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Marco Polo Marine: Reason for price weakness.

Tuesday, May 6, 2014

Yesterday, a couple of readers asked me what could be wrong with Marco Polo Marine since the share price declined. A reader also asked me where the next support could be, using technical analysis. Last night, I checked if there were any announcements from the company and found a plausible reason for the recent weakness in share price.

We know that Marco Polo Marine has an Indonesian subsidiary, PT Pelayaran National Bina Buana Raya (BBR). Well, the subsidiary has released 1Q 2014 results and the numbers are very bad. Of course, BBR is not all of Marco Polo Marine's business but it is a significant part. So, I would expect Marco Polo Marine's own quarterly results to be affected. How badly affected would depend on how other business segments perform, of course.


Now, the BBR story:

Over at BBR, revenue reduced by 11% while direct expenses increased almost 20%.

The OSV segment of the business did well as revenue improved some 57.3%. However, Tug and Barge vessels segment of the business saw a reduction in revenue by some 47.5%. (The two segments put together, OSV segment now has a 61.5% share of total revenue.)

OSVs are clearly profitable while Tug and Barge vessels are not. Why? OSVs recorded $4.8 million in revenue and incurred expenses of $2.1 million. However, Tug and Barge vessels recorded $3.18 million in revenue but incurred expenses of $4.37 million! This segment bled massively!

In the same quarter in the preceding year, the Tug and Barge vessels segment of the business turned in a revenue of $5.84 million and incurred expenses of $3.95 million. This suggests to me that the expenses incurred by this segment has been quite consistent but the revenue drop, year on year, is astounding!

If this were to continue, BBR would be better off without the Tug and Barge vessels segment of the business. Gross profit declined a massive 62.5%. Operating income declined by 73.5%. After financial charges and income tax, total comprehensive income reduced by 92.1% for the quarter, year on year!


How does this affect my investment thesis?

With the decision to gear up significantly to purchase a jack up rig which could potentially double earnings in FY2016, I was prepared to accept lower earnings in the next two years because of the much higher finance costs resulting from the MTNs although I have to admit that the jack up rig was never a part of my initial investment thesis for Marco Polo Marine.

With the jack up rig and higher finance cost thrown in for the next couple of years, I rationalised that as long as operating income improves steadily over time with more OSVs being added in the same period of time, logically, any decline in earnings due to the higher finance costs could be cushioned. This was an important assumption.

I said that to stay invested in Marco Polo Marine is to believe that:

1. Earnings will improve as more OSVs join the fleet in the next 2 years.

2. The rig delivery by end of 2015 will improve earnings massively.

If well executed, the strategy will catapult earnings upwards, possibly doubling EPS by 2016.

Now, for earnings to improve gradually over time until the jack up rig is delivered by end of 2015, I had focused on the OSV segment of the business as the growth driver. I had simply assumed that the Tug and Barge vessels segment of the business would continue plodding on and that the segment's revenue and expenses would more or less stay constant.

So, for BBR's Tug and Barge vessels segment to turn in a massive loss is a shocker and this has thrown a spanner into my thesis for having a significant investment in Marco Polo Marine.

Does it mean I no longer believe that Marco Polo Marine is on the right track? No. In fact, if not for the decision to focus on growing its fleet of OSVs, BBR would have turned in a loss making quarter instead of one with much lower earnings.
 
Unfortunately, to be realistic, FY 2014's numbers could turn out to be disappointing, everything else remaining equal. This is even if the Tug and Barge vessels segment of BBR's business should see revenue improving and expenses reducing in the next two quarters to what should be the mean.

Lower utilisation of the Tug and Barge vessels in the preceding quarter was put down to seasonal factors (i.e. monsoon period). Expectations of a reversion to the mean did not happen. Is this weakness in the segment temporary or is it going to be more enduring? I am inclined to believe that it is temporary but if a reversion to the mean does not happen in the following quarter, then, the risk of being invested in Marco Polo Marine could be much higher than initially thought.

I am staying invested as I still believe in the growth story but I should move Marco Polo Marine higher up in the pyramid (see related post no. 1 below) from an investment that is for growth and some income to just being an investment for growth. Without the income component, my approach will demand that I trim the size of my investment in the business.

See BBR's 1Q 2014 results: here.

Related posts:
1. Motivations and methods in investing.
2. Marco Polo Marine: Drilling for higher income.

26 comments:

Ice said...

Dear AK.

So is it a good idea to cash in now since they should do better by 2016?

Thanks!

AK71 said...

Hi Ice,

I won't say what is good for you to do. This is something you have to decide, taking into consideration your motivations and circumstances. :)

Also, we have to remember that 2016 is quite far away. So, it could be a long shot although everything looks good now on paper. Remember that nothing is guaranteed.

yeh said...

Hi ak.
How do you think about marco polo high debt and low liquidity?
This is my main concern.

Thanks

AK71 said...

Hi yeh,

High gearing is quite common in the industry that Marco Polo Marine is in. Actually, when I first spotted Marco Polo Marine, I liked it because its gearing level was relatively low compared to its peers. This has changed over time as it ramped up CAPEX.

Having said this, if the cash flow from operations grows stronger over time, actually, a higher gearing level is not an issue. If borrowed funds is able to generate much higher returns, it is a good thing.

With the OSVs and the jack up rig, the promise of much higher returns seems realistic. However, I had not counted on a bug bear appearing in the form of the tugs and barges turning in a loss. Hence, my decision to move Marco Polo Marine higher up in my pyramid of investments.

I am now discounting any dividends from the stock for the next couple of years, which is also prudent because of the huge CAPEX that has been confirmed. I am, of course, talking about the jack up rig.

As for the low liquidity, I never had an issue with this because of my beliefs. Hock Lian Seng and Old Chang Kee have low liquidity too. ;)

Don't invest more than what we can afford to lose and if we invest in good companies which we believe will do much better in future, why is there a need to sell?

Janice said...

Hi AK,

If I read correctly, you would trim your holdings in Marco Polo based on the last line of your blog post?

Or would you continue adding since the price is attractive now compared to the time you bought at 37.5?

Janice said...

Hi AK,

Wanted to ask your as well what do you think of DynaMac?

Considering this as an alternative to MarcoPolo as well as I believe that is also undervalued.

AK71 said...

"Though the chartering of tugboats and barges of the Group has been and is expected to continue to remain subdued, with the offshore oil and gas exploration and production activities in the region expected to remain robust, albeit a possible slowdown in Indonesia in part due to the legislative and presidential elections currently in progress, the Group expects the offshore business of its Ship Chartering Operations to continue to spearhead its growth for the next 12 months.

"Notwithstanding that the Group’s Ship Building and Repair Operations are expected to face keen competition from shipyards
in the region, the Group’s new ship-building program focusing on the building of mid-sized OSVs, even though the program caters mainly to internal demands, continues to keep the Group’s shipyard occupied for the next 12 months.

"While the global economy continues to show early but still uneven sign of recovery, the Group continues to keep a vigilant
watch of market conditions and their ensuing impact on its operations.

"Against the backdrop of relatively stable oil prices and perceptibly favorable demand-supply dynamics over the longer term, the Group’s Rig Under Construction, which is financed in
part via the MTN, paves the way for it to embark on the business for the chartering of high-specification jack-up rig.

"While the building progress of the Rig Under Construction, which is slated for delivery in November 2015, is being closely monitored, the Group is actively on the lookout for potential partners to complement its resources and expertise for its eventual rig chartering operations."

Page 10 of:
http://infopub.sgx.com/FileOpen/MPM_Q2FY2014_Result_Announcement.ashx?App=Announcement&FileID=295560

AK71 said...

Hi Janice,

All I can say is that the price of 36c is lower than my last purchase price of 37.5c. However, does 36c now give better value for money? We can say this if the business fundamentals have not changed from the time I bought at 37.5c. So, have they changed? I think they have.

Marco Polo Marine's balance sheet is now weaker and its overall earnings are also weaker.

If the Tug and Barge vessels segment of the business does not pick up in the next two quarters, then, we ought to tread even more cautiously. Can the growing OSV segment of the business pick up the slack?

If the Tug and Barge vessels segment of the business continues to be a drag, I hope the management is savvy enough to shut it down.

So, for now, I will not add to my long position. Instead, I will trim it for the reason I stated in this blog post. Then, wait and see.

I think my plate is quite full for now. So, I won't be looking at DynaMac. Thanks. :)

flyingchicken said...

Hi AK

What do you think about the "Sell in May and go away" theory? From the past, I can see that STI fell ~5% in 2011, ~10% in 2012 and ~11% in 2013 from the peak somewhere near May to last Jun-Jul period.

Do you think it is a gd idea to trim off winning positions and accumulate cash now or would you brush it off as an urban myth?

AK71 said...

Hi flyingchicken,

I don't have an opinion on this although you might want to read this:

http://singaporeanstocksinvestor.blogspot.sg/2014/03/tea-with-enza-explaining-mr-markets.html

All the best. :)

flyingchicken said...

See many ppl talking about this "Sell in May..." thingy and check out the charts, Seems valid though...Anyway, I'll get out some of my positions if possible. Thanks for sharing the link!

Clueless Punter said...

"While the building progress of the Rig Under Construction, which is slated for delivery in November 2015, is being closely monitored, the Group is actively on the lookout for potential partners to complement its resources and expertise for its eventual rig chartering operations."

I know this sounds speculative, but does this look like a potential future catalyst?

AK I know you were confident of the CEO's aggressive plan and also his foresight to get into flagging early. I'm not sure if he is really shrewd and is on to something or is he really a dangerous risk taker.

Back to my point, my impression of the Indonesian market is that it appears to be a neat little pond now that the flagging rules have been in place for some time. For MPM to look at potential partners, is it likely that they are looking to corner this little pond now?

AK71 said...

Hi CP,

This is why I say that things have evolved from my original thesis for investing in Marco Polo Marine. The jack up rig was not a part of my investment thesis in the beginning.

In my last blog post, I ended by asking "Do we share Sean Lee's vision and are we able to take the same leap of faith? Or do we think he has a few loose screws in his head?" ;p

Well, I wouldn't say that investing in the jack up rig is speculative. The timing of the delivery to coincide with cabotage enforcement for rigs in Indonesia is one point in MPM's favour and shows careful planning.

Obviously, rigs are something new for MPM and they need a partner with expertise in their operation. They have more than a year to find one.

To invest in a business that has higher CAPEX and growing through leveraging, I need to see growing operating income. I need to see that the CAPEX is bearing fruits. In MPM's case the CAPEX is bearing fruit (i.e. OSV segment is doing well). However, the Tugs and Barges have been a drag and a big one. :(

yeh said...

Today drop again.
I think just put in stock In freezer and wait for it to ripe:)

I think the lowest I get this stock is 34.5 cent
Not sure whether will reach that level not:(

AK71 said...

Hi yeh,

It remains to be seen if the tugs and barges will make a comeback or continue to be loss making. Until the OSV segment of the business becomes more dominant, the tugs and barges segment must pull their own weight.

Otherwise, Marco Polo Marine is better off closing down that part of their business and they should then think of transforming more completely to being just an OSVs and jack up rig owner.

seefei said...

AK
thanks for the post. It is informative and will help me to decide on my MPM investment.

I notice counters in chartering business like ezion are highly leveraged. It is a nature of this business.

Look like MPM is shifting its focus on ship building to chartering business. The rig maybe is the beginning. If the rig can be successfully chartered out by end of 2015, it is not unreasonable to expect more capex on such venture.

I will keep faith with MPM since my exposure is small. Again, thanks for the post.

AK71 said...

Hi seefei,

You are welcome. :)

For sure, if the strategy is well executed, Marco Polo Marine's earnings will skyrocket in 2016, everything else remaining equal.

The thing is that everything else should remain equal but it did not. The shocker of a loss by the tugs and barges was unexpected.

Having said this, everything should not remain equal because I would expect the new OSVs joining the fleet over the next 2 years to contribute materially to earnings.

Now, I will wait to see if the tugs and barges' performance revert to mean. Over the next two years before the delivery of the jack up rig, it would seem that we cannot just focus on the OSV segment. The OSV segment might be the growth driver but we cannot have the tugs and barges sabotaging any improving numbers.

I am staying invested too because Marco Polo Marine has the potential (and promise) to do much better but with the tugs and barges conundrum thrown in, I am making an assumption that EPS will be hit harder (and it has already taken a hit from the cost of the MTN). I am also making the assumption that we might not see any dividends in the next 2 years.

AK71 said...

Marco Polo Marine Ltd and Nam Cheong Limited have formed a joint venture company following the sale of Marco Polo Marine Group's 50% stake in Marco Polo Offshore (IV) Pte Ltd to Nam Cheong Group on 19 August 2014.

The JV Co recently purchased a newly built Accommodation Work Vessel constructed by the Nam Cheong Group. Following the acquisition of the AWV, the JV Co is pleased to announce that it has secured a long-term firmed five-year bare-boat contract with an estimated value in excess of US$27 million. The Contract value does not include the two-year plus subsequent two-year further extension options subject to mutual agreement between the JV Co and the charterer, which if fully exercised, would result in a contract value of almost US$50 million.


Source:
http://www.btinvest.com.sg/markets/news/92286.html?source=si_news

letissier07 said...

"including but not limited to accommodation work vessels, work-boats, accommodation work barges, anchor handling tugs and supply vessels and, if mutually agreed, such other assets and undertakings as the joint venture may acquire or participate in the future"....

Hmmm...Oil rigs?

AK71 said...

A positive development and Mr. Market is showing his approval in the usual way today. ;)

However, I will caution that for Marco Polo Marine to do better, its tugs and barges business must pull its own weight.

Of course, the real game changer is the oil rig that is due for delivery at the end of 2015.

ozxinvest said...

I have recently asked the management regarding the tug and barge segment and here it goes,

Ans: The division currently exerting a drag to our Group performance is the tugs and barges division.

We are looking to improve the performance by broadening the customer base and expanding to carrying more types of minerals, aggregates.

As there are operations, assets, etc, we cant just shut-down operations. It is however suffice to say that we are looking to gradually scale-down and focus on OSVs.

For Ship Building and Chartering,

Ans: We have one AHTS 8,160 BHP for imminent delivery and one about every 3 months.We are integrated company, i.e. full chartering (both commercial and technical) to charter the vessels that the shipyard builds, i.e. each vessel being built has a designated purpose mainly to charter while we do not rule out selling to 3rd parties at the right price.


For Rig partners progress,

Ans: As mentioned, we are at different stages of discussions with different potential partners. We will make the announcement via SGX-NET to all shareholders when there is material development.

AK71 said...

Hi ozxinvest,

Thank you so much for sharing this with us here. Much appreciated. :)

The tugs and barges business is a legacy issue. Easy for me to say Marco Polo Marine should just get rid of it but I guess it isn't as easy as that. -.-"

To stay invested in Marco Polo Marine is to believe in its transformation which should become more apparent by end 2015 or early 2016, if everything goes as planned. :)

ozxinvest said...

It's not too long from now in fact. I don't know about others, but another 2 years of waiting time for a potential of doubled earning (which would probably lead to doubled stock price) is actually considered short term for me. Will keep accumulating while it's still being unloved and trading about 30% below NAV with reasonable earnings. Expecting a string of good news coming out in the next few months. JV with nam cheong is pretty unexpected though,looking forward to see which other potential and interesting JV partners they are in talks with.

ozxinvest said...

From fool.sg
http://www.fool.sg/2014/08/20/has-nam-cheongs-bold-business-strategy-paid-off/

A new joint venture

...In the same day as the new contract was announced, Nam Cheong also revealed a new joint venture with fellow ship builder Marco Polo Marine Ltd (SGX: 5LY). Under the terms of the JV, the former would be buying a 50% stake in a wholly-owned subsidiary of the latter. The JV has already purchased one of Nam Cheong’s vessels, a 200-men accommodation work vessel (AWV). With the vessel already securing a five-year US$27 million bare-boat charter contract, it seems that the JV would be busy from the get-go.

Nam Cheong and Marco Polo Marine also believe that there are synergies that can arise from their partnership: Nam Cheong is strong in shipbuilding while Marco Polo Marine can provide expertise in ship chartering. It would be interesting to see how the JV can grow for both companies.....

AK71 said...

Hi ozxinvest,

Thanks so much for the comments. Much appreciated. :)

Yes, 2 years isn't that long a time to wait for good things to happen and accumulating on weakness, in such an instance, sounds like a good idea. ;)

AK71 said...

"At its latest earnings briefing, Sembcorp Marine warned of increasing pressure on margins, and there are concerns that any pull-back will have a knock-on effect on supporting players in Singapore.

"Chief Financial Officer of Viking Offshore and Marine JK Low said: “If you look at it in this industry as a whole, it is an ecosystem, there are various players playing. So if the big boys like Keppel and Sembcorp Marine are experiencing pressure, clearly as a supporting player, you will find that we also have to work with them, hand-in-hand in tandem to win orders."

"Analysts Channel NewsAsia spoke with say the global offshore and marine sector is coming off its peak last year, and with current conditions, it looks unlikely to pick up until at least a year later. However, looking ahead, they expect competition from China to ease as oil-rig builders there focus on delivering orders, rather than acquiring new ones. With world oil demand expected to continue on its upward trend, they add that long-term prospects for the industry still look strong."

Source:
http://www.channelnewsasia.com/news/business/singapore/singapore-s-rig-builders/1329210.html

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