of 10-Year SGS and SSB for Year 1

Fig. 4: Price Performance of 10-Year SGS and SSB for Year 2

In the 1st year, the 10Y SGS went up in price due to the fall in interest rates, resulting in a capital gain of 6.57%. On top of that, investors in 10Y SGS would have pocketed a coupon of 2.375%, which, based on the purchase price of $98.61 in end Sep 2015, is equivalent to a yield of 2.41%. The total gain for the SGS is 8.98%, compared to 0.96% for the SSB. The table below shows the comparison between SSB and SGS for the 1st year.

	SSB	SGS
Capital appreciation	-	6.57%
Yield	0.96%	2.41%
Total	0.96%	8.98%

However, in the 2nd year, interest rates went up, especially during the Nov to Dec 2016 period, resulting in a capital loss of -2.53% for the SGS. The yield for the 2nd year, based on the price of $105.09 in end Sep 2016, is 2.26%. Thus, investors who hold the 10Y SGS for the 2nd year would have a net loss of -0.27%, compared to 1.09% for the SSB. The table below shows the comparison between SSB and SGS for the 2nd year.

	SSB	SGS
Capital appreciation	-	-2.53%
Yield	1.09%	2.26%
Total	1.09%	-0.27%

Thus, when interest rates go up, it is better to hold SSB, as they are capital protected. However, when interest rates go down, it is better to hold SGS, as they can generate capital gains. By juggling between SGS and SSB, you can get the best of both worlds. The contrasting performance of SGS and SSB for the past 2 years shows that the discussion in Getting the Best of Both SSB & SGS is correct.

See related blog posts:

• Getting the Best of Both SSB & SGS
• Singapore Savings Bonds – A Year On
• SSB Interest Rate Estimates