Mainstream
For whom the wells run dry
Emmanuel Samarathisa 
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Oil prices have been on the uptrend since their devastating crash in 2016. And there are indications that the bullish sentiment will remain for the world’s most traded commodity despite headwinds such as production hikes from the Organisation of the Petroleum Exporting Countries (Opec) and Russia, US sanctions on Iran and the tense Sino-US trade war.

US-based Goldman Sachs recently forecast that the buoyant oil price run will continue. Indeed, at the time of writing, major oil benchmarks were hovering around US$70 per barrel. This might spell good news for local listed oil & gas (O&G) companies but not everyone may be fit to milk the profits from this rebound cycle. They include those that are highly leveraged and those that need to regularise their operations.

Consider bunkering and storage company Petrol One Resources Bhd which was recently threatened with delisting from the main market after failing to implement its regularisation plan by Aug 11. Six years ago, Petrol One was issued a PN17 notice, usually given to companies with serious financial struggles, despite being granted numerous extensions.

In Petrol One’s case, its auditors highlighted the company’s troubles in 2012 when they wrote a disclaimer on its 2011 financial year and a default in payment by its major subsidiaries.

Petrol One never regained its footing, citing “challenging equity market conditions”, and has since appealed against the delisting. But is Petrol One the only financially distressed company that has missed the chance to ride this positive wave for the O&G industry?

In this article, FocusM looks at the debt-to-asset ratio or the percentage of total assets financed by liabilities or debt of some of the most highly leveraged companies (see table). Minorities may be asking if there is light at the end of the tunnel for them.

Tushar Mohata, head of equities research at Nomura Malaysia, says debt alone may not provide a complete picture of the worth of a company. Neither is this an exercise to determine whether a company’s debt ratio is good or bad as that, too, is a very contextual matter. But looking at the debt ratio informs an investor how risky or leveraged a company is compared to its peers and the industry average.

Some of the factors Mohata uses to gauge a company’s finances include comparative gearing such as net debt to EBITDA or net debt to equity versus peers, interest coverage ratio, earnings trajectory and cashflow trends. “Before buying a stock, we would look at many other factors and there is an element of subjectivity too, like what’s the growth story, whether valuations are compelling, the catalysts, etc,” he adds.

Bloomberg data was used to chart and benchmark all the O&G companies in its database and listed on Bursa Malaysia, according to the industry average of 24.24%.

A few caveats about this data. First, it is a general list pulled from the keywords “oil” and “gas” which means it might differ from search to search on the terminal itself as well as when compared with Bursa. Second, it lists companies across subsectors.

So, Petrol One is a bunkering and storage company while Icon Offshore deals with vessels, which means context varies from company to company as some might be capital intensive.

Third, the figures might change pending action from these companies, such as a haircut, so the numbers reflected are according to the time of writing.

From this list, it seems that Perisai Petroleum is highly leveraged thus raising the question of whether it will follow in the footsteps of Petrol One? To recap, the upstream service provider fell into PN17 status on Oct 12, 2016 after its unit Perisai Capital (L) Inc defaulted in payment of the principal and interest for RM375 mil multi-currency medium-term notes.

Recently, Perisai Petroleum received a nine-month extension from the Kuala Lumpur High Court to restrain all proceedings and actions brought against the group. In a filing with Bursa, it said the restraining order is to facilitate its financial regularisation plan through a proposed scheme of arrangement. Perisai Petroleum declined to comment on its debt-asset ratio or plans to change its gearing.

 

‘Prudent’ cash management

But Icon Offshore, which ranks third on the list, believes it will be a beneficiary of the O&G rebound and will be able to pare down its debt through “prudent cash management.” The company tells FocusM it is looking to restructure its existing loans to further “strengthen” its balance sheet.

“Icon's debt servicing obligation has somewhat reduced availability of cash for new investment, but has not impacted its operations. Sustaining safe operations remains a priority to Icon,” the company says.

Icon recently marked its third consecutive loss-making quarter but its net loss narrowed to RM4.66 mil in the second quarter ended June 30 (2QFY18) from RM6.56 mil a year ago on lower tax expense.

In a Bursa filing, the company said loss per share came in lower at four sen from 56 sen in the previous year while quarterly revenue slipped 3.1% to RM53.19 mil from RM54.9 mil.

Despite its finances being still in the red, Icon believes its vessels are priced competitively to win contracts. It says this is evident with the improved utilisation rate of 64.7% for its fleet for 2QFY18 compared to 58.9% in the corresponding period in 2017. “Icon will continue its cost-cutting measures, especially in reducing operating expenditure and borrowing cost via debt restructuring, to increase its competitiveness,” it says.

For example, the company points to winning a “number of long-term contracts” under Petronas’ integrated logistics control tower tender which it believes will provide long-term revenue. “And coupled with revenue from our spot vessels and a market that is on the uptrend, this would put us in a much better footing when the market rebounds fully,” says Icon.

The company has earmarked a budget to drydock a number of its vessels. “This will ensure that our vessels are well maintained and are readily available to participate for tenders in view of the expected rebound in the O&G market,” it says.

It believes these measures will not require it to undertake a haircut to further pare down its debts. It’s worth noting that other leveraged companies such as Scomi Energy, with a debt-asset ratio of 35.02%, recently undertook a haircut in its attempts to return to sustainability.

But two companies on the list, Dayang Enterprise and its subsidiary Perdana Petroleum, have already bucked the trend by posting net profits for their latest financial quarter. Dayang in particular has taken research houses such as PublicInvest Research “by surprise” with its 2QFY18 results due to strong improvements in its vessel utilisation which jumped to 70% in the second quarter as compared to a mere 27% in 1Q.

Perdana Petroleum posted a net profit of RM10.09 mil for 2Q ended June 30, 2018, after five successive quarterly losses. It also attributed its positive results to a higher vessel utilisation rate of 70% compared with 63% in the previous second quarter.

 

A subjectivity bias?

One factor to look out for, moving forward, is the defensiveness of the country’s institutional investors as well as government-linked companies such as Permodalan Nasional Bhd (PNB). Most recently, PNB stepped in to back a RM4 bil cash call after Sapura Energy Bhd proposed the rights issue which it says is part of a “broader strategic plan to strengthen the group’s core businesses, boost its financial position and create better value for shareholders”.

“The rights issue will enable us to strengthen our balance sheet and continue with our growth momentum which includes bidding for and executing higher value projects globally,” Tan Sri Shahril Shamsuddin, president and group CEO of Sapura Energy, says in a statement.

Shahril recently made headlines for surviving an ouster after minority shareholder, the Employees Provident Fund, tried to remove him at the company’s annual general meeting in July, upon finding out his total pay package was a whopping RM71.92 mil for FY18 ended Jan 31.

According to a news report, PNB views Sapura as “one of the few local Bumiputera companies with a strong track record and significant global presence in over 20 countries.” This plays into what Mohata said earlier about the “element of subjectivity” where the worth of a company is determined by more than its fundamentals.

PNB, the second-largest shareholder in Sapura Energy with a 12% ownership, cleared the air about its involvement in the company saying the rights issue is to be utilised to pare down Sapura’s debts of RM16 bil, of which RM10.9 bil is long-term debt. The reason for the clarification is due to PNB being the controlling shareholder of Maybank, which is said to be one of the creditors of Sapura Energy.

In addition to the rights issue, Sapura is also eyeing an initial public offering for its E&P arm and also exploring a possible strategic partnership for its drilling business.

More recently, it proposed to sell a 50% stake in its upstream business to Austria’s OMV AG for US$1.6 bil (RM6.64 bil).

 

‘Red flags’ analysis

So how should investors go about determining whether a highly leveraged company is worth investing in or not? Huang Juin Hao, senior portfolio manager at Affin Hwang Asset Management, says some of the factors he considers are the outlook for the stock and sector alongside fundamentals such as business model, transparency and disclosure, financials such as valuations, ratios and financial disciplines and ESG (environmental, social and governance).

He also uses “red flags” analysis. “It’s essentially our negative screening investment process, where we keep an eye for companies with questionable practices, if they have violation of records and breaches,” says Huang. This includes companies with financial restricting issues such as debt or even questionable practices such as ethical breaches of labour policies or sourcing of materials, among others.

“We also look at the trend, historical, present and future expectations of debt-to-assets and debt-to-equity as one part of the package of financial ratios and financial discipline factors under our investment consideration,” he says. “Hence, even though a company may be highly leveraged, if it scores well on other factors, this may give it a high overall investment rating.”

On the O&G industry, Huang believes the exploration and production (E&P) sector is “beginning the process of catching up” after the 2016 price plunge which led to underinvestment in capital expenditure (capex). “As such, we anticipate rising O&G capex spending from the major E&P players. This is expected to benefit the E&P services sector, which had been impacted in prior years by shrinking contracts due to cut-backs in E&P spending.”

Mohata points to the cyclical nature of sector recovery and believes early cycle beneficiaries will be asset owners in general, such as floating production storage and offloading (FPSO) and jack-up rig players. “We expect yards to expect (recovery) a little later in the cycle as capacity and utilisation globally and regionally among yards remain low,” he says.

Lee Sook Yee, chief investment officer at Kenanga Investors Bhd, notes that service players have reported utilisation for assets such as rigs, vessels and equipment, “which is indicative of a recovery”.

But she cautions against bullishness. “Margins could take longer to recover given the overcapacity situation where many rigs/vessels still remain idle and will come back into the market to keep a lid on prices,” she says.

She is more positive on upstream companies which will benefit from higher oil prices and also the weaker ringgit. “Most of these companies do not hedge and thus will benefit from the higher oil price while with regards to currency, there is a net positive impact on profits as most of the revenue is in US dollars while some portion of their cost is in ringgit.”

Lee observes that there have been some “bright spots globally”, citing sectors such as FPSO where there is a pick-up in contract awards due to new-field developments such as in Mexico, Brazil and Africa.

“Locally, the focus of the industry remains on Petronas and its capex/opex budget going forward, given the changes in government/leadership and also proposal by the states with regard to revenue sharing,” she says. Indeed, only time will tell who else will not be able to ride the O&G rebound wave. But it is worth remembering that this bullish run will not go on forever. FocusM




This article first appeared in Focus Malaysia Issue 299.